The US / Iran War never happened. You think it did, but it didn’t. We didn’t stop global oil production for over three months, deplete inventories at an unprecedented pace, or disrupt and throttle oil flow for 20% of the world’s energy supplies. We most certainly didn’t empower and reinforce a militaristic theocratic Iranian government hell-bent and motivated on destroying its adversaries. We also didn’t gaslight the world into thinking that after this debacle? . . . it’ll be fine.

We did, however, manage to stop the turmoil for a few weeks. Under a hastily concluded Memorandum of Understanding (“MOU”) on June 17, the two warring parties crafted a 14 bullet point agreement. The US’ crack team of negotiators (i.e., Kushner and Witkoff) settled on a strategy of “performance based” economic inducements. If Iran takes specific actions, the US would reciprocate with commensurate economic relief. Leave it to two financiers to solve everything via money and promises of economic prosperity, after they’ve killed the Ayatollah’s family no less. Tough sell, so be wary of the hand that offers gilded gifts, when the other wields a knife.

The MOU effectively created a dètente, which allowed the US to catch-its-breath, refill its quiver, and calm the markets. The Iranians used the respite and the temporary lifting of the US blockade to sell down trapped oil inventories. Around 80M barrels of Iranian oil exited the SoH. Once drained, the shenanigans restarted. Neither side trusted each other, nor were they truly committed to what was in that document. How could they when their political positions were diametrically opposed. Iran effectively promised control of the Strait of Hormuz (“SoH”)? How does that work if the US petrodollar depends on its ability to protect its Persian Gulf allies and control the waterways? So when Iran began closing the strait, the US balked. What was written on paper became all too untenable in reality.

So conflagration spreads as the US and Iran exchange fire. It’s a war between the world’s greatest superpower and an impoverished and isolated country armed with drones and ballistic missiles. Effective as the strait remains blocked. In normal times, we’d expect oil prices to be over triple digits, but through relentless jawboning, the administration’s kept prices rangebound. Every time prices crossed triple digits, a well timed social media post, or leak to a media proxy like Axios, have wrestled pries lower. At this stage, you have the traders’ rapt attention and capital. Given the volatility, few investors can hold any long commodity position. Especially not in the short-run, so open interest has plummeted and short-interest has soared. If the administration won’t let prices rise, then we’re left with the physical market to force it higher. On that front, the increasing pressure stemming from falling inventories have been slower than expected. China, one of the largest oil importers, reduced imports by a staggering amount, instead cutting refinery runs and drawing inventories to avoid buying in a tight market. This, coupled with the release of Strategic Petroleum Reserves (“SPR”), has prevented prices from spiking.

Still these are patches though, bandaids on bullet holes. The SoH remains materially disrupted, and production losses pile on. The reimposition of the US blockade will worsen the situation, and the +1B barrels of production already lost will rise. The US has suppressed oil prices by gaslighting the market into complacency, but do so long enough and the physical market can crack violently. Make no mistake, a choked strait now becomes a stranglehold, and we’ll find out who’ll tap out before the world’s energy resources tap out. Iran knows this and it’s very resilience can threaten the world’s demise.

Oil Demand & Oil Supplies

What a tumultuous quarter. What was off is now back on. A war begun on February 28th that was supposed to have ended quickly, is turning into another Middle East debacle for another US president. Though lasting for over 100 days, the fighting came to a standstill when President Trump realized there likely was no quick end . . . and that the US was losing. Fortunately for the world, if not oil bulls, this war has carried little scar tissue so far, at least on the oil pricing front as the administration incessantly jawboned an impending ceasefire was around the corner. In the past 3 months, an imminent peace deal has been announced nearly +25x. Many of these announcements were met with an oil selloff as the risk premium bled away. Accordingly, this meant few market participants could hold long bullish positions even if the SoH remained disrupted.

So yes, while there was a real material physical disruption, few could bet on it given the price volatility.

Eventually, the MOU was signed on June 17th so this entire misadventure came to a quick end, or so the world thought. +100M barrels of trapped crude immediately gushed out of the Persian Gulf, and oil prices plummeted as investors mistook the sugar rush fora super glut. Consequently, bearish positions increased markedly, eventually eclipsing any semblance of rationality as they reached near-COVID levels. Here’s Giovanni Staunovo’s chart at UBS, showing the absurdity.

With the paper market dipping to COVID levels while the SoH remained disrupted, it makes us wonder . . . really?

The MOU brought about a 60 day ceasefire to conduct negotiations on uranium enrichment, management of the SoH, and the lifting of economic sanctions. We wondered whether Iran would exert more pressure as the clock wound down to maximize concessions from the US. Since February, Iran’s learned that it can effectively shut the SoH with drone and missile strikes, deplete global inventories reserve to dangerous levels, and push the US administration further since Trump is unwilling to stomach a prolonged conflict given market turmoil. Sure enough, the ceasefire lasted all of 3 weeks. As the US began routing ships through a southern Omani corridor, bypassing the Iranian northern corridor (the middle of the SoH is currently mined), Iran attacked. The Iranians saw the alternate route as a threat against their rights under the MOU, an attempt to diminish their leverage. In short order, the IRGC sent drones into the sides of a few vessels after which everyone declared “fights on.” So we’re trading attacks today. The US will attempt to pound the Iranians back to the negotiating table using air strikes, but unless decapitation strikes lead to regime change, we wonder what’ll change this time when 3 months of bombings couldn’t.

Looking ahead, won’t the Iranians keep the strait closed for a few more months and watch as the global economy heads towards an energy crisis? The SoH has become their nuclear weapon. It’s an economic one and everyday they retain control is another day their leverage grows. Their ultimate goals are insuring regime survival and regional hegemony, and the SoH affords them an opportunity to achieve both.

If the US isn’t willing to commit ground forces, will they be able to completely negate the Iranian threat to shipping to allow it to normalize? We don’t think so. One missile can quickly reprice insurance premiums and deter shippers from sending their ships through. Even if the disruptions were intermittent, commodity prices, which are priced at the margins, will remain elevated.

Realistically, we think the US could even concede. No tolls were charged under the MOU, but there were thinly veiled discussions of environmental, security, or safety transit “fees.” Call it what you want, but what it really is is a military victory translating to a political and economic one. Allies of Iran (i.e., Russia, China, and maybe India) will obviously receive a loyal customer discount, but expect everyone else to pay. We’re betting that something acceptable will come to fruition. We have to. Given the desperation of the Trump administration to pivot away from this debacle, they’ll likely provide almost any incentive to induce the Iranian government to accept. So long as they can sell it to the public, or their Republican base. Even if they can’t fully sell it, they’ll try to sell it enough or distract enough so that the news cycle can move on from the misadventure. Bringing Iran back into the international community by lifting all sanctions, and reinvigorating its economy could be painted as a win. Never mind that doing so empowers the very adversaries you tried to eliminate just three months ago to no avail.

Red lines that were once unthinkable will be smeared, blurred enough so that we can just agree to something . . . anything . . . so that we can all just move on. Uranium enrichment? They promise to open up for inspection, the greatest, bestest inspections. We wonder just how deep those underground caverns will become once we shower them with reconstruction funds. That’s a lot of centrifuges to buy. What’s left though is a refreshed, refocused, and rearmed IRGC whose focus will be on acquiring a nuclear weapon to solidify it’s future.

Meanwhile, Saudi Arabia, the UAE, and Iraq, will build alternative pipelines and ports to bypass the SoH in the future. The Saudis and UAE will likely complete their projects by 2027, and that should materially reduce Iran’s ability to disrupt their oil exports. Still pipelines and pumping stations are soft targets, vulnerable to attack, so even those can be threatened in any future kerfuffle.

Energetic Nonchalance

None of the above has mattered for oil though. Sure, all of the risk should’ve mooned crude prices, but instead, oil prices have round-tripped the entire debacle. There’re are a few reasons for this. First, visible inventory draws have turned out to be a fraction of what analysts (including us had anticipated). Between the +100 days since the war began and MOU was signed, global inventories have drawn ~420M barrels.

Before the war, ~20M bpd of oil and oil products flowed through the SoH. Since its closure, the Saudis, UAE, and Iraq have rerouted some of their exports to the Yanbu (+3.6M bpd), Fujairah (+1.1M bpd), and Botas-Ceyhan (+0.2M bpd) pipelines, respectively. The ~5M bpd rerouted means the SoH net exports fell to ~15M bpd. The SoH wasn’t entirely closed either as ~2M bpd of Iranian exports or dark tankers transited, which further reduced the outage to 13M bpd. The 13M bpd of net outage should’ve equated to a total of ~1.3B barrels draws, so why did we only see a 420M barrel visible, and a 600-700M barrel total draw (if we assume secondary and tertiary stocks also drew)? Demand destruction and China.

Demand destruction certainly happened not because of economic contraction, but simply because some countries couldn’t find fuel. We know from reports that things like plastic bags and low-end plastic products were in short supply in Asia. Prices of petroleum products in South East Asia also spiked dramatically, which curtailed demand in the developing markets. We estimate about 1-2M bpd of demand destruction, so 1-2% of global demand. Here’s the IMF’s take on it.

The IMF estimates that demand destruction registered ~6M bpd, but most of that figure is China, and that demand really never disappeared. For the past 3 months, China has stiff-armed and reduced imports by an average of 4M bpd. Today that crude diet has reached ~7M bpd.

It’s a staggering amount for a country that imported ~15M bpd pre-war. By reducing its intake, China’s freed up barrels for other countries, supporting global oil balances. We’re not convinced that this was done because of Chinese largesse. In fact, it’s likely a strategic decision to prevent an uncontrolled price spike. The move also tempers the argument that China’s energy security is beholden to Iran, or that a US attack tangentially weakens China’s energy security. Instead, the middle kingdom turned inwards by banning product exports and imposing price caps on domestic petroleum products. The combo quickly made refining unprofitable as crude prices spiked. Consequently, refineries cut utilization to operational minimums (from the mid-70s to the mid-60% range). Prior to the war, China was building SPR inventories by ~1M bpd, and if we use a 4M bpd average decline in imports, there’s a 3M bpd gap. In all likelihood, product stocks drew by ~1M bpd, and crude 1-1.5M bpd. Demand destruction and exports redirected to the domestic market likely rounds out the remaining balance.

Unfortunately, Chinese inventories are opaque. Product stocks aren’t accurately tracked, and part of China’s crude stocks are stored in caverns that are difficult to gauge with satellites. Still what we can see is that it they’ve begun to decline given the intensity of the push-back.

Landed Chinese stocks have recently accelerated their decline, and have fallen by 2.2M bpd in the past few weeks. How long will this continue? Only China knows. It has 1.2B barrels of stored crude, so theoretically it can endure for quite awhile, but with current net imports running 7M bpd lower today that’s a heavy amount to destock.

As prices have calmed recently, China’s removed some export restrictions, which means Chinese teapot refiners (those not state owned) are starting to lift demand and refinery utilization. China’s actions will play a big role in determining how the war’s impact plays out. If it elects to drain its inventories, then the oil market can remain suppressed. In all likelihood, China will return to the market, and any incremental demand increase should lift prices higher as it’s a step-change in demand in a tight market.

Once and For All?

So what happens next? The SoH has closed again and the US and Iran are exchanging fire. The MOU has been declared dead, and the US plans to attack for a week straight to degrade Iran’s ability to threaten shipping lanes. The goal may prove to be impossible given Iran’s topography and size. The SoH reopened for ~3 weeks during which Iran shipped out nearly 80M barrels, which at recent prices was worth ~$6B, and it gave the regime some breathing room for another sustained campaign. Once attacks restarted, shippers turned cautious again. As tankers dipped so did the estimated oil flows out of the Persian Gulf. Today we’re hovering at 50% of normal (i.e., 11M bpd). This includes rerouted crude in the aforementioned pipelines.

We expect flows to slide lower as the reinstituted US blockade on Iran begins anew. Iran will suffer more airstrikes in the interim, and how it retaliates (i.e., does it attack the bypass pipelines or close the Red Sea) will determine the next phase of this campaign. The US appears to be taking out Iran’s maritime infrastructure, the one used to control the northern corridor, but we’re not sure they can eliminate the shipping threat without landing troops at Bandar Abbas or Qeshm Island. If correct, this campaign has many stages left.

So we’re really back to where we started, except inventories are much lower. Oil prices have bounced, but the recovery has stalled near $80/barrel for WTI. Given the size of the outage and current reserves that’s . . . unusual. We hesitate to claim that there’s manipulation in the current market, but if crack spreads (i.e., what refiners make) are any indication, the culprit is in crude. Jet, diesel, and gasoline margins are screaming higher, and near $120-140/barrel. Historically crude prices are tied very closely to products. We think it’s inevitable crude prices catch-up if this conflagration lasts.

Our working assumption is that eventually some sort of agreement favorable to Iran will be finalized. Outside of killing all of Iran’s leaders and attempting a regime change, the US has very little leverage given Trump’s aversion to landing troops. Air strikes can only do so much. This means Iran’s in the driver seat on managing the SoH, uranium enrichment, and the lifting of economic sanctions. We believe they may eventually get all three. Control of the SoH protects the nuclear issue, and vice versa, and now that the Iranian’s have a chance keeping both, they’ll start from that position.

A few weeks ago, Trump shared this tidbit at the G7 summit meeting. This was after a ceasefire had been signed, and negotiations were progressing. The clock is ticking and if it continues, in his words “bedlam” will happen if oil ran out.

Our Companies

Like oil, our energy equities have round-tripped back to February 28th prices (i.e., when the US attacked Iran).

OXY finished the quarter lower than its share price before the war started ($47/share vs. $53/share). It’s since bounced higher after the quarter-end, but you can see it’s only at pre-war levels even though oil prices and geopolitical risks are significantly higher.

At $65/barrel, we anticipate OXY will generate around $5.2B in free cash flow (“FCF”) or $1.3B a quarter. Tack on a 10x multiple and this is a $50/stock . . . basically where it’s at right now. Fortunately, oil prices did average $95/barrel, $30/barrel higher, in Q2, which equates to another $1.5B in cash for the quarter. Add that onto the $1.3B and OXY should generate ~$3B for Q2 in total. It all likelihood, this figure will be higher because OXY makes interest and tax payments in Q1/Q3, so Q2 typically has higher cash flows. By the next quarterly report (in a few weeks), OXY will have achieved its near term goal of paying down its debt to $10B after ending April at $13.3B.

The company almost certainly knew this was achievable when it offered up that goal during its May earnings call (as they’d already booked half of Q2 by then). Fortuitously, oil prices cooperated when the SoH closure stretched out. Though prices fell off at the tail end, OXY should’ve earned enough to repay the debt. At a 6% average interest rate, the debt pay down will reduce interest expense by $180M a year, again apply a 10x multiple to that, and its good for about $2/share.

Really though, what’s next? We’re stuck at $50/share right now, after touching mid-$60s on March 31st. Oil prices are ~$80/barrel, but based on inventory data we should be mid-90s. To reiterate, forget the mid-90s or even triple digit oil. If oil prices persist even in the mid-80s, cash flows would be close to $9-$10B a year. Apply a conservative 8x multiple and the stock would be close to $80/share, 60% higher than today. OXY’s shares are significantly undervalued and after bulking-up via M&A, repairing its balance sheet, and refocusing on oil production/development (post-OXY Chem divestiture), the company’s deep inventories and significant midstream infrastructure makes it a compelling takeover candidate. If the public market doesn’t recognize the deep value here, we think a larger company eventually will.

Transocean

Similar to our OXY holdings, our Valaris (“VAL”) investment also round-tripped. As you may recall we purchased shares of VAL last quarter after it announced a tie-up with Transocean (“RIG”). At close, each share of dAL converts into 15.235 shares of RIG. In RIG’s most recent quarterly update, the company indicated that the US Department of Justice (“DOJ”) issued a second request and will require additional time to review the transaction for anti-trust issues. The government’s forced to take a closer look because a combined VAL-RIG (“New RIG”) will own a larger global share of the 7th generation offshore drilling rigs.dThere are a few positive factors though, New RIG will only own ~1/3 of the 7th generation drillships, and given it’s a large global market, it’s not an entirely dominant position. Additionally, thede are 7 stacked rigs, which is indicative of a soft market, and RIG can add those back, or sell them if the DOJ requires mitigating actions. A New RIG will become the leader of the industry with $10B in drilling backlogs, but Borr and Noble will still be nipping at its heel.

We think eventually an approval may require some divestitures, but overall the drilling market is large enough if we look at the totality of drilling ships and jackups that a combined VAL/RIG should clear the necessary hurdles. VAL shares currently trade at a slight discount to the RIG shares, which is the market pricing in a fairly high certainty that the merger will be consummated.

We continue to hold the shares, and may look to add if we see some weakness.

Parting Thoughts

The oil market’s round-tripped the entire US/Iran War. Frankly, that’s bizarre, considering the conflict never ended. It’s moving to a new phase. While the MOU signed on June 17, allowed trapped Persian Gulf tankers to exit, the market extrapolated the temporary relief (+100M barrels of pain numbing anesthetic) as normalization. It then proceeded to forecast a resumption of free trade, reintegration of Iran back into the global economy, and a super-glut of oil supplies in 2027. Not so fast, as Iran’s recent attacks coupled with US counterstrikes have ended any illusion that the parties are close to a lasting agreement. Their positions are simply too far apart and intractable.

This will all take time. Negotiating leverage will need to be won on the battlefield. The brief respite has allowed both sides to catch their breaths and refill their stocks (whether it be in oil, weapons, or coffers). Refreshed, they’ll likely keep bombing each other, but avoid strategic targets lest the situation spirals uncontrollably. The US military controls the battle space, but the Iranians run the clock. It knows that the global economy is weeks/months away from “bedlam,” and/or wholly relying on China’s good graces to be the world’s energy savior if we run out. Both options are obviously deeply unpalatable for the US.

Again, conservatively global production is down 10-11M bpd today. Sure “visible” inventories are drawing half of that, but both of those numbers are still overwhelming. OECD commercial inventories point to a mid-$90s price for oil, but product prices are the tell. They’re already pricing $120-140/barrel.

Is it really surprising that Iran will do all that it can to keep control of the SoH? It’s an economic thermonuclear weapon . . . and second only to the pursuit of their first thermonuclear weapon. We handed it to them, and they’ll try to keep it.

So as we write this the ceasefire is dead, the MOU is dead, the US blockade on Iran is reinstated, and the attacks are intensifying. Product prices are trading over triple digits, and crude is lagging badly even as inventories plumb new lows. From our standpoint, as the turmoil continues and the disruption lasts, social media postings claiming that an agreement is near will become increasingly ineffective. Positioning is already bombed out and the market was short before the latest barrages, so who’s left to sell? To us, the administration’s dug a hole, but they’ll keep digging. It’s the only option. Nonetheless, even when it does, we’ll find ourselves in a whole new world.

Mommy: Those kids came over and wanted to play next to you?

Addy: Yea, I suggested they dig a hole in the sand.

Mommy: They just kept digging and digging . . . I thought they’d end up in China.

Me: hmm . . . I wonder what’s actually on the other side of the world.

Mason: (casually) . . . The Indian Ocean . . .

Me: Wait, what? . . .

Me: Seriously? Like, really? Not China? The Indian Ocean?

Mason: Yeah.

We better stop digging.

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May you celebrate safely and happily with all your friends and family. Except for the oil bulls. No oil bulls must suffer with the shame and ignominy of being . . . well energy bulls.

No fireworks for you since oil’s continued its slide as the Strait of Hormuz “normalizes.”

Given the bevy of information, and the holiday season this weekend, we know you’ve little patience and time to wade through it all. So to shortcut that process . . . let’s proceed under the guise that each picture is worth a thousand words. Here’s a few important pictures for you.

As the SoH normalizes, this is what visible inventories look like. Remember visible is only a partial snapshot of what we can obviously see, and so you’re missing tertiary and secondary reserves out there which is about 40% of the “stuff” out there.

Not much eh? Give or take 400M barrels have flowed out of the world’s coffers, which pales in comparison to what we’d expect given the nearly 10-12M bpd production outage over the past 100 days. You’d expect to see about 1.2B barrels lost, but that hasn’t been the case as seasonality (i.e., builds tend to occur during the lower demand winter/spring season), prior oversupply (we were oversupplied prior to the war), and China’s ability to dramatically reduce imports and dip into product stocks (which aren’t visible), have greatly mitigated the draws we can see today.

Fair enough, but if we were to “add-back” and factor in the various items above, our “gut feel,” sorry “estimate” is that we still ended up drawing somewhere around 700-800M barrels effectively.

Now the market obviously doesn’t believe that. Oil prices have cratered in the past few weeks and round-tripped the entire war based on the assessment that draws weren’t that severe, the SoH has normalized, and that some demand destruction has to be permanently baked into models going forward. We highly doubt any of that, but then again, we’re the bag holders for the time being.

Invert all of that, and you then must come to the conclusion that the world has been overproducing 10% of its entire energy supplies for far too long. We easily kept storage levels too high, production too flush, and wastefully tied-up working capital. That would seem a bit counterintuitive in a commodity space governed by razor-thin margins and little price stability. Over time, and we write that with a pound of salt, people are rational. Sectors, businesses and yes, even people, are rational. They don’t deploy and tie-up capital just to do so. We clearly didn’t “overproduce” 10% (i.e., 10-12M bpd of oil) of something that we didn’t need. In fact, just the opposite, we thirsted for it, and the truth is, despite how vague, opaque, and unclear the oil data is, we can assuredly say, we drew.

We drew heavily, we drew intensely, and we drew recklessly.

Yet, the price is right though isn’t it? That view is always determined by the lens you view it. Short, medium, or long-term. Here’s a great article describing that view, and it’s one we’d agree with. In the short-run, it may be right. Restoring some semblance of flows from the SoH means stuck traffic in the strait immediately escapes. It’s a prison break, and 60 day prison breaks are by nature unruly.

The exit is fast and furious. We’re suddenly draining the Persian Gulf of stored oil tankers, as as crews and boats trapped for 3 months make a run for freedom. Can you blame them? Sure, one or two will get plunked and damaged by Iranian tantrums, but for the most part, the ships and their cargos are freed.

Outbound tankers surged . . .

Inventories drained . . . as did oil prices . . .

You dump that much crude that quickly, and you can saturate the market. It’s inventory transfer though. Shifting barrels from the East pocket (i.e., the Persian Gulf) to the West pocket (outside of the Persian Gulf). Still they’re barrels that’re available for global consumption.

Given the rerouted oil since the war started, the SoH traffic really only needs to go back to around ~70% of pre-war levels. The rest of the oil will likely keep transiting out via the pipelines the Saudis and UAE used during the war (Yanbu and Fujairah).

For now, we’re close, averaging about 50%, throw into it the rerouted pipeline oil, exports out of the Persian Gulf are near 75%, so down about ~5-6M bpd. Considering the turmoil that’s not bad, but the key question is if it’s temporary. Much of that is tankers making the jail break, so that piece will subside.

What matters is tankers moving in, draining stocks and allowing production to restart. That’s a bit up in the air as only about half of what’s needed (i.e., the amount of ships, are entering the Persian Gulf). Here’s Rory Johnston’s graph of that.

You see? A long way from normal . . . even if “normalizing.”

So basically, even if you can drain onshore inventories, and everything runs efficiently, you can only restart half the production at the current pace. We’re effectively still short about 5M bpd of production if all those tankers end up loading.

For right now though, the prison break and resulting sugar rush is enough to overstuff the market largely because the Chinese continue to flex their muscles.

By controlling product prices and limiting product exports, China’s slammed their domestic refineries. Low to negative margins means refiners stopped importing crude and curtailed refining operations. Many to minimum levels. This likely means Chinese product stocks have drawn sharply, but given that information is opaque, the market is left guessing, and discounting any draws there. This is a main reason why there’s such a disconnect in the inventory balances we see vs. the market narrative. As China has throttled crude demand by nearly 4M bpd for 100 days, that’s 400M barrels of demand decline, which really bolsters global balances. It continues to this day, and mitigates the impact of the closure.

What’s unlikely though is that China’s product stock didn’t decline. There probably was some demand destruction, but odds are product stocks fell materially. 1 for 1? Unlikely, but half? Yes, at least. China’s refining capacity runs about 14.5M bpd (EIA), and overall refinery utilization rates has dropped from almost 75% this time of year to ~65% in May. 10% is nearly 1.5M bpd, and June is most likely lower. Even state owned refineries shared in the cuts, though the independent teapots took the brunt of it.

Overall, it appears that nearly 1.5-2M bpd of utilization is offline. China exports about 400K bpd of products, and since those were stopped, and rerouted to domestic supplies, we’re probably seeing a 1-1.5M bpd decline in product inventories, along with some domestic demand destruction (though that should be minimal given product prices were capped). So 4M bpd of crude demand, assuming 1M bpd was originally used to fill SPR coffers and “extraneous,” you’re looking at 3M bpd of crude demand curtailed, and half of it results in crude draws and the other half product draws.

Quite impressive really, but when will China return to the crude buffet? Will it be soon? We’re not sure, but we don’t think so before the 60 day MOU wraps-up. China knows everyone’s waiting for them, but if they step back into the market now, they likely spike prices fairly quickly. Sure there’s some Iranian and sanctioned barrels currently to be had, but that’s temporary. They’re better off by burning some inventory, artificially suppressing prices for a bit, and letting the West suffer with higher produce prices. Stay patient and wait to see what happens to the negotiations. If they go poorly, and war resumes, China can then tap into its crude reserves, which thus far has stayed in decent shape. If, however, it goes well, then prices at these levels may just last longer. There’s no reason to rush, and to spike oil prices in the interim will only incentivize the Iranians to hold out longer. We believe China will seek stability in energy costs, and prioritize trying to achieve that in the longer run. So they wait.

Which means in the meantime, we’ll see product stocks keep dwindling everywhere. It’s what we burn. We’ll see higher product crack spreads, and refiners making exorbitant cash flows. We’ll also see crude inventories keep falling. Though the SoH has returned to half its original capacity, whether that stays at that level is questionable at best, and even if it does . . . it’s still not enough.

This is no longer an outage of epic proportions, it’s merely a run-of-the-mill outage of historic proportions. Don’t believe us? Listen to the administration, the very people who have actively suppressed oil prices. They’re starting to say the quiet things out loud.

““I think what the president has told us to do is use this MOU to sort of refill the world’s oil economy, to refill some stocks and then to see where the hand is," Vance said.”

Still we have a temporary reprieve. For now.

As barrels flow out of the Persian Gulf, and trade flows start to normalize a bit, this is a sugar rush. A deluge of crude because of the prison break, and China’s flexing of inventories. None of that can last though, product prices (i.e., as tracked via crack spreads) continue to notch new highs. There’s a shortage, and it’s being expressed on the product side. Inventories continue to be drawn, and though it doesn’t feel like it, it remains, and it will come back to haunt us if the MOU fails to lead to a comprehensive and lasting agreement.

Ultimately, we think it will. We think the administration is hell-bent on buying Iran’s acquiescence, and so what were third rails, or red lines will be swept away or erased. Nothing’s off the table when the alternative is war and “bedlam.” Bedlam is never good for stock prices and political survival. Having said that, the oil market is still sorely mispriced. When you destroy price discovery, there’s nothing to incentivize energy producers to commit capital and begin the restocking process. Therefore, from an inventory perspective, we continue to fall. Sure at a slower pace given the return of partial oil flow in the SoH, but don’t let the price fool you. It’s temporary, it’s a sugar rush, and it will eventually hurt. Just not today.

Today is Independence Day!

Tomorrow is something else entirely.

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14 points.

14 points, each one a gut punch.

You knew it was bad.

You knew IT HAD TO BE BAD, since the US wouldn’t release the text until “the signing.” It’s like a report card gone wrong, and the kid’s hiding it.

What could begotten, was get. The Ayatollah’s channeling Inigo Montoya in the Princess Bride, and Trump’s saying . . . as you wish.

Man that’s painful.

$300B reconstruction fund, immediate lifting of oil sanctions, control of the Strait of Hormuz (“SoH”), no ballistic missile discussions, and uranium enrichment discussion to begin and last for 60 days until a “final agreement” is made . . . yeah good luck with that.

What about those Iranian frozen funds?

Yeah for sure, they gave that up. Under the table of course, but no doubt they gave on that.

For all the bluster and bellicose, this was capitulation born out of weakness. After months of fighting, blockades, and tightening sanctions, the US found itself in a completely untenable position. The Iranians warmed up for the World Cup by scoring on every shifting US goal post: regime change (still here), uranium enrichment (we’ll talk later), and reopening the SoH (how much should we charge after 60 days).

Ultimately, IR walks away now with de facto control over the SoH. Sure they’ve agreed “not to toll” during the 60 day negotiation period, but realistically why wouldn’t they after? It’s an added moat they’ve never had before, but open for a free trial period. Securing a nuclear weapon was always the golden ticket to insuring the regime’s permanence, and the IRGC worked hard to preserve that right. Tack on control of the SoH now, and they effectively control Iranian, Iraqi, and Kuwaiti exports. It also impacts Saudi Arabia and the UAE’s oil exports, but they’re already working on workaround pipelines, which means in a year, they’ll have repiped. Nonetheless if anything, the US/Iran War showed that energy infrastructure is highly vulnerable to asymmetric warfare. Drones, ballistic missiles, sabotage. These soft targets are simply too numerous and difficult to defend (cost effectively). Especially when it only takes one hit to disrupt operations. Pipelines help, but again, pumping stations are also numerous and vulnerable, so the threat remains.

Really though, all of this adds up to “friction.” The costs to defend, reroute, and redirect what was a VLCC dominated trade through one strait. The market invariably optimizes for economic efficiency, and anything other than a short pipe to the water’s edge means higher costs. Now it’s choosing between filling long pipelines flowing to different waterways, or subjecting yourself to tolls that previously didn’t exist. That’s your added cost.

What about geopolitical premium? Well let’s be honest, the market won’t give that to oil investors. China’s frankly done a fantastic job anesthetizing the world by flexing its strategic petroleum reserves (“SPR”). By slamming imports lower, and drawing on its stores (crude/petroleum), our Chinese brethren has bought the world some time, and arguably, the SPRs did their job. As did the US’ SPR. Sure, it’s been depleted severely and needs to be refilled (as the releases w\ere structured as loans), but for now, their release has prevented a stockout.

Tick, tick tick . . .

All of this had a clock though. The market couldn’t hear it, but oil analysts knew. The ticking kept getting louder and louder as the weeks passed. We had thought it was 6-8 weeks before bad things happen, but it turns out, those who knew . . . knew.

Unsurprisingly, the White House “declined to elaborate.” Um . . . yeah. Even in the palace of truth, that is a stunning admission. Sure, oil analysts suspected it, but to publicly divulge that data point means he effectively eroded the US’ negotiating leverage over the uranium issue. Notice also that the 60 day negotiating period is on the uranium issue, and not the SoH reopening. So once we cede control of the SoH (okay sure, shared between IR and Oman), the threat of stockout and bedlam will continue to exist. At any given point between now, the 60 days, and really . . . until we refill our tanks . . . we’re about 4 weeks away from “bedlam.”

Fantastic.

For all the uncertainty above, oil prices cratered to $75/barrel from $80/barrel last week. We think if Charlie Munger were here, he’d look at that and say . . . that’s just stupid.

It’s pricing in a full return to pre-war levels and normality, which my friends is EXTREMELY OPTIMISTIC. It presupposes that the winner, the Iranians, are thinking that way. It presupposes that they will negotiate in good faith and won’t intentionally leverage any advantages it has with the fact that they control a strait and the US/world is weeks away from a stockout. It presupposes that they will do so knowing that the US president has absolutely no desire to engage militarily. So no, none of that will happen.

So 60 days. 60 days while IR rearms and refills its financial coffers. 60 days of constrained tanker flows, and IR’s “management” of the SoH.

Sure we’ll shift barrels sitting in floating storage (i.e., trapped) in the Persian Gulf, from our left pocket to our right (outside of the Persian Gulf), but those barrels will forestall just a few days of consumption. While total floating storage is still elevated, much of it has already leaked out. We’re nearly back to levels seen in January.

Interestingly, we’re willing to bet that the recent decline in oil prices will spur increased demand in the coming weeks. It’s a sugar boost, but that’ll fade. The headaches of a vastly strengthened IRGC negotiating with a belligerent and weakened US are just getting started.

US oil inventories, the last bastion of reserves, will continue to draw for another 3-4 weeks.

We think European and Asian refiners will grab at the new flows coming out of the Persian Gulf and the US to refill coffers. They’ll need to buttress their stocks in case things go awry in the next 60 days. We’d be surprised if the buying shifts completely from the West (US) to the Middle East.

It’s why we think the oil market and oil prices are completely oversold. As the paper market fully unwinds, what’s left is the physical to discipline. In the short-run, with all the volatility, there’s going to be very few paper buyers. So the selling pressure intensifies and will peak. Eventually, we’ll find a floor as shorts unwind, and we think that’s in the $80s to 90s. Inventories would certainly indicate that $90s is the right figure, and nothing’s changed that unless the expectation is that dramatically large builds are coming even as the SoH stays impinged. We’re also entering the heart of the high demand season for the year. Tack on the recent fall in prices and the additional cargoes being released from the Gulf, and we’re likely to see demand pick-up.

Will prices run-away? Doubtful because again, China. It can and will likely continue to flex its SPR, which still contains over 1B barrels, and that can keep things in check globally. For June, imports appear to be at about the same levels as May, so the strategy carries on.

Look at the red section on the left. That’s China, slamming imports down by 4M bpd. About 1M bpd of that was “extra” to fill its SPR, and by turning it off, it’s really a 3M bpd delta. China then slammed refinery utilization down by 1.5M bpd, which likely means products drew.

The remaining 1.5M bpd? Crude draws. Only 0.5M bpd of that is visible, but they have caverns and the draws are likely coming from there.

If there’s one thing we’ve learned being an investor in the oil patch is that things aren’t always what they appear. Why aren’t draws higher, why aren’t prices higher, etc.? Much of the frustration coming from those bullish oil prices is that prices haven’t reflected the reality of what’s happened. You would think drawing over 1B barrels of inventory would usher in higher oil prices than the $75/barrel we’re seeing today, only $10/barrel above pre-war levels. You would think draining reserves, and being 4 weeks away from “bedlam” would mean prices rise to incentive all-out production to prevent such a possibility.

You’d think.

It isn’t, which means economically, what’s supposed to happen isn’t happening, and inevitably that will result in much higher prices later. Price inflation is always the byproduct of elevated demand and low supplies. That’s econ 101, and unless we can print molecules, the market will need to deal with that reality in the coming days. How long? Give it 60 . . . because even if the inventory data is murky, and the prices unreflective of the environment, we have little doubt the Iranians know where the pressure points are, and we have little doubt they’ll start pressing all our pain points.

14 of them.

We’ve made our bedlam, and now we’ll lie in it.

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Alright alright.

Ladies and gentlemen we have a deal!

Greatest meal deal ever. It’s like a Tacos Supreme Combo.

3 luscious Taco Supremes plus an ‘Murica sized big gulp of sugary carbonated water to help all that medicine go down. Mary Poppins couldn’t be prouder.

Eventually . . . and inevitably, we figured he’d cave. He had to. He had no leverage. He literally backed the USS Boxer, and its Marine Expeditionary Unit, away from Asia a few weeks ago, which was a pretty big signal that he didn’t have the stomach to escalate the situation. In turn, Iran had to translate its military leverage into a diplomatic one, and it has. Could it or should it have waited until the markets dislocated, and the global economy came to a grinding halt? Debatable. Moreover, Iran has to be suffering economically as well since their oil flows have plummeted because of the US oil blockade. Regardless, I for one am glad they didn’t. So instead, they relented a bit and signed (or will sign, or will sign shortly after Trump’s birthday tomorrow) a Memorandum of Understanding (“MOU”).

The MOU has six general points:

1. Lifts the blockades on the Strait of Hormuz (“SoH”) within 30 days. Iran will clear the mines, and not collect tolls, whereas the US will remove its blockade. Iran has claimed it will charge service fees to facilitate transit so that outcome is still in the air. We think that’s likely. They’ll get something, but something that’s palatably worded for the world. Facilitation fee, support fee, or security fee, something. It’s all about optics.

2. Iran commits to never pursuing a nuclear weapon. It will agree to either a 15 or 20 year halt to uranium enrichment and dismantling of its nuclear sites. The parties will negotiate the technical details of the monitoring over the next 60 days. Most likely, they’ll end up in a state where they keep the uranium on their soil from which they can enrich the uranium in small concealable batches (as if inspectors will prevent them from developing a nuclear weapon, which they’re infinitely more motivated to obtain).

3. Hostilities against all Iranian proxies (Hezbollah, Houthis, etc.) will cease. Israel has claimed it’s not part of the MOU, but we think the US has enough sway over Israel that even if there are violations here, they’ll be small and both parties (Iran and the US have incentives to overlook it).

4. Missile program - Iran will keep this. Don’t expect much movement here.

5. Compensation - Iran has asked for $270B in reparations for war damages, and the US will likely grant the release of $24B held in banks worldwide. They’ll release those funds as conditions are met, but expect a “sign on bonus” for Iran. They’ve asked for it, and they’ll get it.

6. Sanctions - oil and gas sanctions on Iran will be lifted immediately. So Iran should be able to start recovering economically.

So framed another way. This is a 60 day ceasefire that reopens the SoH for 60 days while the parties sit and negotiate the specifics of the nuclear deal. Don’t read that as a threat or chance that we’ll go back to war.

President Trump has shown zero appetite for that, and wants to immediately restore the SoH.

Most likely, the US will end this entire endeavor with an IRGC in a strengthened position. It’ll get sanctions lifted, billions in cash, retain its missile program, and exercise de facto control over the SoH. As sanctions lift, they’ll rearm, refortify, and upgrade their weapons package. I fear that’s the longer-term scenario. This is an emboldened and empowered entity, and the US an unfortunately embarrassed one. Iranian drones and ballistic missiles have shown that the emperor has no clothes, and with that, it’s stripped the US of its cloak of perceived military invincibility. The lesson that quantity has a quality of its own has been retaught, and that a continuous barrage of cheap munitions can economically and strategically hobble your foes.

Impacts on Oil

Putting on our investor hat though, what this allows us to do is to reframe the oil trade. What the administration has orchestrated in the past few months has been nothing short of phenomenal. It’s kept energy prices rangebound and arguably under control as it’s weaponized the volatility of the paper markets. We’ve known all along that the paper market is >30x the size of the physical one, and in the short-run that can push physical price indicators aside. Trump’s team has successfully eviscerated investors’ appetite/ability to take bullish positions in the front of the curve. Given the volatility that each tweet engenders, holding positions became untenable. In fact, the risk/reward eventually favored shorting the oil market, and that’s what investors did.

Combine bottomed out sentiment . . .

With high short-positioning . . .

. . . and eventually once the headlines flipped to a favorable peace deal, the bottom softened for oil prices.

So $80-85/barrel it is for now.

Lower Chinese imports coupled with reduced demand has mitigated the otherwise enormous 14-15M bpd supply loss. As of now, it appears that the collective voluntary measures have reduced visible global draws in Q2 to ~5-6M bpd (note the key word “visible”).

We think it’s higher as some of that is really due to seasonality, and China’s reduced imports and lower refinery runs means it likely drawn down product stocks. Still, price doesn’t lie, the price on the screen says $85/barrel, even if we think visible and less visible inventories have drawn.

So what’s next?

What’s next is the recovery.

How fast and when?

For takeaway capacity, it’s a no brainer. The Middle East (Iraq, Saudi Arabia, UAE, etc.), will quickly and furiously build/expand their alternative pipelines. Iran has proven it can weaponize the SoH at any time, so export capacity needs to be increased. UAE should be set by 2027, and the Saudis undoubtedly soon after. Will the upgraded pipelines like Yanbu and Fujairah be under threat? Sure, but they’re arguably easier to repair than prying open a strait under enemy fire.

As for supply recovery, we have to assume that it’ll take about 2 months. That’s the time needed for ships to exit the Gulf, unload, and return. Only by returning can tanker ships then drain onshore storage and allow producers to restart production.

The ships currently trapped in the Persian Gulf will leave first, transferring around 100M barrels that are sitting in floating storage to hungry Asian/European customers. That immediate shot of adrenaline should help keep prices steady as we get through this busy/high demand summer season. On the flip side, demand should also recover as energy prices climb down from their highs, and summer burn increases to counteract the heat that begins in earnest. We’ll still have a net shortage, but if China maintains its posture on reduced imports, we can muddle through. Call it a visible draw of 3M bpd draw over the next 60 days. By September, we should be ~80% recovered on supplies. Thereafter, near or full recovery by year end. We think that’s a decently conservative estimate, and largely what the energy agencies and Goldman Sachs thinks.

This does mean oil will continue to draw in the coming months. Largely because of the lag effect of sailing times/production restart/disruption, seasonality, and uncertainty as we muddle our way through this MOU. Fair value for oil is nearer $90-95/barrel right now (below is only looking at commercial stocks), and will nudge higher in the next few months as we recover.

The path thereafter depends on production recovery vs. demand growth.

Will there be lasting impacts to the prolonged shut-ins (we doubt it), will the SoH navigation return to pre-war levels (we also doubt that), will producers ramp production much higher in an $80-85/barrel oil environment (yes, but muted), what will the geopolitical premium be going forward (who knows), and what type of strategic petroleum reserve restocking/build will we see (definitely incremental demand)?

All of these things are still uncertain, but we’ll start modeling them as we move forward. It is safe to say that in the past 3.5 months, we’ve managed to materially drain our inventory reserves and commercial stocks, strengthen a Middle Easter foe to a previously unfathomable position, and severely degrade our perceived ability to project power and backstop/defend alias in a volatile regions.

While we’ve managed to temper oil prices in the short-run, the knock-on impacts will almost certainly reveal themselves as we emerge from the fog-of-war. Shell’s CEO has stated that we’ve globally lost ~1.2B barrels of oil in the past few months, and we think that’s about right. We’re approaching tank bottoms these days, and though we’ve managed to pull-back from the global brink with help from Chinese reserves and a minor reduction in demand, we’re going to get tight if they don’t continue with their largesse. As oil prices drift lower here in the coming days, they’ll find a floor. Once the dust settles, and short positioning clears out, don’t be surprised to see prices drift higher as we keep drawing into the summer. We still expect prices to average ~$90/barrel for the rest of the year, and we should have a better view into 2027 as we get into Q3. Suffice it to say, energy companies are still pricing in $70-75/barrel. So those should receive another uplift.

As we’ve done throughout this whole exercise, we’ve kept repeating the phrase “we shall see.” Just when you think something is set to happen, another entirely unexpected situation unfolds. In January it was $55-60/barrel for years to come . . . and then the market gave us triple digits. Low prices have created pervasive apathy towards energy security, and it’s bred overconfidence that we can seek regime change for a major producer without destabilizing energy prices. Well we found out. Turn the page, and we’ve decided to suppress oil prices for the greater good as inventories draw. Yet meanwhile, we expect producers to refill our emptied tanks even when the economic incentives to do so are uncertain? Hmm, the producers appear to be as skeptical as we are.

2026 is the year the US lost a war in the Middle East, and we don’t think that means energy prices will be, or should be cheaper going forward, nor do we think suppressing oil prices and introducing volatility in the oil market will lead to producers running flat out as we come out of this mess.

Again “we shall see” . . . in the meantime, enjoy your tacos on your birthday Mr. President.

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For those who don’t know, the San Antonio Spurs are battling it out with the New York Knicks for the NBA championship, and after come from behind win on Wednesday night, New York leads the 7 game series 1-0.

The next game is today. The Knicks won their last championship in 1973, so the droughts been long and dry. Led by their floor general Jalen Brunson, the gritty Knicks have a real shot against Victor Wembanyama and friends.

The timing though couldn’t have been more fortuitous as the parent company, MSGS, has just filed a Form 10 a few weeks back to being exploring the spinoff. As you may remember from our last article, MSGS actually owns two professional sports franchises, the aforementioned New York Knicks in the NBA (basketball) and the New York Rangers in the NHL (hockey). It also owns a few minor league teams, but the real value of the company lies in the NBA and NHL franchises.

Given the recent selling prices of other comparable large market NBA and NHL teams, we conservatively projected the fair market value of MSGS at $11B, and we were too conservative on that. Let’s shoot our shot.

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Nothing major, just a minor fender bender. Stopped in the middle of a parking lot, waiting for a young lady to back out. She backed out, then kept backing . . . then backing . . . then . . . oh this is gonna be close . . . and

Bonk.

Doh. Oh well. It’s minor, no one’s hurt, stuff happens. A few scratches and dents, let’s trade insurance info.

She said sorry, and I said no worries, everyone’s fine.

Insurance adjuster calls and says . . . she said she was stopped after backing up and you drove into her.

Which then made me question my recollection. Was I really not stopped? Was I moving? Fortunately, my son who was with me in the car started laughing after I told him.

So I think this is what the kids call “gaslighting” these days. It’s a term that comes from the eponymous play Gas Light, where a manipulative husband slowly dims the gaslights in their home, but continuously lies to his wife, insisting that she’s imagining the creeping darkness.

It’s something we seem to be doing much of these days. Served so casually and frequently, sprinkled with a dash of deception. Problems are never anyone’s fault, it’s yours. You’re overly sensitive. Your analysis is wrong. Your judgment? Way off.

My facts are right, and I’m living the truth. You? You’re confused at best, and delusionally wrong at worst.

Really? Is this really how life works today? Because for a split-second even I’m doubting myself. Was I really not stopped, even though I was the one honking, knowing that she was about to hit me? Did I really just decide to whimsically truck someone in a parking lot? Why’d I do such a thing . . . wait, but did I?

The Jedi mind trick is REAL I tell ya, and none of us are even Jedis.

Yet that seems to be my life these days. One where my real life mirrors my investment reality, because guess what?

The Strait of Hormuz (“SoH”)?

Yeah . . . apparently that doesn’t matter either.

We actually don’t need 15% of our world’s energy supplies. You can cut it off and nothing misses a beat. We don’t need buffers, we don’t need healthy inventory levels, and we don’t need a material supply response. We’re Just Fine.

Once a peace deal is signed, everything will be awesome. Scratch that, right now? EVERYTHING IS AWESOME!

Why wouldn’t it be?

$87/barrel . . . WTI

$91/barrel . . . Brent

That’s the price of oil today. Makes sense. Frankly there is no shortage, at least not one that’s visible in prices. There’s no real shortage because none of this matters. We’re losing only 8-9M bpd. Sure it’s much more than that, but Strategic Petroleum Reserves help paper over 2M of the losses, demand destruction another 2M bpd, and voila, we have “only” an 8-9M bpd loss. A loss, mind you, that will quickly disappear soon when peace breaks out.

Soon meaning, whenever the US/Iran finally agree to reopen the SoH. To be honest, this seems likely. Eventually both sides will need to reopen. Iran to solidify diplomatically the military gains its made on the battlefield, and for the US, a detente so it can put this entire folly of an excursion to bed.

The non-stop jawboning and messaging from both sides means nobody can really stomach the trade. You can’t take a position in the prompt when the volatility and unpredictability works against you. As you bounce from headline to headline, you financially bleed from the thousand of knicks and tweets. Hence oil prices not only tread water, but start to sink even though the SoH remains closed. Besides, any CTA program worth its “momo” will tell you a flat to down line pales in comparison to this lunar moonshot of a line.

People go where the momo goes, and the momentum has achieved orbit. Whether that’ll be around the moon or Mars, it’s still to be determined, but it’s sure better than this . . .

So there you have it. One unconstrained and another forced into a predetermined channel. A tale of two charts. Not just that, but a tale of two narratives.

The Tidal Wave

Surely once the SoH reopens, the oil will flow. Not just flow, but it’ll be a tidal wave of supplies. First, OPEC and OPEC+ will surely ramp right, I mean they have been since they were removing all the quotas right before the war began, right? Well yes, but that actually didn’t result in any higher production.

Other than seasonality (i.e., increasing production/exports in the fall/winter), the above chart seems pretty flat doesn’t it?

Okay, then what about Venezuela and a few of the underpeformers, they’ll pump right? Didn’t we “take over” (oh sorry “free”) Venezuela to ramp its oil production? Other than a minor bump, there hasn’t been much change. Maybe the experts were right, maybe boosting the country’s production will require material capital investments, which’ll take awhile.

Hmm. Okay then the US . . . they’ll react, right? That’s the quickest and most price sensitive barrel. Drilling is about to go through the roof . . .

Oh yeah, now we’re talking! Look at that blip! 3 months into this. Up. Yet, despite that, we’re down YOY in rigs, frac spreads, and rigs in the prolific Permian basin?

Go figure.

It’s amazing really because what’s happening is that the SoH closure stemming from the conflict is inducing only a few suppliers to produce some incremental supplies. Sure oil is up from $60/barrel to $86/barrel, nearly 40% more, but really there’s been no step change in drilling.

The administration has done such a successful job in numbing oil prices, that the analgesic’s worked on the supply side. In other words, by suppressing the potential price spike, they’ve also neutered the supply response. What producer would willingly overproduce if the prices are so uncertain? Sure, on the fringe, you’ll get some supply response, but on the whole? Not much. The anemic response we’re seeing stems directly from the uncertainty they’ve created.

So then ripple that logic even further. If it’s not responding at these higher prices, what the likelihood production increases when peace arrives and you try to jawbone it lower even more? Exactly . . . nada.

Nonetheless that’s not what the narrative currently screams. Once the SoH reopens, supplies will increase. Increasing supplies mean recovering inventories, and that means lower energy prices going forward. In turn, that’ll create deflationary pressures, allowing the Fed and other central banks to lower rates, benefitting stocks.

Again, all of that’s predicated on supplies returning. Not just returning, but returning to their peak, and then some, and recouping the 1.5 billion barrels that were, or will be lost. The excess will also quickly refill all our coffers.

Really? 1.5B? Look you can quibble with that figure. Maybe not as much production was lost, maybe it was more, or will be more . . . or less. What matters really is the directionality.

The market is expecting that. Despite removing 20% of the world’s supplies and consuming 20% of the world’s inventories, will we quickly revert back to the lower prices we’ve had at the beginning of the year? Call us extremely skeptical.

Unfortunately for us, that’s the expectation and it’s ALREADY PRICED INTO THE MARKET as oil has already started its drift lower with the impending peace treaty/cease fire/negotiation to negotiate that’s coming soon.

The stock market is at an all-time high, and the bond market has stabilized. If either steps out of line, then expect another jawbone. We’re already into June now and Trump’s in “no rush” to negotiate. Well publicly at least.

We don’t think that’s anywhere near true as reports of his various and constant overtures are most likely true. What we do know is that inventories continue to drain, producers have been non responsive, and once the SoH reopens, production is even more likely to wallow further if prices decline. Who’s going to refill our inventories? Collectively? No one.

In fact, there’s a greater chance that we’ll have lost some production with the prolonged shut-in. Regardless, jawbone away. Keep telling us those lies. Keep telling us the room’s getting darker, and that we’re most assuredly wrong.

We’ll just sit here and hope that they’ll stop shortly, otherwise it’s really lights out for everyone.

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Okay, let’s talk oil. $96/barrel right now after what’s news reports that an agreement to defuse the current standoff is within reach between Iran and the US. Though there still are issues, particularly around what’s in and what’s out of the initial agreement, there seems to be some progress being made, or at least a concerted effort to do so.

Is this really a 30 day extension of the current ceasefire, or is this a transitory step to something more . . . permanent? It’s unclear.

What is likely happening is the framing of the issues, and the cadence of the steps each party will take as we walk through these next few weeks. Call it a trust exercise, or heck call it “trauma bonding,” if you want, but whatever it is this will take time. Particularly when both parties are saying “you go first.”

Really though the Iranian’s are feeling flush at this stage. It has the leverage in both time, geography, and political will. The US does have two weapons though: a military hammer and a really large bullhorn. Frankly, it’s using the latter to great effectiveness as oil pries have milled around in a very specific Goldilocks range.

Thanks to US jawboning, the price has stayed fairly rangebound between $90 and $110/barrel. The increased volatility stemming from an outlandish tweet at anytime of day, amplified by certain media members, means traders simply can’t hold long positions with any conviction. Not only will their systems automatically flag the vol, but the value at risk also jumps. What ends up happening is the capital gets skittish.

With traders vacating their traditional role, we’re left with the physical market to tighten and tell us what the true price of a barrel of energy should really be. What’s surprising to us is how well the physical market has hung in there for the past month. While inventories are falling, a buyer’s strike from refiners is occurring. There’s little reason to buy if the pundits, the President, and analysts are all predicting a quick resolution to the conflict. Though they’ve been doing so for the past few months, one of them will be right one day, and the longer this drags on the more likely that happens.

The zeitgeist is almost certainly that oil prices will fall quickly in such an event, and from a risk/reward standpoint, let’s play it out and wait. Draw inventories and reduce run rates, and pray for a speedy resolution. Why bid on high dollar barrels if you can stay patient? Sure product stocks will draw if refiners don’t produce, but that’s the consequences of picking your poison.

Everyday is a Draw

We’re 2/3rds of the way into May, and the overall deficit is approaching 9M bpd as visible oil inventories start to truly reflect the supply outage.

Compare that to the same chart last week, and already we can see May figures have increased from 7M bpd.

Lag-Effects

It’s the lagging impact of this entire venture. Once Asian stocks depleted, the pull on Western inventories have picked up materially. Supplies disrupted in March and April are only starting to show up in the other visible parts of the world (i.e., Europe / US). Storage information/data in these regions/countries is less opaque, and the March and April outages are beginning to show given the lagging impact of how oil moves through the system. It’s lagging both in terms of how it shows up in the data and in timing. As Western crude/products start getting pulled in large amounts, land stocks will draw, but oil-on-water (“OOW”) will increase as the barrels are exported. Once they land, OOW will decline, and land stocks will rise, only to finally fall when the barrels are refined/consumed. Eventually though, it will all fall, OOW will settle, whereas land stocks will decline. It has to unless China decides to just step-in and plug any gaps with its vast SPR (doubtful).

From a timing perspective, we further anticipate this will continue into late summer, as March’s SoH outages “show themselves” in the figures for April, and April’s SoH outages show in May, and so on and so forth. We can already see the impacts in April’s data as inventories of both US crude and products have started falling counter seasonally.

It’s clear from the charts above that product stocks here will get spicy. We typically build inventories now and into the summer for consumption in the fall/winter season, but this year, we’re seeing a counter-trend, which means there won’t be as much available by October. Product prices are likely to stay elevated into year-end, which means refineries will run flat out. Commercial crude inventories are doing much better though since releases from the US SPR have been so hefty. That portion won’t stop for awhile. Net/net, commercial crude stocks will still draw despite the SPR release and for many months as seasonality coupled with global export demand pulls barrels away. WTI and Brent pricing will need to close that gap for barrels to remain in the US, but they’ve yet to do so.

Zooming out a bit, our real-time OECD tracker also shows the bleed down. With little to no evidence of demand destruction (particularly in the better insulated and wealthier countries (i.e., filled with high energy consumers)), the draws will keep occurring until supplies improve.

In total, global onshore storage though is falling, and will continue for the coming weeks. Here’s Eric Nuttall from Ninepoint.

Though not as steep as he initially projected, we think the draws will still be about the right amount in quantum, if not pace. If no one’s cutting back materially in their habits, then the draws are inevitable.

Drawing Now, and Drawing Later

So what happens in the coming weeks, will matter for inventory balances at the end-of-summer. Thereafter, remember, there’s still the matter of “normalizing” the SoH. Most analysts estimate it will take another 1.5 months to reorient the tankers as many have been sitting idle or re-tasked to other routes. Producers will need to drain on-shore inventories before they can restart the field, and they can only do so if the tankers start loading inventories. So even on a conservative basis, pencil in another 200-300M barrels lost as the ships traverse and reform their congo lines. We’re likely well into July before we start to see the first barrels reappear in Asia if things get sorted out . . . today.

It’s unlikely though because the current ceasefire draft between the US/IR means negotiations will begin after Hajj. The sacred Muslim pilgrimage to Mecca starts this Sunday and ends sometime next Friday, which means we’re into June already before the parties really sit down and grind through the specifics. If we’re being optimistic, we’re looking at a resolution likely in mid-June.

Even that’s a bit fanciful because can Iran and US resolve the open issues of uranium enrichment and the SoH in two weeks? We doubt that. The nuclear issue has been going on for nearly a decade, and the SoH has finally been weaponized. What’s the likelihood Iran enters these negotiations on its high horse and flexes its muscle? Yeah . . . high.

It makes sense though. They are “winning,” and the longer IR draws out negotiations, the more leverage it gains as global inventories really start to drain during the high demand summer season. We’re a bit surprised that the SoH has been closed this long, and at this stage, it’s really a wait-and-see approach we’re taking. Every week of closure means another +60M barrels lost. More if you count non-visible inventory draws and China’s SPR releases (some of which is come from underground stores). We still have 10-12M bpd of shut-ins and that’s really the missing key. March, April and May . . . and now likely June. Another month or two of this, and the impacts will directly impact Q4, and effectively all of 2026.

In turn, this will drive full year free cash flows (“FCF”) for E&Ps so high that they will materially deleverage, and/or drive significant shareholder returns (i.e., buybacks). Many companies will likely increase dividends by redirecting the newly freed-up cash used to previously pay higher interest expense, and by systematically shrinking their share counts. Companies could also issue one-time dividends, but again, they’re more likely to repurchase stock to permanently bake-in the benefits stemming from all this uncertainty. Every day is another dollar, and as this continues, it’ll only expose how cheap the shares of energy companies are, and how much of a folly this entire exercise has been.

June, here we come.

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“It didn’t look that bad” . . . that’s what I texted to a buddy. Transocean’s (“RIG”) earnings that is. Not sure why it’s down 8% the day earnings were released this week.

Keep reading the filings though . . . ah there it is, a second Form 8K, which says . . .

Anti-trust. A “second request” from the Department of Justice (“DOJ”). I guess you can’t effectively oligopolize a sector and not expect at least some deeper analysis from the DOJ. Fair enough.

We knew this would be coming, but how do we walk through the analysis? How do we discount the risk of the US denying RIG’s ability to close the Valaris (“VAL”) acquisition?

Well let’s take a look.

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Occidental Petroleum (“OXY”) reported Q1 2026 earnings this week, and for readers, we’ve long argued that it’s one of the most underpriced stocks in the E&P space.

To be fair, this was a mixed quarter. It was great in the sense the company executed and delivered what it promised. It was terrific because the company outperformed in certain areas. Unfortunately, it was also terrible because the management team blundered into a costly derivative, but maybe, just maybe, there’ll be salvation. Let’s get into it.

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Onto Week 10.

12M bpd of disrupted Hormuz flow in April, and this will likely continue into May as diplomacy looks to be a ways away with uranium enrichment and the Strait of Hormuz (“SoH”) reopening intertwined. It’s difficult to sort out since one provides the leverage for another.

1. If the US relents and ends its Iranian blockade, that emboldens the Iranians. Similarly, if the Iranians end their SoH blockade that would also dramatically reduce their leverage at the negotiating table.

2. Uranium enrichment and nuclear development. Will the US be willing to separate this? The US, and the Trump administration specifically, needs a “tougher” deal than the JCPOA that he exited from. Otherwise, how could he paint this as a victory? In contrast, the Iranians smell weakness. The longer the SoH remains blocked, the more leverage it has to not only take control of the SoH long-term, but also retain its nuclear development program. The SoH becomes “the nuke” to be negotiated for, and the “actual nukes” take a secondary position.

3. Will the Iranians be willing to cede nuclear development for 10, 15, 20 years to allow Trump to declare victory? That’s doubtful as the current strategy is working well. Though the blockade has dropped Iranian exports to a measly 500K bpd, and the country is suffering economically, history has proven that they can weather an extended storm (i.e., see prior sanctions with Trump and COVID).

4. Ballistic missile development? No word on this of late. Too complicated given the core issues above, which means Iran gets to keep it.

So effectively we’re left with a stalemate on the panoply of issues, and that stalemate means we bleed.

Bleeding 12M bpd that is, that’s the deficit. That’s the amount of crude and products that’s not flowing because of the war.

Right off the bat we’re already starting to see demand destruction. Prices at $100/bbl oil aren’t so high that they should already kill demand, but it’s happening because of the actual absence of molecules. There just isn’t any supply for some frontier Asian countries. Hence demand is down. Middle East demand is also obviously down, and not hard to see why when missiles and drones fly.

So reduce that 12M bpd by 3M bpd of demand loss, and we should see somewhere in the neighborhood of 9-10M bpd of inventory draws. Well are we?

Thus far, we’re only seeing around 7M bpd.

In total, visible inventories appear to be falling about 6-7M bpd. This includes about 3M bpd of SPR release.

To reiterate, the above is “visible” inventories. What’s tougher to track though is non-visible, non-OECD products inventory and we think that’s the difference. Once that bleeds down, then visible inventories should draw slightly higher, or further demand destruction in non-OECD countries will occur. Non-OECD countries include China, India, Brazil, Argentina and Russia, so these are material in every sense.

Though the charts above are from JP Morgan, if we take a peek at Goldman Sachs’ chart, we can see similar findings.

Goldman though pegs demand destruction at 2.5M bpd vs. JP Morgan’s 3.5M bpd, so split the difference at around 3M bpd, but whatever the demand destruction we settle on for now, the thrust of the argument is about the same. We’re currently drawing around 6-7M bpd of visible stock, and some other portion that we can’t see.

Unlike COVID, this energy crisis will have a delayed impact. Whereas COVID saw immediate demand destruction, supplies didn’t immediately stop, so inventories ballooned. The Iranian conflict has the opposite impact as oil-on-water still flowed for a few weeks as the last ships arrived at their destination. Those supplies have finally tapered off, so the air pocket has firmly arrived at the far flung ports.

For the foreseeable future, we’ll see visible inventories fall further as consumers/refiners pull on all available stores. In turn, prices will rise to further curtail demand as the bidding war progresses and the stalemate continues.

Oil analysts had predicted the sequence to move from East to West. So has the first to draw was Asian inventories? Yup.

Next up, Europe, and finally, the farthest barrels in the West (US) will bear the final brunt . . . or so we thought.

Well guess what?

Brunt? Meet backside.

It’s just getting started, and we’ll see the visible side fully reflect this crisis.

US crude/product stocks are the most visible inventories to track. The Energy Information Administration (“EIA”) provides timely and comprehensive data, and for the week of April 24th, it reported a nearly 23M draw on inventories. If you’ve any doubt, this is a precipitous fall during the “slow season,” one where we typically try to build inventories for the summer high demand season. Products (i.e., gasoline, diesel, jet fuel) are drawing the fastest.

Crude draws are starting as well. Below are two graphs (a crude chart excluding SPR inventories (i.e., US commercial crude stock), and a second crude chart including SPR (i.e., total US crude stock). Commercial inventories are being supported by US SPR releases, but despite this, commercial crude inventories are still falling (i.e., the SPR release helps mitigate not eliminate the inventory declines).

We’re expecting further fireworks in the weeks to come, especially as May starts to kick-off the higher demand summer season. Just take a guess as to what prices will do then. Again, remember, even if the SoH were to reopen today, we’ll have another 2 months of logistics sorting itself out, so another 2 months of draws.

For the time being we’re at a stalemate. While the US and its allies can continue to manipulate the paper market to suppress the prices of oil, the inventory shortage will inevitably translate to price. (Say what you will about Zerohedge, but this is very likely to be true given the movement in oil prices yesterday with little headlines).

What’s an investor to do? Well, despite the above, we think Eric Nuttall’s tweet about crude inventories is ultimately the most fitting.

Barrels are draining and barrels will continue to drain as the stalemate continues. Every additional day the SoH remains closed, means Iran gains further leverage in any negotiation. In truth though, it effectively needs to hold out for one more month (here’s a Financial Times piece on the timeline).

It’s why we think the next step will likely be another US attack on Iran. What can’t be achieved at the negotiating table will have to be gained on the war table. The US has little leverage here other than blustering and bellowing for Iran to capitulate, but Trump’s desire for a deal is so intense and the potential impact to the global economy so unfathomable that Iran knows the longer it waits, the better the deal.

Unfortunately, a win for Iran is a loss for Trump, and hence, the chasm between their positions can’t be easily bridged unless one of them loses another chess piece. The clock favors the Iranians, and they know it.

As the weeks pass, something has to give, and Iran won’t unless kinetic action forces it to. After which, the table will be overturned, and everyone will pick up the pieces to see where things stand in the sand.

Tick tock. Tick tock.

Week 10 here we come.

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That’s Goldman’s estimate of production shut-ins for the Middle East. We had pegged it around 11-12M bpd, so a smidge higher we suppose.

Our original assumption was that the US/Iran War would end on April 21, the day the ceasefire ended. We wrote that to be conservative, with diplomats winging their way back and forth to Islamabad, there was a chance some sort of agreement could come to fruition. Hence it was safer to assume that a miraculous agreement could be crafted to resolve the seemingly intractable issues between the US and Iran (i.e., the Strait of Hormuz (“SoH”) closure and Iran’s nuclear enrichment program).

The deadline passed uneventfully though. This week saw the ceasefire extended indefinitely and the resignation of Iran’s Head of Parliament Mohammad Bagher Ghalibaf from the negotiations team. News reports soon surfaced that Iran’s Supreme Leader Mojtaba Khamenei had reprimanded the Iranian negotiation team for the first round of discussions because they had placed the topic of nuclear enrichment on the table. Whatever the reason, the IRGC and the Ayatollah appear to be in firmer control, which should mean harder line positions prevail. So off we go, finishing up a 7th week of this campaign. We’ve likely lost ~700M barrels of oil as of April 21st, and now that it’s apparent negotiations may take more time, we’re in bonus time. Like soccer though, we’ve little clues how long the bonus time will last.

The US’ blockade of Iran’s blockade is an attempt to apply more economic pressure, but since Iran largely sells its oil to China, those vessels have been unmolested. There’s little reason for the US to anger the Chinese, especially as their own meeting is scheduled for early May. So if a majority of Iran’s oil continues to flow, we do wonder, when is a blockade not really a blockade?

A Day of Delay, Keeps Lower Prices Away

The question does remain though, how long do the combatants have to survive this? The US believes it has effectively as much time as it needs, and certainly more than Iran. The idea is that Iran’s storage will eventually hit tank tops and in a few weeks, they’ll be forced to shut down wells. In contrast, Iran sees the global economy and postulates that the higher oil prices go, and the lower the stock market moves, the weaker the US’ resolve in furthering this war. It’s obvious the US wants to TACO and that a ground offensive is unpalatable militarily, strategically, and politically. Despite the headwinds, the stock market has rallied massively in the past 19 days. Moreover, oil prices have remained below $100/barrel even as the physical market indicates tightness. In fact, the administration is actually quite pleased with the current state of events, as it gives them the perception of leverage in the ongoing negotiations. Whether it really does or not is questionable.

On Saturday, the US is sending Steve Witkoff and Jared Kushner to Islamabad to engage with the Iranians. Takes about 16 hours to get there, so figure they’ll start chatting Monday. What’s telling is that the US didn’t send Vice President JD Vance, who led the delegation last time. We think this speaks volumes, as there’s still a chasm between the two sides. Frankly, we’re not entirely sure they can bridge it, but the Iranians will be going as well, though the two are not meeting directly.

The US will certainly not give up control on the SoH to the Iranians, and accept a permanent tolling system. Granting such a concession would be viewed as a strategic loss and anger the Saudis/GCC coalition. It could also impact the sanctity of the petrodollar, as the GCC would view the US as unreliable allies.

Furthermore, the US is seeking an agreement that’s tougher than the JCPOA for nuclear enrichment, but can Iran actually swallow such a bitter pill? We don’t think so. We don’t think so because Iran actually thinks it’s winning militarily (note: they are). Not in the conventional sense, but from the strategic one. They still control the SoH even with a devastated air force and navy. Drones and mines are sufficient these days, and Iran has been effective in employing them.

The paper market and the stock market have been entirely dismissive of the supply outage. No thanks in part to the jawboning that’s created extreme volatility and higher margin requirements, which then dampen the risk appetite of traders. So oil languishes below $100/barrel, and it gives the generalists betting on technology, semiconductors, and AI, that all is well, and all will be well . . . because just look at the stock prices, we’re making money.

If so, then neither side has felt enough pain yet to force a compromise. Instead of malleability, we’re looking at recalcitrance and a prolonged period of negotiations.

So Monday it is . . . for the next round. April 27th. 6 days after April 21st. Multiply that by 14.5M bpd and we’ve just lost another ~87M barrels. For every week the SoH remains closed we’re looking at 100M barrels of crude never produced. That figure’s permanent, and it is real. Now the real drawdown in inventories will be less because of demand destruction (we think around 4M bpd) coupled with SPR drawdowns (3M bpd) will soften the impact, but SPR drawdowns are inventory reductions, just in a different pocket than commercial stocks. In the end, both pockets are on the same pants, and them pants sure be getting tighter.

In Totality

We’ve seen the tally anywhere between 700-900M bpd lost (not including the 200M bpd likely to be lost when the SoH starts to reopen because tankers are mispositioned and production restarts need to ramp). We’re also not factoring in any complications to restarting oil fields that have been laid dormant for a month, or refineries and infrastructure that need to be repaired.

This is fine.

This is fine right? No . . . fine is furthest from the truth. Asia’s cupboard is threadbare, and Europe is running dry. As US inventories drain in the coming weeks (because of the export demand as everyone pulls barrels away), prices will creep higher. Those that have not will buy from those who have, eventually pricing out the other have nots.

The US, the last location to drain given its distance from the Middle East has begun to see increasing draws. Product exports have recently hit an all time high.

Crude is following, as the weeklies have started moving.

In totality, our contemporaneous OECD tracker is starting to show the divergence overall (US/Europe/Japan/Fujairah).

Remember the above includes Japan, and Japan has stopped reporting product changes, but we can guarantee it’s down by tens of millions.

Inevitably, unless massive demand destruction kicks in, our global choice is between losing a historic amount of inventories . . . or unfathomable amount.

The first green dot is already set though. We’re in late April, so visible inventories will almost certainly fall to the indicated level. It’s shy of the 1B or more we think will be drawn from inventories because the above chart doesn’t fully capture the harder to see product stores. Again the safer assumption is 1B barrels lost as of now (inclusive of a 2 month ramp-up that sees the world lose 200M barrels), and every week thereafter another 100M barrels.

So at this juncture it’s really how much further do we bleed inventories down.

As the weeks play out and visible inventories start draining hard, we’ve little doubt that oil prices will recapture their highs on the front-end. Once the back-end of the curve starts to move, the E&P equities will also find a new floor. Contrary to commentators out there, we still think energy matters.

Molecules will rule over paper. While the paper market can hang on every Presidential tweet and distort what’s happening because volatility prevents market participants from seeking real price equilibrium, inevitably a stock-out will force the issue.

The haves will outbid the have nots, and you can take ours . . . for a rich price.

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(Link Below)

Open Square Capital Quarterly Letter (Q1 2026)

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That’s where we’re at. Sure the price of oil is well above $100/barrel today, but it’s $70/barrel at the back-end.

It’s a reflection of what’s become of the market all these years. One where energy holdings cratered to about 3% of the overall value, more than halving from 2022, and multiples more from earlier before.

It’s what happens when you spend most of 2010-2014 lighting shareholder’s capital on fire under the pretense of chasing growth. Forget profits, and the market inevitably forgets you. It is the weighing machine after all, and this sector has been found wanting.

So slam the overall value of a sector to 3% of the S&P 500, and it becomes a nuisance. Well actually neglected, as thinking it to be a nuisance means you’d actually have to care about it. Most don’t, so neglect it is.

As an investment analyst, follow a neglected sector for long, and you can watch your career die. Besides, there’s no investment banking fees to be had, so why even bother. Similarly, it’s a trash bin of companies with terrible capital management, so if anything you can short it. Over the long haul, if there’s a way this sector can torch capital, it’ll find it.

So we’re left with 3%, and when the current energy crisis struck, there were fewer analysts to cover it, let alone to understand it. The only group remaining were those who’ve been buried in the sector for so long that they can instantly recognize the crisis for what it is . . . not short-term.

Others though will look at the futures market for confirmation. See? It’s predicting a cheaper price in the near future. Just look at the chart from Javier Blas.

$70/barrel by December! All will be well. Well . . . that’s not quite what it’s saying, but okay. Who are we to quibble, we’ve only been doing this for years.

We are the 3% after all.

The one great thing about social media (and especially Twitter) is the near instantaneous expert commentary (real or otherwise) that appears whenever a novel issue breaks out. As the US/Iran War wages on, market generalists have freely opined on geopolitics, military strategy, energy flows, and the nuances of the oil market. Aided by their preferred AI agent, the analysis has been delivered quickly, boldly and confidently.

This won’t last long they say, it will be painless, and once the Strait of Hormuz (“SoH”) is reopened, oil prices will plummet below the levels seen in pre-conflict. A peace dividend for all.

Frankly we don’t know. We don’t know what the day after will look like, the Day 1 after the all clear sounds. Can it end on April 15th? When Trump’s “2-3 weeks more” nears its end? Will Iran let him walk away, and reopen the Strait? As of now, we’re not entirely sure this thing doesn’t go far, far longer.

As this war drags on, the global energy situation will worsen. This is a 10-11M bpd deficit, and it will quickly carve-up the world. There will be the haves and have nots, those who can afford the exorbitant prices, and those who cannot. Those who produce energy domestically and those that do not. Third world and emerging markets like the Philippines, Thailand, Vietnam, Indonesia are going to feel the pain, but eventually that pain will migrate to Europe, and then the US.

Here’s some of the items we’re thinking through as the pain spreads, and why we think the pain lasts longer:

1. TACO - Trump Always Chickens Out works when things are unilateral (e.g., self-imposed tariffs), but in a war, it takes two to TACO and Iran has little incentive to eat and soothe the pain for the Trump Administration. This will drag on.

2. Abandon the Strait - Impossible. It would represent not only a strategic and tactical defeat for the US, it would subjugate Saudi Arabia, Kuwait, Oman, and the UAE to the whims of Iran in the future. Iran would effectively control nearly all oil flows out of the Middle East. In addition, given that China purchases most of Iran’s cargo, and Russia provides significant support, guess who benefits and gains further leverage behind the scenes? If the US was unwilling to let China gain an economic toe-hold in the Panama Canal, what makes you think they’d let Iran become a toll-taker in the Strait of Hormuz? Walking away isn’t a viable option.

3. Existential Threat - By removing the Iranian leadership and attacking Iran’s infrastructure, the remaining members of the IRGC know that this is a fight to the end. There’s little daylight to negotiate when everything is on the line, and they know the US/Israel could attack again in the future. If it’s a choice between our lives and your global livelihood, they’ll bet on the world blinking. This effectively extends the conflict and forces participants up the escalation ladder until the pain becomes unbearable.

4. The Price Gap - few appreciate the magnitude of this deficit because the prices aren’t accurately reflecting it. Whether it’s the jawboning, or the belief that this war can end immediately, there’s plenty of reasons for skepticism. Ironically, the artificially lower prices actually forestall real conflict resolution, and in fact allows the US and Israel to press their attacks. This reinforces the market’s optimism because all they see are successes of targets being bombed and the tweets about Iran’s inevitable capitulation. The war, however, continues, and the SoH stays blocked. Yet, since the back of the curve is at $70/barrel, then surely we’re fine? We are not.

5. SPR - the Strategic Petroleum Reserve releases aren’t a salve. It’s a bandaid on a bullet hole. The volume is insufficient, and the value is questionable. At full capacity, we think the SPR can release 2.5M bpd against a 10-11M bpd global deficit. In addition, much of the 400M barrels of SPR release (e.g., US’ 176M barrel release) was designed as a loan so refiners would need to pay back the loan at a later date with interest. Refiners are balking at that currently so the uptake on SPR barrels have been tepid. Eventually though, if there’s not enough barrels outside of the US, you can surely bet that US exports will ramp higher.

6. Immediate return - there’s a perception that once the SoH is reopened the barrels will quickly return. Logistically given sailing/discharge times, we put that at 2 months. So even if the war ended today, it would take 2 months to sort out the logistics of transportation, and for the first barrels to show up. The delta between supply/demand will shrink as the weeks move on, but we should expect inventories to fall further even after a ceasefire and detente is declared. Having said that maybe . . . and just maybe the curve is correct. It’s expensive today, but if it clears up, prices should fall, but stay elevated for a few months, and then head lower, though still remaining in backwardation, and still much higher than before.

7. Inventories - there’s also a perception that because there’s so much inventories on land and on-the-water, we can easily drain and handle a 1B barrel drawdown. That’s an illusion. If we continue this war until mid-April, we’ll have exhausted a significant amount of oil-on-water, and land inventories. By the end-of-April, analysts anticipate that close to 1B of barrels of oil are lost for the entire year when all’s said and done. This isn’t unreasonable given the 10-11M bpd of shut-ins, coupled with a slow logistical return. None of this is taking into account any damage to field integrity, etc. for oil fields that have been shut-in for so long. Kuwait estimates it would take 3-4 months to bring production back online. Hardly surprising as you’d need to repressurize the field and conduct tests.

For the time being, inventories are draining from oil-on-water first as the physical air pocket increasingly impacts other regions besides Asia. As the last oil is delivered, watch inventories on land drop precipitously. We’d expect to see product stocks fall first, and then eventually crude. For some OECD countries like Japan, they’ve already stopped publishing data on product inventories, which tells you a lot about the direction of their reserves already. Europe is next.

Sum it all up right now, and the charts don’t look that bad. The issue though is its early stages, and the data lags a bit. We’re most definitely hemorrhaging inventory here, and it’s only just beginning as the Western world will begin to see the impacts this coming week. The data’s starting to trickle in, but doesn’t fully capture the lost barrels. The irony is that the US, whose actions are causing the closure, will feel it last and likely feel it least. Inevitably though, energy is a global commodity, and despite being a net exporter, US prices will catch-up.

We believe the oil price curve is completely mispriced here given the duration and quantum of outage. A $5/barrel bump at the back end of the curve doesn’t adequately reflect the lost barrels. If anything, the minor bump represents hopium that immediately after reopening we return to past.

We completely disagree. Geopolitical uncertainty, inventory depletion, and supply balkanization/uncertainty moving forward means longer-term oil should be somewhere near $90/barrel even if the war were to end today. Given that it is not, and on track for another 2-3 weeks?

Expect triple digit prices to stay. Especially if the US does send boots on the ground (our base level assumption), and their stay isn’t short (also our assumption).

So price oil at the back end at $70/barrel (and energy equities too)?

We’ll see you on the other side of that trade.

God Bless America and our troops.

After a month of conflict, we can all assuredly agreed that the Iranian excursion was at best . . . ill advised, and at worst . . . well . . .

So we wait for the weekend as special forces (Tier 1 operators), a Marine Expeditionary Unit (“MEU”), the 82nd Airborne, land based fighters and bombers, and coalition forces assemble to capture some of Iran’s islands in an attempt to unblock the straight.

Will they succeed? Absolutely.

Tactically that is.

The tactical/military superiority of the US armed forces can’t be denied. They’ll almost certainly take whatever land, air strip, port, or oil infrastructure they set out for, and with minimal casualties. Of that we’re fairly certain given the poor training and degraded Iranian capabilities.

What we’re uncertain of though is whether a quick strike and victory, necessarily gives the US sufficient leverage in its negotiations. Negotiations that are seemingly getting more desperate by the day.

Among the few options floated include taking Iran’s strategically located islands in the Persian Gulf.

First, the US could take Kharg, Iran’s oil export terminal on the top left hand corner of the map above. Second, it could take Qeshm on the bottom right. Kharg, a major export terminal would be beneficial as it would shut-down the main spigot for Iran’s oil exports. Iran can divert its supplies, but not as easily, and not in full. Yet if the US was already willing to unsanction Iranian oil for fear of harming the oil market, it’d be inconsistent to then capture Kharg, and jeopardize flows there. Still, in trying to gain leverage, capturing Kharg would be the way to go. It’s much further in the Persian Gulf though, so would require a longer logistical tail to hold, which increases the military risk. Kuwait or Saudi Arabia’s assistance could help as they could resupply the troops from there. Still though, would the US be willing to completely shut-off flows when oil is already impacted? We’ll see.

Alternatively, the US could capture Qeshm. Currently, Iran is demanding that the US recognizes its right to control the strait (one of a list of 5 demands), and it’s using the waterway between Qeshm and the mainland as a toll gate. Capturing Qeshm would deny the Iranian’s the ability to use the facilities there. Issue with Qeshm? As you can see, it’s much larger. It would also likely mean ground operations in Bandar Abbas, and that means you’ve landed boots on Iranian mainland soil, which will take the entire war up the escalatory ladder.

Would it Matter Anyways?

Regardless of what the US does, what doesn’t immediately disappear is the asymmetrical threat posed by the Iranian drones and mines. If so inclined (and able), Iran can send enough drones to overwhelm the naval escorts when they cross the strait and/or at least pester the commercial tankers. Even if the escorts were successful, the disruption, logistical burdens, and insurance/economic costs likely means only 20% of the original traffic can be restored. Here’s Vice Admiral Kevin Donegan of the US Navy (in an interview with Goldman Sachs).

20% of normal flows? That’ll hardly make a dent in the supply outage.

Besides, we’re skeptical that sending boots on the ground means the Iranians will quickly capitulate as they only need to drag the war out for another few weeks. If Iran can keep the strait closed, or materially disrupted for 2-3 more weeks, we believe the global economy will come crashing down, deterring future aggression from the West.

So would they be willing to sacrifice a tactical loss for a strategic victory? Yes.

Today, we continue to have nearly 10-11M bpd of production shut-ins. Exports through the Strait of Hormuz are down by nearly 15M bpd, and SPR releases are just beginning. Despite accounts on Twitter sharing that some vessels have passed, it’s a far cry from the norm. Vessels traversing the strait are the exception and not the rule.

More importantly, production shut-ins are topping 11M bpd, and will take weeks if not months to fully come back if the war were to end today. You think we can last? Asia is already in full emergency mode:

1. Philippines - have declared a national energy emergency program, 4 day work weeks, and directives to limit travel and reduce power usage

2. Thailand - mandatory work from home for civil servants, strict air conditioning settings to save energy and subsidizing product prices;

3. Pakistan - 4 day work week for government offices, closed schools and cut fuel allowances

4. India - restricted LPG usage to ensure supply to households

5. Sri Lanka - limited fuel purchases and made Wednesdays a holiday for fuel consumption.

6. Japan - suspended public reporting of product inventories and intervening in the paper market to suppress prices. Restricting exports of petroleum products.

7. South Korea - implemented petroleum price caps and public energy savings program.

8. Australia - introduced export curbs on refined products (the country imports roughly 80-90% of its petroleum products). Relaxed fuel specifications.

Note that this is this week only, and countries are beginning to buckle. Even if the war were to end today, it would still take weeks to restore product flows and transport crude and products to the impacted countries. By next week, Europe will begin to feel the pain as the tankers that would normally show-up don’t.

This slow-rolling outage will accelerate in the coming two weeks, and by our estimates, if a resolution and immediate resumption of supplies doesn’t occur, we’ll have lost so much inventories (i.e., ~450M barrels) that inventory reserves will be depleted and prices will begin to moon. Any longer, and the scarring will be severe. Energy Aspects estimates if the outage lasts until the end of April, we’ll collectively lose 920M barrels of liquids. That my friends is nearly unfathomable.

Complacency

As of Thursday’s close, the SPY and QQQ are down only 5.6% and 6.4% year-to-date, respectively. Trump’s back and forth about striking and not striking energy targets in 5 day, and now 10 days, has flip flopped the market. After each TACO though, the market rallies are getting weaker, and oil prices have fallen less. It’s a dangerous indicator that the TACO-ing is becoming less effective. The paper market can be fooled, but the physical market is starting to discipline as the molecules just aren’t there.

Unfortunately, unlike the US’ unilateral tariffs, it takes two to TACO this time, and will Iran bite this time? Only to give up all of its strategic advantage just when the leverage will soon swing decisively in their favor? Only to negotiate with a Trump Administration that has already burned it twice (i.e., attacking during negotiations)?

We’re doubtful.

The nuclear option outside of developing a nuclear weapon was always to weaponize the Strait of Hormuz. It was simply unthinkable because of the global consequences. Who would decide on such a pyrrhic strategy? Apparently, someone facing an existential crisis.

They’ve finally done so, and that missile has been fired directly at the global economy. So fool them once, shame on us. Fool them twice? . . . they’ll let it burn.

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(Disclaimer, we hold plenty of energy equities, USO/BNO, and shorts on select tech companies. Due your own due diligence, but for the love of all that’s good . . . be careful out there in the coming days.)

Just not today.

We’ve stepped into Iran’s hurt locker, and now enclosed, we’re still swinging away.

Doubling down because that’s what people with strength do right?

So the USS Boxer joins the USS Tripoli and its MEU in the Gulf. We won’t speculate what the MEUs will be used for (e.g., Kharg Island or the shoreline next to Strait of Hormuz), but just simply look at timing. It takes about 3 weeks for an MEU to sail from the West Coast to the Gulf. USS Tripoli will arrive before that (sometime next week), but even if it’s successful in gaining a tactical victory and taking a strategic foothold, would that compel the Iranian’s to lay down and accept a full ceasefire and peace accord? Doubtful, which means this excursion likely drags on for another 3-4 weeks.

We doubt it because by the end of next week . . . we’re bingo fuel.

What we mean by that is we’ll have effectively wiped out the entire “glut” built last year. Moreover, we’ll be dipping into commercial inventories, the draining of which will make oil gains go parabolic in the West.

Oman is at $170, Dubai at $150, Asia at $150, Europe is at $110, and the US? $98. Whew . . . only $98. Don’t exhale though because it’s coming. A slow zombie horde of undead prices. Here’s JP Morgan.

Next week, oil prices will creep higher as the shut-ins continue and supplies falter. Despite the tumult, the S&P 500 and QQQ are only down 4% year-to-date. This insouciance will allow the administration to keep wandering down its chosen path. Fair enough, but every day this continues, means another dollar added to the back of the curve when oil supplies resort themselves. We think even if the all clear sounded TODAY, we’re looking at $80/barrel oil when the fog-of-excursion lifts. If you need marines to land and force a capitulation in three weeks? Triple digits. Goldman agrees . . . higher for longer.

So what’re we doing about it? Well, let’s just take a quick look at Occidental Petroleum (“OXY”) and one of our holdings, and how we’re positioned for the above.

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We’re trying to desperately find one, but the consequences are all unpalatable. Declare victory and walk away? Strengthen the enemy long-term. Give up? Never. Deploy the full power and might of the US armed forces? Embrace the tar baby. There are no good choices right now.

This was one of the worst strategic blunders, made on the basis of hubris, supported by faulty information. For months, the investment community and government agencies were peddling analyses that we were witnessing one of the greatest global glut in oil ever. JP Morgan, Goldman Sachs, the IEA.

Nearly everyone.

The IEA anticipated a 2.3M bpd build in 2026. Goldman came in below that at 0.8M bpd.

This narrative was so pervasive it stuck. So armed with wrong assumptions, and fresh off the back of a successful Venezuelan regime change, Gaza takeover, Hezbollah decapitation, and global economic arm-twisting, we ventured forth to pursue regime change in Iran. Quick and easy right? This my friends is the very definition of FAFO.

So here we are today, one where oil prices are ticking higher as the war, err excursion, no wait excursion to prevent a war plays out. Whatever this was/is, it’s a bad trip. The US can and has easily achieved some tactical victories, but strategery-wise? Not so much.

Since we last wrote, oil prices have climbed from $85/barrel to $120/barrel, only to have fallen back to the current $95/barrel level after President Trump shared that this will be a “short” war, and that Iran’s military capabilities are being materially degraded.

Fair enough, the market immediately sent oil plummeting to $80/barrel. In addition, the IEA in coordination with various countries decided to release 400M barrels of oil from their strategic petroleum reserves (“SPR”). In the US’ case, 173M barrels, to be available next week (for refiners to bid), and to be delivered over 200 days. Since SPRs in every country can’t deliver more than 3M bpd combined, we’re not sure how that fully offsets the nearly 15M bpd currently lost.

Even as these salves were prescribed to ease the market’s discomfort, Iran began mining the Strait of Hormuz and attacking ships anchored in the Persian Gulf or attempting to run the blockade. The escalation quickly eroded the market’s confidence that all is well, and that all of this will be completed in short order. Accordingly, oil prices have risen again.

Financial Impacts

The broader market though, has largely shrugged off this whole episode. For the most part, it’s flat. Sure there’s significant volatility, but here’s the performance of the indices since the beginning of the our excursion on February 28 to March 13:

S&P 500 -2.5%

Nasdaq -1.1%

Russell 2000 -4.8%

Other than the Russell 2000, the broader market has largely shrugged off these attacks despite the disruption to oil, petrochemicals, fertilizer, noble gases (e.g., helium in semiconductor industry), etc. Arguably, the US is better positioned to weather the energy supply shortfalls, but with its just-in-time supply chain, eventually the inflationary costs will rebound as manufacturers worldwide struggle with shortages and higher energy prices. The supply chain can hold-out for a brief pause, but as the days roll-on the damage gets increasingly exponential and calcified.

We think the market’s overly complacent here. The buoyant stock indices mean the market is predicting a rosier future, one where energy prices might come out of this whole debacle actually lower.

Is that possible? Maybe. Maybe if the US cowls Iran . . . but man-o-man, that sure seems doubtful right now.

What we do know is that each day the market fails to fall, it further grants Trump carte blanche to continue his attacks unabated. In turn, the longer the attacks continue, the greater the harm done to oil supplies and oil prices in the future.

That’s the calculus. It’s the US vs. Iran vs. the stock market/global economy. Who will capitulate first?

So let’s level-set again. Oil exports out of the Strait of Hormuz runs about 20M bpd. ~150 vessels of all types (i.e., petroleum, container, agriculture, etc.) traverse this 22 mile channel. It’s shallow, so the crossing corridor is only about 3-4 miles. Surrounded by mountains, Iran has numerous places to launch drones both in the air (UAVs) and water (USVs) to disrupt the flow of traffic. Tack on mines too (buoyant, rising, CAPTOR (torpedo launching)), all deployed from fishing trawlers, or dhows (junk trading vessels). There’s thousands of those, so deconflicting the area will be difficult.

Plus, it only takes one hit to ratchet up the economic costs. One drone getting through, or one mine causing damage means the whole market gets repriced. Even a minor disruption can be material. If 150 vessels a day transited the SoH, what happens when only 130 do? Isn’t 20 still a material disruption?

From purely an oil perspective, let’s do some math on what’s actually happening. 20M bpd of oil flows through the straight. A few hundred thousand to about a million barrels are still flowing as Iranian exports to China continue. The Saudis have also reversed a pipeline that runs East/West and can potentially redirect 5-7M bpd there, so the disruption is around 14-16M bpd.

The oil isn’t entirely lost though because if the artery is plugged, producers can shunt it to storage for a limited time before they have to shut-in their fields. Unfortunately, the IEA reports that ~10M bpd of production is currently shut-in as storage tanks are getting closer to full capacity. Note that this is the most important figure because it’s the real production that’s lost. So take that 10M bpd and multiply it by the number of days, and you’ll start to see some large numbers. 100M barrels in 10 days alone, 200M in 20 days, and that’s not even factoring in the delays if/when the US and its allies can reopen the strait and how long it takes the ships to get refueled, repositioned, and sailing again. Ripple that through to inventory balances, and assuming 1/3 of that impact shows up in IEAs inventory figures, and you suddenly get a base-line of $90/bbl (i.e., the price oil should fall back to once all is said and done).

It’s the difference between a hiccup in your supply chain vs. a real supply shock. Stock-outs are what we’re worried about, and life is coming at us fast.

Prolonging the stock-out though is effectively Iran’s strategy. It’s two-fold right now,

1. Deterrence - make this endeavor so costly that strategically, the US, Israel and any other ally will be deterred from attacking Iran again;

2. Resilience - no matter what you do, this regime will survive. More importantly it can survive longer than the stock market and global economy can hold-out on such a large supply disruption.

Unfortunately for Trump and investors betting on a TACO (i.e., Trump Always Chickens Out), the timeline this time isn’t entirely in his control. For the most part, the clock is ticking, but that clock isn’t controlled by the West. The longer this lasts, the higher the economic pain, and it behooves Iran to keep testing that pain threshold. Closing the SoH, or even threatening to close it, gives them the ultimate leverage in any negotiation. Attacking oil infrastructure through the Middle East also encourages the Saudis, Kuwait, Qatar and the UAE to call on the US to bring about a ceasefire/truce on terms favorable to Iran.

Oh wait, they know that.

So for Iran, each missile launched, each drone sent, is an invitation to their hurt locker. Spread the pain and really test everyone’s resolve. The desire to exact revenge and retribution will also drive Iran’s thinking. While it has been weakened, and not immaterially, it knows that this battle is existential, and if they’re playing the trump card of closing the SoH, it better be for a larger pot.

Kinetic Affects

As the US and its allies are still marshaling naval and ground forces in the region, it will take another few weeks before a proper military escort can begin to break the blockade. In fact, likely month-end.

Tack on the repositioning of combat troops and we’re looking at least another few weeks.

Our rule of thumb is that oil prices will rise $1/bbl, conservatively, every day this excursion continues if we assume 10M bpd of shut-ins (i.e., real production lost). What we mean by that is every day the SoH is closed, equates to about $1/bbl of premium when we “return to normal.” If everything gets sorted by month end, we think this is what inventories and oil prices will look like.

Any longer than that, and we’re rebasing higher. Two caveats: first, there’s bound to be some demand destruction as oil prices climb, airfares getting expensive and road trips not taken, but the world can likely keep calm and carry on for a few weeks (so we’ve disregarded that for purposes of this exercise). Second, you’ll notice that in the chart oil prices have previously dislocated from inventories since mid-2024. That’s largely because of the calls for “inventory gluts,” etc., so tack on whatever discount to the $90/bbl fair value you think is appropriate (i.e., the discount that you think will “survive” even after this debacle). Suffice it to say if oil stuck around in the $80s after kumbaya breaks out, oil companies will print money (they need to if the world wants producers to increase production).

We don’t know when this will all end, it could end suddenly and oil can plummet, but what we do know is that the US is beginning to manipulate oil prices . . .

. . . and trying desperately to find a palatable political narrative . . .

All of these shifting statements and market manipulations will prevent real price discovery. It’ll deter producers from drilling and pumping more because of the potential volatility. Furthermore, it prevents the market from responding to the real shortage, and shifting enough capital to address the issue, which will inevitably exacerbate the issue.

Ultimately, selling financial paper and lowering prices via press statements can suppress oil prices for a bit, but the physical always disciplines, and the Iranians know that.

Again, this is a race against the clock, but the Iranian’s are holding the watch. The longer this lasts, the higher oil climbs.

Welcome to the hurt locker.

Iran’s one of those topics where we have a lot of opinions about, but very few convictions in with the uncertainty so high.

As the US engages in “offensive operations” against the country, we’ve just started Day 6 of this conflict. Iran’s now effectively blocked the Strait of Hormuz, a small maritime chokepoint in which 20% of the world’s crude oil flows. It’s not only narrow, but fairly shallow in certain areas, so even in the best of times, it requires careful coordination when moving VLCC behemoths in/out of the Persian Gulf.

Lob a few drones at anything that transits there and you effectively plug it. Lest you’re a daring owner cut from the same cloth as Jack Sparrow and you run your tankers at night with your AIS turned off to break the blockade, most will stay away. Still that’s a lot of risk to take, and for most multinational shipping companies, one they’re unwilling to take even if you give them adequate insurance coverage. Sure the US can backstop shipping insurance all it wants, but will they also cover the lost income if an Iranian drone sinks a ship? Unlikely. Will it cover the replacement value or the ship, or the fair market value of the ship? Who knows.

So thus the strait likely stays closed unless international pressure forces Iran to reopen it, well really the IRGC. For now though, that pressure won't come from Iran’s largest customer, China, because guess who’s still allowed to transit the passageway? That’s right, good ‘ole Xi Jinping, and everyday this “operation” continues, Xi gains increasing clout. Besides China, no one else is willing to transact with Iran today, and later when the country needs to start rebuilding, guess who’s at the front of the line for those contracts. So yeah, the strait’s closed . . . but not to China.

Shutting-in Supplies

Oil prices have vaulted though due to all these shenanigans. Climbing from $73/barrel on Friday to today’s $84/barrel.

That’s 15%, give or take, and it’s just the beginning if the situation persists. How high really depends on how long this goes. The longer the strait is closed, the more storage facilities in Saudi Arabia, Iraq, Kuwait, and the UAE fill-up. Once those tanks are filled, then production shut-ins start to happen.

Iraq has already announced a cut to oil production of nearly 1.5m bpd. If that doesn’t sound like much, Iraq produces 4M bpd, so yeah, that’s plenty. It’s inevitable though because spare storage is finite at ~300M barrels in the region. So by 2-3 weeks time, we’ll fill those puppies to the brim, and then force the fields to idle.

In turn, that shut-in translates to an increase to oil prices by $10 to $15/barrel for the month, so think $85-90/barrel for Brent. In the short-run, it’ll almost certainly exceed that if we cross longer than 10 days . . . and we’re nearly halfway there.

The market though (as represented by the S&P 500) has been fairly nonchalant.

It’s barely down in the past 5 days, and it’s almost certainly looking at a TACO scenario whereby Trump Always Chickens Out. It’s willing to overlook the near-term rise in oil prices (we are after all “glutted with oil”), and the temporary bump will not only prove fleeting, but even more encouraging is that once the Iranian populace revolts against the IRGC, we could see oil prices decline even more as the vast production potential of that country is unleashed.

Never mind the political uncertainty a toppled IRGC will lead to, or the sectarian issues that’s deeply embedded in that region. No doubt 100K former radicalized IRGC members will blend quietly back into a new cosmopolitan Tehranian life, and all will be well.

Call us doubtful.

Still, this is the path we’re on. Despite the rhetoric of the administration, this endeavor doesn’t appear to be fully thought through. The administration is likely counting on a quick capitulation. Flush off the success of Venezuela, the surprise surgical strikes in Iran should bring about a regime change as protesters reappear. Our good deed in Venezuela worked, so no doubt it’ll work in Iran. Moreover, oil prices shouldn’t rise too much right? We have nearly 4M bpd of spare capacity AND a super-glut of inventories, so the oil market will stay calm. We firmly believe that’s what they believe, and as you know, we firmly believe that it’s wrong.

So based on these faulty assumptions, and limited past success, we’re off to the races in wiping out the IRGC leadership. It’s regime change we’re after, so it’s existential for the IRGC. So surely, they’ll go quietly into the night.

Yeah right. There’s no way. Iran will continue to lash out at its neighbors and ratchet the pressure on the global economy. It certainly knows that the longer it can last, the better it will survive. The US can only continue its operational tempo for so long. Given the sheer distance and the vast size of Iran (i.e., larger than Alaska, and more than twice the size of Texas), the ability to project air power is finite as men and machines invariably wear down. There’s also a plethora of hiding places in the mountains for Iran’s weapons, and they’ve no doubt become adept at shooting and scooting.

So bear down and survive. Iran knows there’s two things that can end this conflict . . . the market and munitions.

Munitions & Markets

The market’s patience, and dare we say complacency, is limited. Continue to block the strait and eventually oil prices will leap so high that demand destruction (i.e., a recession) must follow. It also isn’t just the Strait of Hormuz that’s the issue, Iran’s attacks on lightly defended refinery complexes in the region also shuts in production. Saudi’s Ras Tuna’s refinery (550K bpd of processing), Kuwait’s Ahmadi refinery, Qatar’s Ras Laffan LNG complex, and Bahrain Petroleum Company’s Ma’ameer refinery (400K bpd) have all been targeted. Attacks and repairs halt production, which increases the need to reroute or store the incoming crude. Damage enough infrastructure and you’ll force producers to shut-in production. Translation - everything and anything is up for grabs, my pain is your pain.

The cumulative impact is real. The longer the conflict goes, the more the pressure grows. If energy prices vault as a % of GDP (as it did in 2022), it will cascade the market.

Trump ties his personal and presidential success to the stock market, and if the real time report card starts to slide, then the odds of a TACO Tuesday ramps higher. What isn’t clear though is what happens after. Can he TACO if the IRGC remains intact. Can he even TACO at all?

He can certainly declare “Mission Accomplished,” but like the ill-fated Bush declaration, the knock-on effects of an even more dangerous and now betrayed Iran grows. Good luck negotiating with that, and we all better tighten our borders.

Munitions is the second issue. Eventually, the US will run low on stocks (both offensive and defensive weapons). In fact it already is.

It’s started shifting missiles from Asia to the Middle East, which tells you what inventories are really like for the US and its allies. Missile stocks are quickly dwindling given the sheer number of threats. Just today Bahrain intercepted 75 missiles and 123 drones in a refinery attack, but can it do the same the next time? Even after downing so many weapon systems, the refinery was still struck. What of its other neighbors, or even more lightly defended targets? As inventories fall, drones and ballistic missiles will start getting through with increasing frequency despite Iran’s lower launch rates. So it’s a race between finding and destroying the launchers vs. the rate at which defensive missiles deplete.

Tick Tock

Regardless of what happens, there’s a ticking clock here. The longer this goes on, the more pressure the US will face to cease hostilities and look for an offramp. Product prices (i.e., diesel, gas, jet fuel, etc.) are already roofing as refineries are taken offline (either because of lack of crude supplies or refinery attacks), and as prices climb at the pump, political support will degrade further. Inflation was already one of the largest issues in the upcoming midterm elections, and that was before energy prices climbed higher.

For Iran? The calculus is much simpler. Just-in-time refinery operations worldwide provide little to no resilience for our global energy market. As their attacks persist, as they continue their oil blockade in the strait, even for a short while, the market shock will force the US’s hand. Sure OECD countries and non-OECD countries will likely release supplies from their Strategic Petroleum Reserves (“SPR”) in short order, but if Iran is disrupting even half of the flows in the Strait of Hormuz, the 10M bpd loss will still be quickly felt worldwide.

We’re on Day 6, and thus far this is an energy shock, and one the world is unprepared for if it crystallizes and far too complacent about. So said another way? We think this has to go higher for the economic pain to be real. We have to go risk off before we can dial the risk back. Markets are like people in that they only really change when the cost of something becomes far too great to bear.

$84/barrel today just isn’t there yet, so the beatings will continue . . . until morale and oil prices improve . . . and they likely will.

That’s the rough figure we use for Occidental Petroleum (“OXY”), a company we’ve been holding for a bit. This one’s been in the dog house for awhile after recently closing the CrownRock acquisition and selling its OXY Chem division to Berkshire Hathaway. The stock’s languished as oil prices trended lower in 2025. Having shed $10/barrel from $70 to high $50s, OXY similarly sympathized and fell by $10/share, give or take.

So $10 x $10. The’s ur rule of thumb. It essentially means that for every $10/barrel oil price moves, we’d expect (all else being equal), OXY’s stock price to move $10/share. 10x10.

10x10 . . . well that is, until this quarter.

Because finally, we’re getting some traction.

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It’s something I have saved on the desktop. Nothing obnoxious, it’s unobtrusive, but it’s there.

I’ve had it for awhile now.

I’ve seen it repeated, many, many times, and in many places.

Sometimes on the things I own, sometimes not. Fortunately, not so many.

The chart doesn’t always repeat, but in Mark Twain’s parlance, history sure does rhyme.

That’s not surprising though because human nature isn’t surprising. We get bulled-up, we get excited, and we get greedy. Then the euphoria rips, and the grifters grift. The institutions legitimize it and the investors harp it. The media focuses on it and retail gets swept up in it.

Then . . . and only then, is when it tips, and when it tips, is when we all get nervous. Michael Burry it seems, senses some nervousness (his chart below for Palantir).

For some, nervousness lends itself to bravado. “I want IT to crash, so I can buy more!”

. . . no you won’t.

Nervousness lends to seek answers “What do you see in the charts? Where’s it headed?”

. . . I don’t know, but maybe down?

Nervousness leads to questions “Why isn’t the management team defending the price?”

. . . they were busy selling.

. . . and buying things that surely speaks to the revolutionary nature of what they’re doing . . .

It doesn’t matter though.

We don’t understand it. All the US government contracts, all the software platforms, Gotham, Foundry, AIP, and Apollo. Awesome game-changing, face ripping, sweet-mother-of-GOD dashboards and tools that allow companies to manage their supply chains, detect financial fraud, and hunt terrorists . . . simultaneously.

Such an endeavor cannot possibly be valued because we simply can’t comprehend the types of services their consultant (nay . . . “Forward Deployed Engineers” (“FDE”)) provide. Got it?

No sir, these FDEs are embedded with clients and mission driven to engineer solutions to tailor Palantir’s proprietary platform to the client’s unique data-set.

Isn’t that what most consultants do?

Fine. Maybe we don’t get it. Maybe FDEs and their crack sales teams are AI ninjas that provide so much value that they can simply turn over random rocks to find billions of additional revenue each year.

Heck, let’s growth them at an even faster rate than today. How’s 70% to your liking? More than the 60+ they’ve been doing. Let’s be more aggressive because we simply don’t know. 70% every year for the next 5 years. How’s that look?

By the end of 2029, we’re looking at $37B in revenue! Quite honestly, amazing . . . but even if the stock doesn’t increase from the $135/share today, it’s still nearly 10x revenue. Again we go back to Scott McNealy’s quote reminiscing about the 10x revenue multiple investors were willing to pay for SunMicrosystem’s stock at the height of the internet bubble in 2000.

People today? Hold my beer.

. . . 72 TIMES REVENUE. Oh wait but that’s trailing 12 months. What of 2026?

Fine, 43 TIMES REVENUE.

Feel better?

Or do you feel nervous? Because again, take a look at this chart.

THIS. DOESN’T. INSPIRE. CONFIDENCE.

There’s an air pocket there. An air pocket in which the oxygen’s dwindling, and the fear is increasing. In all likelihood, fear will become extreme, and in time fear will turn to capitulation.

“It’s already fallen so much . . . I might as well keep it.”

When momentum shifts, then the cascade really begins as traders press it lower. Longer-term investors will hold though. They always do because of anchoring bias. Well actually every psychological bias kicks in, creating a toxic stew of stupor. So most won’t sell, most will hold. HODL they say.

Eventually this may all turn into despair and dismay. There’s few natural buyers in the wasteland. Very few who’d step-in to catch a falling knife. Perhaps a bit lower, some compounder bros will deem it worthy enough to take a look, but that chart will make any position small. A starter position if any. If their buying fails to arrest the landing, then lower we go. All the way to the floor, where the carrions of the investing world dwell. The grave dancers, the roaches . . . the value investor. Still, that time has yet to come. That’s further down the road and much further to the right of these charts.

Maybe this’ll come to pass, maybe it won’t. We own puts on the stock and are short common shares, so we’re certainly talking our book. We’re probably wrong, but just look at that chart. How’s the bravado feeling? It’s certainly a bargain today than it was yesterday . . . at 43x Revenue.

Yeah we’re nervous too.

“I want IT to crash, so I can buy more!”

You just might get your wish.

Please hit the “like” button and subscribe below if you enjoyed reading the article, thank you. (Disclosure: Note we own June ‘27 Puts with a strike price of $95 and other instruments short PLTR shares).

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What it was instead was “blah,” and “blah” doesn’t cut it when your subscriber base is shrinking and there’s fears around the durability of your business.

That’s the market right now though, and you play the hand you’re dealt. Anything short of glorious results will get scorched, and the market certainly torched the stock sending it promptly careening 30% lower on this one. Understandable, but as we look at the underlying results, we’re wondering . . . overreact much?

Small misses can lead to disaster though. Everyone knows that, heck there’s a proverb.

For want of a nail . . . the kingdom was lost.

What’s the nail you ask? It’s basically this . . . $30M of revenue, for a company with $2.5B in total revenue. So written another way $0.03B.

Yeah, slightly more than 1%. The reason is because this is about optics and expectations. The issue is PTON has declining subscriber enrollment, and though it is profitable, the Street wants to see top-line growth. If you can’t get subscriber growth right now, at least get revenue growth since you just increased prices in October.

Here’s what the annual guidance has looked like in the past few quarters. Though we ended FY 2025 with $2.49B, PTON’s guidance for FY 2026 in Q1 was $2.45B, so down about $40M. 1% year-over-year, not great, but maybe they’ll beat it.

Relaunched product line and increased subscription prices, awesome. Revenue growth right?

Nope.

For Q2, however, PTON really clipped out and fell out. The company had guided to $675M during the busier holiday season, and unfortunately for shareholders, ended up landing at $657M, missing by $18M. That miss, and likely whatever insight the company already knows from its busier January season (think NY resolutions to get healthy) resulted in the full year guidance falling by $30M ($18M from Q2 and likely $12M in Q3), thus leading to the further reduction in full year guidance from $2.45B to $2.42B.

Again . . . for want of a nail . . . the kingdom was lost.

The $30M and heightened questions around growth led to a near wipeout of the company as shares lost 30% of their value. PTON’s market capitalization fell by nearly $700M.

Said another way the $30M miss was valued at near 25x revenue. More accurately, the value’s really attributable to the market’s lost confidence in the company (i.e., the diminished faith in the investment community that a turnaround is afoot). If you can’t grow top-line, eventually the melting subscriber counts will catch-up to you. A company simply can’t cut expenses infinitum, and profits will eventually follow where topline goes.

Yet, there’s still time. The company is free cash flow (“FCF”) positive, and the existing users still love the product. This is still a very sticky business, and even with the price increase, subscriber churn rates didn’t blow out.

In contrast to the disappointing top-line, the bottom-line metrics continue to march higher as operating margins, Adjusted EBITDA and FCF have all been guided upwards as expenses have been brought down (both in totality and as a % of revenue):

The cost reduction efforts have resulted in an increase to the bottom-line guidance.

1. Gross Profit Margin increased year-over-year from 49.1% to 53% and for the full year PTON forecasts an increase from 49.6% to 53%.

2. Adjusted EBITDA has also been increased. At the beginning of the year PTON guided to $425M, and as of today, it’s guiding to $475M at the midpoint. We anticipate the company reaches $500M as we hit Q3.

3. Lastly, FCF has similarly been trending higher, guidance moving up from $200M at the beginning of the fiscal year to $275M as of today. Similarly, we think this will eventually land around $300M by fiscal year end.

As FCF lands, debt should be somewhere in the ~$200M net debt range, and ready for refinancing in about three months (May).

So where did we go wrong?

Subscribers

Well it appears that our internet scrape data pointed at too high of a subscriber count addition. Though interest/search for the new products was high, that didn’t necessarily translate to more sales. There could be a lag effect as the consideration cycle for exercise equipment is longer, but that would be too optimistic a view to take given the aggressive promotions PTON ran during the holiday season. If performance marketing didn’t move the needle then, what happens to sales afterwards once marketing budgets soften?

So while we had forecasted only about a 40K subscriber count lost, the company delivered a 71K reduction, and that’s a significant number of equipment not sold and subscription revenue not earned. Some of this could also be a one-off impact from the higher subscriber cancellations than we modeled (we used prior price increases as an estimate). Though that could be a factor, we think the 1.9% churn this quarter was still lower than anticipated, which means that as we lose subscribers, those that are left are the “hard core” users, and thus tend to be stickier . . . which is a long-winded way of saying . . . they likely didn’t sell as much equipment.

So where does the data point to today for Q3?

Ironically very near where PTON’s guidance is for the quarter. Still that Q2 miss sure does casts aspersions on the accuracy of that tracker (though you can see it has historically been very accurate).

We think it’ll creep back on trend though because the price increase last quarter did throw a monkey wrench into the entire exercise. Moreover, if PTON is guiding to the range our tracker is seeing (with the most important New Year / January sales already under its belt), that gives us comfort it’ll meet it.

Product Sales

What’s slightly more accurate was tracking PTON’s Cost of Goods Sold (as a proxy for Connected Fitness Products Revenue assuming a 15% margin).

You can see we can land fairly close to where PTON’s end up, but since it PTON missed earnings by $20M, it doesn’t take much for a small blip to swing our forecasted numbers. We assumed too high of a COGS, which led us to assume miss on the Connected Fitness Revenue. We’ll temper that forecast next quarter.

Keys to the Kingdom

So overall where does that leave us? Well it leaves us where we started.

FY 2026, which ends on June 30th, is a reset year. We just thought the inflection would start this quarter with the introduction of the products as a catalyst. This hasn’t panned out, which means we’ll need to reassess PTON’s other plans.

The company has slashed expenses, continues to repair its balance sheet, will refinance debt shortly, and re-introduced a new line of products. H2 2026 likely sees an introduction of a cheaper PTON Tread, which will help with attracting new subscribers. Again the treadmill market is nearly twice the size of the bike market and PTON recognizes that its treadmills are twice the average price of its competitors and uncompetitive in the marketplace. Lowering the price means tapping into a larger addressable market and potential subscriber base. This likely happens in the September/October time frame, which would be just in time for the holiday season.

More importantly, investors are still waiting to see what the other new vectors for growth will be. This won’t really start until PTON refinances its existing debt in May. Once done, it’ll lift the overly restrictive debt covenants that prevents the company from pursuing M&A to flesh out the product portfolio as Peter Stern pivots the company from fitness to wellness.

Investors are currently demanding that the company slash operating expenses to pay down debt. Fair enough, but once that process has run its course, what becomes of the enhanced FCF? That should be answered in May.

Remember, it’s about a return of capital and return on capital. We need to see both as investors, and Stern’s plan needs to begin snowballing as we get into the latter half of the fiscal year. We anticipate seeing more M&A, content licensing deals, and joint ventures as PTON moves the brand into other categories.

Ultimately, experiencing this sell-off was largely our self-inflicted. While the trackers are directionally important, we placed too great of an emphasis on their precision. Sales of new equipment did indeed turn out sluggish, and PTON has now been forced to reset expectations after a banner FY 2025 where they handedly beat and exceeded expectations. It can no longer only keep cutting expenses and enhancing the bottom-line to garner a higher share price. What matters is growing the top line, and while that’s difficult, it’s exponentially harder when debt covenants tie your hands. Those knots will loosen soon, and thereafter, we’ll get a better picture of how PTON reacts after getting knocked.

Though our confidence in the path forward is tempered, we can say with confidence that the sell-off is overdone. This is now a $1.8B market cap company generating $300M in FCF, with a very slowly declining subscriber base, and optionalities to the upside.

At 3.5x market cap to Adjusted EBITDA ($500M), or 6x market cap to FCF, we’re certainly in discounted territory. Again it comes down to the perception of growth (or lack thereof) of the user base. This investment hinges on it, and the market undoubtedly thinks the company won’t or can’t deliver. Therein lies the asymmetry. If PTON and its management team can nail that, then the shares will rerate considerably higher.

For now though the market wants a nail . . . before the kingdom is lost.

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