We’re bounding up the escalation ladder. Both sides. For sure one side, Iran, is shoving, while the other, the US, is trying to climb down.

Oil prices have vaulted in the past few weeks, and understandably (and predictably) so. We have, after all, chosen violence.

Like any high altitude expedition, once you embark on this adventure, it gets more treacherous as we head higher.

What we find interesting though is the complacency.

Despite this . . .

leading to this . . .

It’s the visible inventories though. That’s what people are focused on. Even with the Strait of Hormuz (“SoH”) disruption, we’re only really seeing visible inventories draw by 3-4M bpd, and a material amount of that was from SPRs. (Eric Nuttall’s chart).

So obviously, we’re wrong, or obviously demand destruction is occurring to absorb the 5-7M bpd that we’re “not” seeing (or 4-6M bpd if you even take out the fact that inventories were building around 1M bpd pre-war)).

Absurd.

It’s absurd because even a 5M bpd demand collapse (let alone anything more), would be tantamount to a COVID/pandemic shut-down, and last we checked, everyone’s still flying and traveling. Flights are still higher year-over-year.

We do readily admit that demand has taken a hit, likely about 1% or thereabouts worldwide, which translates to 1M bpd give or take. Small, but not hugely material when measured against the supply disruption. You can see it in the US figures. Since June, implied demand is about 1% lower.

Broaden that out a bit, and you’ll see a slightly higher demand hit in Europe and India. So it could portend for a larger demand hit, and likely will as prices rise here, but again . . . prices need to rise.

Extrapolate it further and just assume that the world is down slightly, 1%, or 1M bpd. That’s just still not enough, which means if we’ve lost that many barrels from the Middle East, and demand hasn’t fallen off precipitously, inventories must be drawing heavily elsewhere.

In fact, doesn’t it mean non-visible stocks are drawing worldwide? Doesn’t it mean product stocks are drawing globally? Doesn’t it mean China’s drawing crude and products heavily given that Chinese imports have been much lower this year?

We thought so . . . there just wasn’t much data for a few months, and we just needed proof. So it begins . . . as Goldman states in their latest report:

“Chinese gasoline/diesel stocks drew by 2.2/1.7mb throughout August, likely nudging Chinese refiners to raise runs.”

There it is. It’s starting to show-up, and why wouldn’t it? Eventually one would lead to the other unless high pre-war imports were all for SPR stocking (unlikely), or Chinese refiners ignored working capital (impossible).

Consequently, it does appear that China has started bidding again for barrels, which is driving up prices in Asia. With product inventories depleted, China will likely ramp refinery production here to avoid product tank bottoms. Furthermore, just take a look at seasonality, imports tend to rise historically into year-end, and product inventories increase as refiners turn that crude to products near YE/Q1 to be used through Chinese New Year and throughout the year.

Extra bonus if increasing imports now also puts more pressure on the Trump Administration with higher fuel prices, inflation, and in turn interest rates for the US midterms. Better yet, it also strengthens the Chinese’s hands in the upcoming US/China trade summit with Xi and Trump (September 24).

China’s restraint in Q2 coupled with the MOU, which allowed floating storage to destock in the Persian Gulf, helped calm the market over the summer and dampen the impact of the war on energy prices. With the global buffers depleted, we’re largely reliant on China’s largesse and inventories, but their willingness to extend a helping hand is approaching its limits. The country’s reentry into the market represents unwanted extra demand just as inventories have thinned. Without adequate supply, and with continued violence in the Middle East, the only solve right now is price, and a higher one (i.e., high enough energy prices to coax real demand destruction).

Unless of course you believe Iran will relinquish all of its tactical and strategic gains thus far (i.e., control over the SoH, de facto control of Yemen, de facto control of Iraq, control of the Red Sea, retreat of US forces from its military bases), reopen the SoH, and stop pressuring the US pre-or-post midterms? Yeah, we didn’t think so. In fact, just the opposite.

Hence as we grind higher, and as visible draws start to reflect the true cost of this war (as the “invisible buffers” fade away), just remember, we chose this.

We chose violence, and price violence will choose us.

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That’s where we’re at in all this. Just “declare” victory, and it’ll work out. If wars were only that easy.

We’re far beyond the point where nonsense surpassed common sense. In fact, Wall Street now has the privilege of paying $100K a month for early access to these gems. Today, we’re at the stage where propaganda has stopped working well, so we just throw gibberish against the wall and hope something sticks.

Behind the scenes though, they’re wringing their hands. Floating thought balloons to see how the public would react to a change in strategy.

Declare things are over . . . but preserve the optionality that they’re not. So get through the midterms with a facade of a victory, and then go full-bore again post-election (or appear to, so as to maintain toughness).

It’s a master class in “strate-gery.” This will probably go down in the history books as one of the greatest “self owns,” since we didn’t need it the campaign, nor did the public ask for it. We chose this out of bravado, ignorance, and incompetence. Hardly surprising though if you rename the Defense Department to the Department of War. Not surprising if war is actually what you get.

So here we are. Stuck and struggling.

Iran knows it. It’s winning strategically, tactically, and even socially. Their meme game is particularly strong.

It’s being played at a level that matches their ground game because despite being totally destroyed, it can still plink and plunk tankers here and there. Oil prices are reacting now, or at least more so, climbing from $75/barrel to today’s $91/barrel (WTI). Bond prices are also reacting (inversely so) as rates climb steadily higher with inflation.

Much of the recent rise in energy prices have yet to be captured in the inflationary data, but it will. Hard to ignore higher diesel and gasoline prices when it’s the direct inputs for so many products and services. It’s not just the spot, but the entire curve of energy prices that are starting to climb here. The market’s sensing (and rightly so), that this may just drag on longer than anticipated.

It’s not that the Strait of Hormuz is fully shut. No. Stuff is still getting out. Lot’s of stuff, and charitably we’d say “kinda” enough. We’re moving 17M barrels a day (says the US) out of the Middle East. That’s a fudge figure because it’s the “Middle East” and not specifically the Strait of Hormuz. Third party data service providers though are within 2-3M bpd of that figure. It’s a range, which is fine. We think many of these services are talking past each other, and you can find the answers in the nuance. The figures depend on whether you’re looking at weekly averages, 28 day averages, only SoH flows, excluding or including pipelines and landlines, etc.

Pick any of those figures, and it’s still a ton of oil moving out of the Middle East, or not . . . depending on whether you’re a bull or bear. We can all agree though that it’s likely still not quite enough. Let’s use the 17M bpd figure, if that’s right, then we’re looking at still a 6-7M bpd hole, or a whopping 40-50M barrels of week deficit. Here’s Goldman’s estimate as a reference point, 8M bpd.

To be fair, that roughly equates to the fall in demand, not end consumer demand, but refinery demand. Refinery demand is down substantially in Russia and the Middle East given the drone/ballistic missile attacks. Nearly 7M bpd.

So effectively, the lack of crude flow is matching-up with the lack of refinery demand. Real end user demand though has barely fallen. Consumers are still consuming, and if airline tracking data is to be believed (as it’s the most timely of indicators), we’re still happily slurping and traveling away our fuels.

It’s why margins have absolutely exploded higher. Here’s the 3-2-1 crack spreads.

Divide by 3, and you’re near $60/barrel. Tack that onto the price of crude and we’re already in the $150s range. There’s just a shortage of product, plain and simple. Typically refinery margins tie closely to crude, but given that refineries are the bottleneck, the margins today are accreting to refiners. Eventually though, two things can happen to reconcile that, either independently or together.

First, China.

If China ever decides to lift its product exports, then the increase in demand for crude will shift the historically high refinery margins to crude producers. The increasing demand for crude will lift prices, while the increased availability of product stocks will compress refinery margins.

Second, regardless of what China decides, if tensions ease in the Middle East and/or Russia, refineries (e.g., in Asia, the ME, and China) will start to source crude to ramp production, and while crude exports out of the Middle East will rise, the pull on crude will reset the floor for how high oil prices will stay. Suffice it to say, if refineries can ramp, then crude demand will strengthen as distributors restock depleted product inventories. To assume otherwise means you’d need to assume that refiners will refuse to capture the sky-high refinery margins, product inventories will stay tight, and demand destruction will eventually constrain consumption. We think that’s unrealistic and incongruous if things clear-up. If wars and the threat of attacks fade, we’ll emerge from the chaos with empty fuel tanks and a hunger to restart refineries to make some money.

The Lull is Over

As we wait though, the recent sugar high has faded. Immediately after the conclusion of the US/Iran MOU in mid-June, 80M barrels of floating oil stored in the Persian Gulf flooded the global market. Much of this was Iranian oil. As that oil made its way through the system, Asian imports temporarily lifted as the sugar rush hit. Satiated, US barrels were no longer in demand, and US exports fell lower. Couple the lower export demand with continuing SPR releases, and US commercial inventories rebuilt. It’ll now fade though. As Asian and European imports decline, they’ll again look to the US. The pull on US barrels should reassert itself as flows stay throttled.

We can see the brief uptick in the charts for crude after the sugar rush, but that’s faded. We anticipate crude inventories will trend lower.

As for products, we’re still exporting. The global and domestic demand is still there despite the high prices, so drain away.

The Wait Begins

We’re two months away from mid-terms and Trump is desperate to exit this quagmire, which is why Iran persists with its maximalist demands (i.e., $300B of reparations, removal of forces from the ME, acknowledgment that it controls the SoH, withdrawal of Israel’s forces from contested areas). The IRGC has calculated that while the US economic sanctions and blockade are hurting, there’s a strategic goal here that could be realized if they hold out for a bit longer. Complete deterrence, and control over the Middle East.

We think the status quo is unlikely to persist because as the US ratchets up the economic pain on Iran, it’ll increasingly lash out. Hitting tankers and oil infrastructure throughout the ME in an attempt to drive energy prices higher, increase inflation, and crash bond prices (as interest rates shoot higher). The near-term goal is regime change in the US, to weaken Trump politically via an economic cudgel, and for Iran, it’s the only way to break the US blockade.

We’re not entirely sure Trump can “walk away” either and declare victory. We’re quickly approaching a legacy defining moment for him. Once past the midterms, we think the US may reengage militarily after resting and rearming its forces. There’s a distinct possibility the US will attack again after electoral pressures fade because: a) Trump has nothing to lose, and b) he dreads being perceived as a “loser” after slandering others with the term. We think the unpopularity of the war among voters have muted the weapons and responses in the interim, but all gloves are off after November.

So tit-for-no-tat for now. The attacks will continue. They’ll continue from Iran, and they’ll escalate. What can they get away with, and what impacts are they having on the market. It’s a careful calculation, made with one drone or missile at a time. The US has refrained from responding in the past few days, eager to downplay the attacks so they can shift the news cycle. All the while continuing its blockade, hoping Iran’s economic pain will foment internal revolt.

For now, while the world waits, product inventories drain, and we think visible crude inventories will follow. Even under the most optimistic assumptions, we’re still not exporting enough, and given the volatility, supplies aren’t responding as producers have little incentive to commit risky capital.

Two months to midterms, and everything’s heating up. Like the administration, we’ll try to sit on our hands, but we just simply think they cannot.

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NOW

ServiceNow (“NOW”), the Santa Clara-based AI platform, has spent the last two decades turning itself into the default operating system for enterprise workflows. Founded in 2004, it has quickly become one of the largest pure enterprise software-as-a-service (“SAAS”) companies in the world.

NOW offers a suite of products, and the core of these solutions is the Now Platform, a cloud system that pulls an organization’s workflows and data that may be scattered across email, spreadsheets, and other tools, into one unified workflow.

At the current share price of approximately $138/share with 1.03 billion public shares, the company has a market capitalization of nearly $138B. NOW also carries roughly $2.9B in net debt (i.e., $7.5B in debt offset by ~$4.6B in cash and marketable securities), which results in an enterprise value near $135B.

So what do you get for $138/share, and how does the platform work? Let’s take a tour.

The Software

NOW is essentially a modern workflow automation platform that plugs into IT workflows, customer workflows, and employee workflows all in one spot. Under every application sits a shared database and a workflow builder (Flow Designer) and the IntegrationHub, which uses hundreds of prebuilt connectors to pull data from Salesforce, SAP, Workday, and the major clouds. On top of this foundation is Now Assist, NOW’s generative-AI layer, which uses LLMs including Anthropic’s Claude to summarize cases and draft responses. In this way, NOW effectively orchestrates the entire customer lifecycle, and in NOW parlance, an “AI Control Tower” for business reinvention.

The company sells its products and services directly and indirectly to enterprises across a wide variety of industries through subscription agreements. In addition to subscription offerings, certain AI and data solutions include a consumption-based pricing component that governs when customer usage exceeds the fixed number of service credits available under the customer’s subscription agreement.

Before diving into the financials, there are two pretty important metrics SAAS businesses such as NOW focus on: Remaining Performance Obligations (“RPO”) and Annual Contract Value (“ACV”).

RPO represents a forward-looking financial metric defined as the total value of contracted non-cancelable customer contracts that have not yet been delivered. RPO includes two main revenue streams: deferred revenue and unbilled revenue. You can view RPO as both a “backlog” and “leading indicator” of revenue.

ACV, on the other hand, measures the yearly average revenue generated from a single customer contract. Think of this as a smoothed-out metric, so it allows you to compare the average annual revenue even if you’ve signed customers to short-term or long-term contracts. Said another way, RPO represents the backlog and future revenue, and ACV shows whether each contract in that backlog is increasingly more valuable (ideally we’ll want both to inflect).

NOW’s Targets

In NOW’s most recent Financial Analyst Day, held on May 4, 2026, the company set a 5-year target of achieving $30B in revenue by FY 2030 with a “Rule of 60+” (i.e., subscription revenue growth rate + free cash flow margin exceeds 60%). More specifically, the company is also attempting to grow its AI ACV to 30% of ACV in order to better highlight the progress it’s made in incorporating AI agentic models into its overall platform. NOW’s “AI” refers to the company’s Agentic AI capabilities, AI Control Tower, and integrated MOvements functionality, which are available at premium prices.

In 2026, the company anticipates generating $1.5B in AI ACV.

So let’s step back and look at their financials, and how all of these goals measure up.

First, starting with the top line: revenue.

NOW reports revenue in two broad categories:

1. Subscription Revenue, and

2. Professional Services & Other

The company reported $13.3B in revenue in FY 2025. 97% of the revenue came from Subscriptions, which totaled $12.9B in FY 2025. Professional services, which are related primarily to the implementation, configuration, and training of NOW’s products, made up 3% of revenue, approximately $0.4B. NOW has grown revenues by 21% and 22% in 2025 and 2024, respectively. For the first half of 2026, revenues are on track to grow 21% (2026 H1 vs. 2025 H1). If NOW were to successfully achieve its $30B bogey in FY 2030, that would represent a nearly 18% CAGR from FY 2025’s $12.9B. Sounds great on paper, but is that truly achievable?

Let’s dive deeper into the financials (note all chart information is from company provided information (e.g., Form 10Ks, Form 10Qs, and IR presentations).

Given the Subscription revenue-based model, gross profit margins are fairly high. The company does lose money on the minimal professional services fee it generates, but it’s immaterial and facilitates the installation of the company’s products. Overall GPM sits around 78% in 2025, down slightly from the 79% in 2024.

Heading further down the income statement, we land on operating expenses. In FY 2025, total opex ran $8.5B, or 63.8% of revenue, down from 66.8% in 2024 and 70.1% in 2023. That significant 6-point drop within two years is a great sign of operating leverage in the business, meaning that revenue is growing faster than the cost to attract it.

Sales & marketing takes the lion’s share of expenses at $4.4B, and it’s also the main cause of that 6-point drop in total opex as a percentage of revenue. As of Q2 2026, Revenue is growing 21% year over year and is increasing at a faster rate than operating expenses. Sales and marketing alone dropped from ~37% of revenue in 2023 to ~33% in 2025, signifying that sales productivity improved. R&D has held roughly flat near 22–23% of revenue (~$3.0B), while G&A shifted down to ~8.5% from 9.6% in FY2023. In other words, every major line item in costs is shrinking as a share of revenue, and the largest one (i.e., S&M) is shrinking the fastest.

The payoff lands on the next line down. EBIT in FY2025 comes in around $1.8B, up from $1.4B in 2024. This jump in EBIT represents a widening gap between revenue and operating expenses growth, and as the business scales further, it’s the number to watch.

The increasing operating leverage is also translating to an improving cash flow statement.

Operating cash flow landed ~$5.4B in FY 2025, and has been steadily rising these past few years. The largest add-backs? You guessed it: depreciation/amortization, which runs ~$0.7B, and stock-based compensation (“SBC”) at ~$2.0B. For a +$100B company, SBC is high, but unsurprising given it’s in the SAAS sector. After factoring in capital expenditures (i.e., purchase of PPE $0.9B, we can see that NOW generated FCF of ~$4.6B, fairly close to NOW’s own metrics of Non-GAAP FCF.

Before we get excited, there are two things to note. First, while the $4.6B in “FCF” appears to be decent relative to NOW’s market cap, we’re not sure why they’d elect to exclude the recent acquisition of Moveworks (worth ~$2.9B ($1.5B in stock and $0.9B in cash)) that closed in December 2025, which if accounted for drops FCF to nearly $3.7B. Perhaps because it’s a “one-timer?” Oh wait, they also purchased Veza (~$1.2B) and Pyramid, and Armis (~$7.75B) in 2026 . . . yeah.

(OSC - The company provides that the acquisitions were needed to build out NOW’s product portfolios. Each of the purchases broadens and deepens NOW’s offerings: Veza (expands AI security and risk portfolio), Pyramid (AI business language and natural language data querying), and Armis (bridges a gap between asset visibility and automated risk management).)

Second, even if FCF was $4.6B as NOW claims, what about SBC? NOW’s share count has been fairly flat these past few years, but NOW has had to repurchase ~$1.8B of common shares in 2025 to keep that share count flat. Said another way, share repurchases are needed to offset the dilutive impact of employee stock compensation, so at the very least FCF should be reduced for this expense.

Nonetheless, continuing with and comparing our $4.6B FCF against the total revenue gives us a ~35% FCF margin, which is an excellent rate, and leaves the door open to either reinvest or return it to the shareholders.

(OSC - This sounds fine so far, but what’s the risks here Maya? Why the sell-off in the space and in this company specifically? What’re you seeing?)

Synthesis

There are a few risks in our minds that should be addressed: vibe coding and the business model.

Vibe Coding

First, vibe coding is all the new hype these days, and refers to building software from natural-language prompts instead of hand-written code. And this prospect is one of the most direct threats to a platform business like NOW, because it lowers the barriers in skill and time to build the very workflow apps in-house that NOW charges for. Popularity in this sector is expanding rapidly: the AI-coding market is growing at roughly a 38% CAGR, with 92% of developers using AI coding tools daily, and over 40% of new production code being AI-generated. Raw vibe-coding output creates the “Shadow IT” problem, which occurs when business units become frustrated waiting for software they believe will make them more effective. This causes them to create an interim solution, therefore skipping the procurement process.

From design and scaling issues to security and compliance concerns, vibe coding as a whole falls short in many areas. As a result, NOW has started positioning itself as a governance and orchestration layer for enterprises, which sits underneath AI coding tools that developers may be using to complement business needs. Its Build Agent tool translates natural-language prompts directly into production-ready enterprise applications. NOW has also extended Build Agent’s governance and context directly into Cursor, Windsurf, Claude Code, and GitHub Copilot, so developers can build from any environment while still operating inside NOW’s governance layer. And even beyond their AI offerings, NOW also has a key differentiator: the two decades of accumulated enterprise workflow data. This gives its AI agents built-in business context that other, more generic, coding assistants won’t have.

We’re seeing this trend across industry, with other enterprise software companies too. Salesforce (CRM), for example, has a similar ideology with their “build anywhere, deploy here” pitch in relation to their Agentforce suite. Same with Microsoft (MSFT) and their Copilot Studio and Power Platform. All of these companies are racing to become the primary governance layer of record, and NOW is competing on the size of its existing enterprise footprint rather than fully building out its own unique technology.

Changing Business Model

Second, the business model is shifting. Can NOW maintain its revenue growth? Even if it dodges getting “vibe-coded” away, will customers still flock to NOW’s offerings? NOW’s growth has historically been a function of users of their software, and AI is exactly the technology that lets NOW’s own customers do more work with fewer people. If growth were still purely tied to headcount, the future of their revenue would be an expected downturn.

Management’s shift to non-seat-based pricing is their direct answer to this risk associated with their prior revenue model. By acquiring half of net-new business through token consumption, infrastructure, and connectors instead of headcount, NOW is deliberately isolating its growth from the headcount reductions that its systems enable at its customers. In theory, this means revenue can keep growing, even if customers are shrinking their employee base, because pricing is now tied to the amount of work being done, rather than the number of logins that are required. This also means NOW’s offerings have to enhance productivity and deliver real benefits.

(OSC - Whether the widespread adoption of AI and LLM models in businesses is effective remains an option question, but admittedly it’s early days. In its recent State of AI survey (November 2025), McKinsey consulting found that nearly 80% of companies are now using AI in at least one business function, but >80% of companies still report no material contribution to earnings from their AI initiatives.)

So if you’re pricing on higher usage, you better hope it drives higher usage. During a Financial Analyst Day in Q2 2026, NOW categorized their pricing model as “Predictability + Flexibility,” essentially presenting their model as a blend of subscription-based pricing with usage-based meters. They also reported that this new pricing model has already made up nearly 50% of net new annual contract value (NNACV). If customers see value in NOW’s AI offerings, we should see that turn-up in higher RPOs and AI ACV.

RPO & AI ACV

So far things appear on track as RPO continues to increase.

(OSC - note that Maya has used the non-GAAP RPO figures, which the company uses. It adjusts growth rates, etc., for constant currency to eliminate the volatility of F/X fluctuations).

NOW breaks down RPO into two main categories: current RPO (cRPO), the portion of RPO expected to convert into real revenue within a year or less, and non-current RPO, any portion that is expected to convert after a year.

As of Q2 2026, total RPO reached $29B, with cRPO at $13.2B and non-current RPO expanded to $15.8B, up from $13B in FY 2025. This increase in non-current RPO could be attributed to longer contract durations, and decreases NOW’s long-term revenue risk.

However, the growth rate on RPO has slowed from its 2025 peak, which will be something to watch in Q3 and Q4 of 2026.

(OSC - Nonetheless, again if we view RPO as both a backlog and leading indicator of revenue, the fact that it’s growing faster than revenue is a healthy sign).

So RPO tells us that contracts are being signed, but what about the value of those contracts? Are customers paying more for the software (i.e., they find more value). For AI ACV, we’re seeing continuing growth. AI ACV landed at over $600M at the end of FY 2025, and as of Q1 and Q2 2026, the number grew to $750M and >$1B, respectively.

As you can see from the chart above, deal size is also growing. A deal with 5+ products is worth substantially more ACV than a single-product deal, and as the mix shifts toward 91% of deals having 5+ products, the average new deal size (ACV per deal) is rising sharply. This is also in agreement with the growth metrics presented, such as the 7.5x Y/Y growth rate. And with NOW’s extremely high retention rate, this growth in ACV only highlights greater net revenue retention potential.

From a business standpoint, this also signifies that ServiceNow’s platform strategy is working. The “Better together” narrative seems to be true, as customers are increasingly adopting the full platform, with 5+ products in their suite through one contract, rather than purchasing a single piece of the pie. Simultaneously, first-time agentic AI buyers grew 45% year over year, signaling that NOW’s customer base is expanding, rather than growing within existing customer accounts.

Gina Mastantuono, NOW’s CFO, commented on this shift, saying that “customers aren’t paying us for tokens, they’re paying for resolutions.” This builds off of the 50% NNACV being non-seat-based, but is also the source of seat erosion. However, seat erosion and ACV growth aren’t offsetting the positive effects of AI adoption. Rather, they signify that value within NOW’s business model is transitioning from headcount-based licensing to outcome-based contracts.

(OSC - this makes sense to us. NOW is charging customers a mix of token-based, assist-based pricing (i.e., AI and platform charged based on the assistance it provides and the cost of consumption) vs. outcome-based (i.e., AI system delivers a specific business outcome (e.g., Salesforce)), so if customers don’t find a use, they wouldn’t be using it, and you should see that in RPO and AI ACV. AI usage typically uplifts the price by 20-30%).

Putting it all together, the current $1B in AI ACV, 40%+ net new AI ACV growth, reported 9x growth in agentic AI production customers over 9 months, and half of new business being non-seat-based, NOW seems to be on the right trajectory to meet its FY 2026 targets, which brings us to the bigger question here.

Buy, hold, or sell?

NOW’s stock has fallen over 22% in the past 52 weeks. However, the decline was less a “NOW-specific” event and more a broader enterprise-software selloff that also hit other large companies in the industry such as Salesforce, Workday, and Oracle.

At today’s price, NOW starts you at around a 3.5% yield (the 3.5% of FCF the business generates against its market cap, or the flip side of paying 28x FCF). Looking at the 3.5% return, the problem is quite straightforward: investing NOW is essentially accepting a worse FCF yield than a total index fund would deliver, which means you’re paying a premium for a stock in hopes of greater future returns. By investing in NOW, you are essentially accepting a lower yield in exchange for growth, and the +20% compounding on the top line (revenue) will lead to greater compounding on the bottom line (FCF).

Over the past four years, NOW has grown revenue at approximately 22% a year and FCF at 26% a year, so there’s a track record of executing. If we make the assumption that NOW’s historical FCF margin remains stable, and the company achieves its $30B revenue targets by 2030, NOW could potentially generate $10B in FCF by 2030. Assuming NOW’s FCF multiple stays roughly the same, or even dip slightly (i.e., 25x, or 4% FCF to share price) and the number of shares outstanding remains stable at ~1B, the stock may reach $250/share. Given the explosive growth of NOW’s offerings and its foray into AI, this doesn’t seem impossible, or implausible.

The honest verdict is that NOW is a high-quality business at a very demanding price. The business growth, up until now, has shown great promise, and the recent pricing pivot has also answered fears of seat erosion. Overall, the stock represents quality at a fair price, not necessarily a great bargain, or a value trap.

(OSC - We agree here. On balance, it’s a promising company in a fast growing space. Given that the stock has run-up nearly 30% in the last month when Maya started this project, we’d also agree that it’s best to wait for a pull-back. Much of the space took another step higher post-CRM’s earnings release yesterday, so the momentum is carrying through as it’s breached both the 50 and 200 day moving averages. In addition, the RSI is also elevated at this stage.

Still, there’s a fair chance this company hits its targets just given where the AI space is headed, and once these features are embedded in corporate IT budgets, they’re hard to remove. We’ll likely take a position as well in the common shares (again after waiting for a slight pull-back. Given the froth in this space, and the elevated market as a whole, it’s better to stay patient with any excess capital. The AI space is still in the growth phase, and there’ll be many opportunities to participate in companies that will monetize it all, so there’s no rush in taking these positions. This harkens back to Buffett’s “swinging at good pitches.” This one’s decent, but stay disciplined at the plate. Great job this summer Maya, and thanks for the great write-up!).

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PLNT

It shows up everywhere, with bold yellow and purple graphics welcoming patrons to an inclusive atmosphere; it’s all by design.

Planet Fitness (NYSE: PLNT) has become to gyms what Dunkin’ is to coffee. PLNT has built its entire identity around the “High Value, Low Price” model. Their gyms offer a judgment-free branding aimed squarely at the intimidated beginner crowd rather than the peptide-shooting bodybuilders, all for an entry price of $15/month. It’s a value proposition of win on volume, not on markup.

By the end of Q2 2026, the PLNT ecosystem has grown to 2,930 clubs (i.e., 2,636 franchisee-owned clubs and 294 corporate-owned clubs), and roughly 21.5 million members. The vast majority of new locations are franchisee-owned, including 21 of the 23 stores opened last quarter. That’s not coincidental, as PLNT intentionally stays “asset-light” by letting entrepreneurs/franchisees put up the capital and take on the real estate risk for each new club. Franchisees own or directly lease each PLNT franchise location from third parties. In contrast, PLNT has no other leases except for its headquarters and one corporate-owned club. Instead, PLNT collects a toll on everything that happens by collecting revenue on monthly and annual membership dues, equipment placements, and royalties.

Today, PLNT has ~77 million shares outstanding, and with a current share price of ~$48/share, it sports a market cap of $3.6B. As of Q2 2026, the company had $2.3B of net cash (excluding $75M of restricted cash), and an enterprise value of ~$5.9B. Since October of 2025, the shares have underperformed the market dramatically.

PLNT shares have fallen from $114/share to the lows you see today after management walked back its own multi-year growth targets in May. Year-to-date, PLNT shares have declined nearly 60% after withdrawing its multi-year guidance in May.

How the Machine Actually Works

Still, it’s an asset-light franchise model, so we’re always keen to take a look. More than 90% of the company’s revenues are recurring monthly dues, which generate royalties that keep showing up whether or not a single new member walks in the door. It’s one of the reasons investors have historically paid-up for the stock: a growing, predictable, subscription-like cash flow with relatively low capital intensity, since PLNT itself isn’t the one signing 10-year leases and buying squat racks for every new location.

Despite this favorable business model, PLNT’s shares are well off their highs after a few management stumbles. The deeper concern is whether the market’s 60% haircut of PLNT’s stock fits the size of what has actually changed. Two forces are entangled here: a marketing change has resulted in a real slowdown in attracting new members, and in turn, the growth in revenue growth and profitability have slowed. For investors, the question is whether the decline is a temporary stumble, or a permanent fall.

Let’s walk through the financials to see if the haircut is justified.

Financials

PLNT separates its revenue across four segments, and each one tells a different part of the story:

1. Franchise: Franchise royalties are the largest contributors to PLNT’s margins and represent fees collected from the thousands of independently-owned clubs running under the PLNT banner. The franchise royalty averaged 6.7% in 2025. In 2023 and 2024, the royalty averaged 6.5% and 6.6%, respectively.

2. National Advertising Fund: PLNT collects roughly 3% of gross membership dues from franchisees and corporate-owned clubs (historically 2%), and pooling the dollars into a fund earmarked for marketing and advertising spend. The fund is effectively a pass-through, as PLNT spends what it collects, netting to roughly zero.

3. Corporate-owned Clubs: this is revenue from the roughly 12% of the fitness clubs that the company operates. The clubs generate membership dues directly.

4. Equipment: PLNT requires franchisees to buy cardio and strength equipment through the company, and to replace them ~5 to 9 years. Every treadmill a franchisee buys is revenue for the parent.

In 2025, PLNT reported total revenue of $1.3B, up 12.1% year-over-year. Of that, ~$0.47B (35.3%) came from the Franchise segment (i.e., $0.38B in franchise royalties and fees, plus $0.09B for the National Advertising Fund revenue, again something PLNT collects, but then spends dollar-for-dollar on marketing), $0.55B (41.2%) from Corporate-owned Clubs, and $0.31B (23.4%) from Equipment sales to franchisees.

In the past three years, total revenue has compounded ~11.2% a year while total opex compounded ~7.9%. That increasing spread shows up directly in higher operating margins, which expanded roughly 200bps from 2023 to 2024 and another ~240bps in 2025, for an increase of 434bps cumulative.

Said another way, PLNT has become increasingly more profitable over the past few years. As of 2025, PLNT’s operating profit margin was 29.8%, vs. 27.4% and 25.5% for 2024 and 2023, respectively.

Like most management teams, PLNT’s executives call out Adjusted EBITDA as their preferred metric. We’ll indulge them and also exclude things like stock option expense, one-time legal expenses, insurance recoveries, etc. Adjusted EBITDA tells a similar story: $0.55B in 2025, up from $0.49B in 2024 and $0.44B in 2023.

As you’d expect, the Franchise segment is more profitable than Corporate-owned Clubs. Even though the Corporate-owned Clubs segment contributes the most to PLNT’s total revenue, it’s also the lowest-margin. Its Segment Adjusted EBITDA margin was 37.8% in 2025, versus 71.9% for the royalty-rich Franchise segment. As a result, Franchise is the segment that actually matters most to profitability. Equipment, while smallest at 23.4% of revenue and 14.8% of segment profit, is the fastest-growing and most volatile line, up 21.1% in 2025 (vs. 10.6% for Franchise and 8.7% for Corporate-owned Clubs), but this segment is largely dependent on the speed of new clubs being built out.

Strip out the accounting noise, and the number that should matter to most investors is FCF (i.e., operating cash flow after capex). This is the cash PLNT has left over to buy back stock, buy other assets/conduct M&A, pay down debt, or return to shareholders. FCF has grown 35% from $0.19B in 2024 to $0.26B in 2025.

A Blown Rep, or a Blown Set? Sorting Timing From Structural

Every gym-goer knows the difference between a blown set and a blown-out shoulder. One means you rest, adjust your form, and you’re back under the bar next week. The other means months of rehab and a real question about whether you can ever lift the same weight again.

That’s the exact question PLNT investors are wrestling with right now.

Today PLNT has 21.5M members as of Q2 2026. Although membership has grown by ~15% over the past three years (18.7M in FY2023 → 21.5M in Q2 2026), we can see that by Q2 2026, sequential growth in memberships has effectively stalled.

Former interim-CFO Tom Fitzgerald, on the Q1 2026 earnings call, said directly: “We added about 1 million net members in Q1 last year. And this year, it was about 700,000”, down from Q1 2025, despite more clubs being open year-over-year.

PLNT has two membership options: Classic Card at $15/month and premium Black Card at $25/month. Of the 21.5M members, ~68% hold Black Cards. Black Card membership penetration has grown ~4.1 percentage points in roughly the past year and a half (63.9% at FY2024 → 68% at Q2 2026), but that rate of growth is also slowing down.

Based on the 2025 Investor Day and 2025 Form 10K reports, management had proposed a 3-year plan designed to grow revenue by low double digits and adjusted EBITDA in the mid-teens percentage. However, this growth algorithm was formally withdrawn in the Q1 2026 earnings call due to shortfalls in net membership growth and the pause in the Black Card price increase rollout.

As recently as the 2025 Q4 call, barely a quarter before the blowup, former CFO Jay Stasz reiterated the three-year growth algorithm and told investors the company expected to “get back to those targets” in the out-years. A few months later, on the Q1 2026 call, that same algorithm was withdrawn entirely, with CEO Colleen Keating citing a net member growth shortfall that had an “outsized impact on the year.” Management damaged its credibility here, as it told the market one thing in February and a materially different thing in May. (OSC - likely explains the CFO getting ousted soon after)

So was the shortfall caused by seasonality, or something structural? Let’s start with the case for a “blown set,” a timing issue. Seasonally, PLNT adds the most members in Q1 (i.e., holiday gift giving and New Year’s resolutions). Combine winter storms that dented January joins, along with a short-lived uptick in cancellations tied to the rollout of “cancel anytime” online member management, and you have a business absorbing a few one-time bruises rather than a business that’s broken. If January’s storms and the cancel-anytime friction were truly one-time bruises though, Q2 should have told a healing story.

Management’s own diagnosis in Q2, however, wasn’t seasonal. Newly appointed CFO Sudhanshu Priyadarshi called out in Q2 2026 earnings “the slowdown in net new joins” directly, and pivoted the company’s stated priority toward “expanding the member base, complemented by rate growth rather than the other way around.”

That’s not the language of a business dusting off a bruise, but a case for the “blown shoulder,” something structural. Management conceded its campaigns weren’t reaching the core “gymtimidated” beginner audience, the exact demographic the entire high-volume, low-price thesis is built to attract.

Marketing Issue?

On the Q1 2026 earnings call, CEO Colleen Keating attributed the recent softness to the company’s marketing, which “largely resonated with a more fitness-minded consumer, yet had less resonance with the fitness beginner or more casual gym goer,” along with broader macroeconomic pressure on consumers.

The 2025 marketing campaign was supposed to prove PLNT could deliver real fitness results without abandoning its judgment-free positioning. Instead, in her words on the Q2 2026 earnings call, the marketing plan “overtorqued” as the cast in the ads skewed toward visibly muscular, athletic-looking bodies. The company built a campaign that visually spoke to people who didn’t need PLNT’s core value proposition, and let it run for a full year before recognizing the mismatch.

Keating referred to the current cast as “the fit getting fitter” rather than the relatable, average, and/or beginner-looking members the brand has historically used to signal approachability. The fix, as management has described, is a return to the brand’s original casting and tonal playbook, not a new strategy.

. . . or Something Else?

The failure though may not be the ad, but the sustainability of the engine itself.

For PLNT, increasing revenue breaks down to two levers: “rate” (i.e., increasing prices on members), and “volume”" (i.e., increasing the number of members). The split between them tells you whether growth is coming from charging people more, or from signing more members. Ideally the rate-to-volume ratio would be 75/25: 75% of increased revenue would come from migrating existing members from the Classic Card to the Black Card, and 25% of increased revenue would be achieved by increasing membership overall. This ratio of rate-to-volume has taken a step down from the first quarter. Rate-to-volume split ran roughly 90/10 against a management-guided target of 75/25 (i.e., 90% of revenue increases came from migrating members to the more expensive Black Card, and 10% from member adds). By the second quarter, there was no volume growth left to speak of. Management disclosed that rate accounted for more than 100% of the growth in revenue.

Mentioned earlier, Black Card penetration, historically the company’s most dependable path to organic revenue growth, has slowed. While Black Card penetration itself is still rising, up 240 basis points year-over-year in Q1 and 210 basis points year-over-year in Q2, it is decelerating from the 340-basis-point annual gains the company was posting earlier in 2025, which explains why price alone can’t keep carrying the top line growth much longer. The cheapest, easiest dollar of incremental revenue per member is already spoken for. So while company grew revenue entirely by charging existing members more, it lost ground on the metric the entire business model depends on.

Weigh the two cases against each other, and the “blown shoulder” argument appears stronger. A single bad quarter doesn’t explain a management team reiterating a three-year algorithm in February and abandoning it in May. That’s not a business absorbing a bruise; that’s a business model that broke. Winter storms and a marketing overcorrection are real, but they’re the kind of headwinds a well-calibrated growth algorithm should have margins of safety for. The fact that they didn’t is telling. From here, growth has to come the hard way: adding more members and clubs.

The Rehab Plan: what management says gets them back in the game

Management’s plan to rebuild the business, and by extension the stock, rests on fixing the marketing engine, defending and growing the member base, and only then touching price again.

Management’s own diagnosis of the Q1 2026 stumble was that the marketing campaign had inefficiencies with the National Advertising Fund. The fix underway is hiring a new ad agency and introducing a refreshed campaign slated for full rollout before year-end, timed deliberately to be ready for the January 2027 join season. Franchisees are funding a bigger share of this by shifting contribution dollars from Local Advertising Fund (7% to 6% of revenue) to National Advertising Fund (2% to 3%) starting in 2026, which centralizes spending and, in theory, buys more precision per marketing dollar. The rationale behind it is that it will increase media-buying scale and save on agency fees. CEO Colleen Keating stated in the Q3 2025 earnings call, “For 2026, the franchisees voted to increase the contributions to our NAFs from 2% to 3% and decrease contributions to local marketing from 7% to 6%. This 1% shift will allow us to increase the size of our NAFs in 2026, and we believe that the shift will unlock new marketing opportunities for our brand while resulting in marketing efficiencies.”

This is a cost-efficiency case, not a targeting one. Cheaper, more efficient distribution of the wrong message doesn’t fix the message. Until a new marketing campaign actually built around the “gymtimidated” beginner is in full swing, the ad fund shift is evidence of process change, not evidence of a fix. Perhaps management has begun to realize this as the CEO shared in Q2 . . .

The advertising campaign that focused on trying to attract more “higher value” Black Card members went too far, and shifted PLNT away from its “gym for all” ethos.

In addition, recent price increases created challenges to attracting new members. Changing pricing has already proven costly as the earlier Classic Card increase from $10/month to $15/month coincided with softening membership growth. Management is now trying to reverse this by decreasing Classic Card membership back to $10/month via promotions/discounts to stem the loss of members. Recently, PLNT had also planned to increase Black Card prices from $25 to $29/month, but paused the full roll-out.

In short, the logic behind pausing price increases is straightforward, focus on increasing the number of members. First, hold off on migrating members to the Black Card until new member growth actually recovers, then take the Black Card increase once volume is back to carrying its share of the load again. Second, reduce the price of admission for new members by lowering the Classic Card price.

To aid with membership additions, management is also continuing the High School Summer Pass program that offers free membership to high schoolers during the summer. PLNT’s now converting north of 8% of its several-million teen participants into paying members, adding a potential future pool of Black Card updates.

Conclusions

Even if we set aside the question of management’s credibility after they withdrew guidance so quickly, in our opinion the growth ceiling here is low. In 2025, the company generated $0.25B in FCF, and with a market cap near $3.6B today; that represents a nearly 7% FCF-to-market-cap margin. For 2026, we project FCF to be fairly close to $0.26B, but more importantly, we see little room for future growth unless PLNT’s management team can execute. The two levers for increasing revenue (i.e., rate and volume) are already challenged. Membership growth has stagnated, and Black Card penetration has limited room left to run as price increases on both Black Cards or Classic Cards have already shown they cost membership volumes. This is a business that’s had difficulty increasing prices without bleeding members, and has likely already converted most of the easy upgrades.

The case for putting new money into PLNT today doesn’t clear the bar. While the fundamentals aren’t broken: FCF is still growing (though anemically), the franchise toll-booth model still throws off recurring cash, and management has a credible-sounding turn-around plan on paper, there’s still great uncertainty until there’s concrete evidence that the marketing reset is actually working. We need to see the company add net members in numbers similar to prior years once the new marketing campaign launches ahead of the 2027 “join” season.

Before that, this is a pass, but not necessarily a short. The business isn’t deteriorating; it’s just unproven in this latest pivot. We project 2026 revenues to reach $1.45B, $1.54B in 2027, and $1.62B in 2028, which is mid-to-high single-digit growth, not the low-double-digit pace management once promised. Even this, however, will be impossible if the company fails to add new members.

The one date worth putting on the calendar is the 2027 Q1 earnings call, when the results of this year’s marketing fix either shows up in the join numbers, or doesn’t. The hiring of a new CEO plus a refocus on increasing membership gives us renewed confidence, but membership growth must be present before investing. Membership influxes should be up year-over-year in Q1 2027 and carry over to Q2, 2027 as proof that PLNT is making positive steps to fixe their revenue engine. Anything less and the stock may take another leg lower.

OSC (EDITOR’S NOTE): We’d agree with this conclusion, and would probably add the risks of deteriorating consumer confidence and the increasing strain of consumers in this “K shaped” economy. We can see it in the spending data. Walmart’s recent report, which led to a fall in the stock, reinforced our current view that the lower income strata is particularly challenged in today’s current high-inflation economy.

As PLNT noted in its 2025 Form 10K “Generation Z represents our fastest growing demographic, contributing to our memberbase that is approximately 51% male, and includes households of all income levels. Approximately 22% of our clubs are located in areas that the U.S. government deems “low income,” providing access to improve health and wellness in underserved communities.” Unfortunately, these are the very demographics that are experiencing pricing pressure, and if nearly a quarter of your clubs are located in low income locales AND you’re having difficulty increasing prices by only $5/month (e.g., the Classic Card from $10/month to $15/month), while the economy is still “relatively” strong, what will happen if the economy weakens from here? Ultimately, we agree with Carter’s conclusion that investors should take a beat and wait to see if PLNT’s marketing shift can reverse its recent trajectory.

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That’s what we’re doing.

Grinding lower, grinding down, grinding away.

Sure, we’ll pretend like we don’t need it.

We’ll pretend like we don’t want it.

We’ll straight-up lie to each other about it.

It’s what we do when we can’t do anything.

It’s what we do when we can’t say anything.

That it’s all been for naught, or that there’s not enough.

This can’t last though, can it?

We’ve been hanging on thanks to China.

Look at those cuts to imports in May, June, and July. China though is returning, or was . . . or maybe it’s not . . . .

What’s certain though is it can’t stay away forever. If demand hasn’t materially fallen off (note: it hasn’t) then that means we’re drawing inventories, and the big dogs (i.e., the US and China) are bearing the brunt.

The US has to continue their draws since this is their war to lose. China though? That’s optional, it’s more . . . strategic, and would depend on their inventories (declining), and their inclination to put pressure on the US in the Middle East. Again balance all of that against the strength of their economy, which becomes wobbly if everyone else gets wobbly. You can’t manufacture what other’s can’t afford to buy. Tides though, could already be changing. You can’t draw your own inventories down too materially.

And if it does, that’s millions of barrels per day of incremental demand appearing suddenly, at a time when inventories (i.e., those that can be seen) are already drawing at >6M bpd.

Don’t expect demand destruction to do the heavy lifting though to offset.

By Goldman estimates it’s only down 1% for the year (i.e., ~1M bpd). We think it’s near that.

For example, just take a look at the number of total flights and total commercial flights worldwide. They’re up 2-4% for the year. TSA traveler throughput is down about 1%, so if we assume slightly less people are traveling, and that eventually translates to slightly less flights, even that drop-off would be immaterial given the production/supply outage. Read it again though, and in real time we see that flights are still up YOY, which means demand at the leading edge of energy consumption? Up.

So we grind.

We grind lower.

We grind lower because we’re A) we simply like our lifestyles and are unwilling to cut back, B) the US is unwilling or unable to escalate kinetically (because of a shortage of defensive munitions and/or each air campaign has become less effective), and C) we’ve shifted to an economic game, ratcheting sanctions to extremes. Less Operation Epic Fury and more Operation Economic Fury. As Secretary of Treasury Scott Bessent commented yesterday in a Newsmax interview:

“Watch this space for more announcements coming next week because we are going to apply measures like have never been seen in the history of economic isolation on a country,”

So it’s economic warfare we’re preparing eh? It’s an economic siege. My blockade vs. your blockade, and my sanctions vs. your ability to endure. It sounds tough, it sounds great, but even if it works, all of this takes time.

It takes time, patience, and resolve. Can the Iranian’s hold-out? We think so as they’ve been living in turmoil for quite awhile, making do with sanctions all this time. There’s also indications that the UAE has been sending billions to Iran to convince the latter to refrain from attacking if war intensifies. Such payments would help the regime prolong its ability to function even with the US blockade and ratcheted sanctions.

All along we’ve said that the physical market will eventually/inevitably discipline the paper market. You can’t burn paper barrels in your cars. You can’t consume paper barrels in your trucks.

If the production outages are real, and they are, then eventually we’ll see it in draws. What the US lacks more than munitions at this stage is time. We’re nearly 6 months into this conflict, and lost production now exceeds 2B barrels. Where are the draws? What was unseen may now be becoming clear. Hidden by all the fog of war has been an a figure, and it draws near.

It’s an inventory figure, and it’s grinding.

Grinding lower.

Grinding away.

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That’s the slide.

That’s the slide that makes everything come together. Now that Richard Jackson is fully in charge, taking over the CEO mantle from Vicki Hollub, we wondered where he’d guide OXY to in the coming months. After reviewing their most recent Q2 2026 quarter, we can rest easy.

It’s the continuation of the same path, but a clarification of what they’re trying to do. It’s a bit slower than we like, and more methodical, but if this is their plan, it means OXY will emerge essentially generating double the cash it generated in ‘25 and debt free.

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Yeah . . . it’s working.

Drones and ballistic missiles, relatively cheap weapons bought in enough quantity, and in sufficient quality to thoroughly disrupt and disable a global “superpower.”

We put that into quotes because the word and the powers it conveyed has always had their limits, but those limits are becoming increasingly clear when they’re helmed and wielded by a particularly flawed individual.

We’ll leave the ultimate judgment to the historians and their books, but we can pretty much guess this chapter?

Riveting.

How it ends though is becoming increasingly bleak. Drones and ballistic missile are the ultimate nuisance weapon systems. They’re sufficiently cheap and plentiful enough that they can overwhelm any defensive system, but not powerful enough to allow you to go on the offensive. Control an area and frustrate a hegemon? Absolutely. It’s like David’s slingshot, and may just work.

So what we’re left with is bluster and anger.

Publicly that is.

Privately though there’s consternation, and it’s quickly turning into frustration.

No he didn’t, yet here we are.

Iran knows it. The longer this goes on, the higher the stakes. We’re being forced to make a Sophie’s choice. Choose between a a global economic recession vs. a legacy defining, petro-dollar risking, SoH-relinquishing, Iranian-strengthening strategic victory that effectively allows Iran to obtain a pathway to nuclear weapons and permanence.

After two weeks of daily airstrikes following the collapse of what RBC cleverly termed the “Rorschach MOU,” the US stood down to allow negotiations. Iran smelling victory continued to harden around a maximalist position, seeking the withdrawal of US forces from the Middle East, lifting of the US blockade and Iranian sanctions, and ceding control of the Strait of Hormuz (“SoH”) in its entirety. Those proposals obviously floated like a lead balloon. Surprisingly though, Iran was the first to act this time, launching a surprise attack on US forces in Jordan.

In retaliation, the US began exacting its punishment, and has promised more. Since then, the SoH looks like this . . .

Though the MOU-ceasefire in June saw a blip-up in turns of oil flows out of the SoH, that increase proved temporary. +100M barrels of one-shot adrenaline. The sugar rush has faded, and the good “vibes” lasted for a few weeks. After which, we’re back to the lows following the recent dust-up.

In total, flows coming out of the Middle East remain near the floor.

Today we’re seeing flows at ~40% of pre-war levels (i.e., ~10M bpd). So yeah, we’re missing 10-12M bpd of crude flows, with the imminent threat of further US and Iranian attacks in the coming days.

Global stocks have recently flattened out, but that’s a legacy graph given the hostilities of the last few days. It’ll start dipping back down again as the weeks pass and US barrels resume their slide.

What’s notable is China. China’s been one of the main factors as to why inventories draws have remained lower than anticipated (at least visibly). As we’ve noted in prior articles, they’ve cut the most, and that’s helped the visible inventories above stay relatively calm.

What happens though if Chinese refinery runs start creeping higher? That’ll represent increased demand and apply further pressure on visible and non-visible inventories. Some of the recent increase stems from higher imports (again the trapped barrels freed post-MOU during the temporary ceasefire). China and Asia overall gorged on those barrels and imports rose dramatically, which coincided with the refinery utilization increase.

Those barrels have been consumed though, and either China’s refineries maintain their higher utilization levels, and add pressure on crude stocks, or they fall back down and drain product stocks. We’re assuming they won’t cut consumption more than they have already, so the question turns to how much are they willing to drain.

We’re in a quandary, or is it a quagmire?

As for the US, well it’s finally starting to come clean. The US has admitted to manipulating the crude market, but we’ve suspected that for awhile.

More importantly, their intervention in the crude market doesn’t solve the product market. Refinery cracks are near all time high because the gas/diesel/jet market is much tougher to manipulate. Normally the two are somewhat linked, and they should be since consumers consume products, and refineries get paid a thin margin for turning crude into products. Yet, the dislocation remains and likely because crude prices are being suppressed. Here’s an illustration from Lukas Ekwueme:

Yes, this is unnatural and there will be a reckoning. Not because we say so, but because manipulation means price discovery and the consequences of US actions are distorted. Prices should rise to incentive higher production to compensate for the outage and/or to suppress demand to reduce pressures on falling inventories. Neither one of those things is happening because of the artificial numbers appearing on the screens.

Instead, the lower prices have simultaneously emboldened and enabled the advocates of the current US strategy (if there is one). Don’t worry, oil prices are “stable” despite the instability we’ve created, so keep on going. Instead of helping, that fallacy simply feeds more rope to the forming noose.

So if surrender is not an option because it’s a legacy defining “loser” event for a leader prone to narcism, what’s left?

Escalation.

Not just any mere escalation, but violent escalation.

Because why not? Though the tactical victories haven’t yielded strategic success, you’ll surely go down swinging instead of retreating like a dog. Violent escalation because that’s the only option in this perfect toxic stew that we’ve been cooking. It’s worked thus far hasn’t it? A dash of media influence, a pinch of political will, and a heaping of market manipulation that’s tamed energy prices. Idea broth to nourish those who choose to fight. Fight soon too since the longer we wait, the more leverage the Iranians gain.

Yes it’s dicey and yes the market’s beginning to really figure it out, but it’s worked . . . so far, and it may just work one more time to coax the Iranian’s back to the negotiating table. If, and only if, this one’s the crescendo.

So we’ll choose violence, we’ll choose extreme violence, and we’ll choose it soon.

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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.