Energy Musings - December 29, 2025

Oil industry fundamentals have been challenged throughout 2026. Oil industry sentiment is even worse. Will there be a huge supply surplus in 2026, or are oil stocks signalling better times ahead?

Oil Prices And Capex Negative; Stocks Are More Optimistic

Friday was a bad day for oil prices. The West Texas Intermediate (WTI) futures price dropped $1.75 per barrel or 3% amid fears that the Ukraine-Russia war might be ending, which would likely lead to sanctions relief for Russia’s oil exports. Earlier in the week, oil prices were rising as the U.S. was aggressively targeting sanctioned tankers hauling Venezuelan oil to Cuba and China. The volatile price action reflects a global oil market that hasn’t been pricing in much of a premium for geopolitical risk. Before Friday’s sell-off, the week was set to be the best week for oil prices in the past month.

For the year, oil prices have been on an extended slide. From January 1 to December 26, WTI spot oil prices have declined by 23%, falling from $73.74 to $56.74 a barrel. As our chart shows, the oil prices jumped up in the early days of January in anticipation of positive actions by the incoming Trump administration to boost the domestic oil industry.

Once Trump began pounding on the table for his trade tariffs, fears of an economic recession exploded, sending oil prices down. At the same time, China’s economic activity, expected to climb, continued to struggle, reducing its oil use.

The slide in oil prices has been relentless in 2025.

Oil prices surged in early June based on growing tensions between Israel and Iran. On June 13, oil prices jumped nearly 8% because of a reported exchange between the parties. Oil traders immediately began speculating on a disruption of oil traffic through the Strait of Hormuz. The geopolitical tensions peaked with the U.S. bombing of Iran’s nuclear facilities on June 22.

Once the Middle East tensions eased, it was a march straight down for oil prices. From $70 to $65 to $60 and now $55, oil prices have struggled to reverse the trend, as OPEC+ continued adding production back into the market and U.S. oil output grew. With demand growth capped because China’s economy has failed to deliver, oil inventories are rising.

A chart from oil economist A. F. Alhajji highlights where the global inventories have grown this year. He calculated that China was responsible for 60%, the U.S. about 10%, followed by Egypt, which is storing oil for Saudi Arabia, and India. Alhaiji asks: “What is driving China’s behavior? If the buildup reflects strategic decisions, does it represent surplus supply or anticipated future demand?” This is an important question because China sees the U.S. interrupting its oil flow from Venezuela. It is also vulnerable because 80% of its oil flows through the Strait of Malacca.

Is China stockpiling oil because of geopolitical vulnerabilities?

This is merely one of many geopolitical questions present in any analysis of the global oil market. Another issue is the productive capacity of OPEC+ members. While there are many reports and government statements on the amount each member country can produce, we know that numerous members have production quotas that exceed their capacity. This is why OPEC leadership has requested an annual assessment of member oil production capacity for use in 2027.

A December 2 article by Reuters stated:

“This follows an agreement reached on Sunday, which marks progress in resolving what has been a thorny issue for OPEC+ for years, and is expected to boost the credibility of the future production deals with investors and oil market participants.”

We fully anticipate that there will be significant differences between countries’ self-assessed production capacity, to ensure that their quotas maximize their revenues. To understand the significance of this audit and its potential impact on OPEC, we present the recent Energy Information Administration (EIA) chart, which explains how it estimates OPEC’s maximum capacity and possible surplus production.

How the EIA sees the OPEC oil market next year.

The EIA bases its estimates on public pronouncements of individual OPEC member production figures. What the EIA does is not dissimilar to what every forecasting organization does. They do it to the best of their ability, so we are not judging their efforts or conclusions, but merely noting that they may be surprised by the audit outcomes. We will not be surprised if some OPEC members hotly contest the audit results, so we wonder whether the organization will accept it upon its presentation.

The EIA explained on its website what it has done to prepare its global oil production forecast, which underlies its oil price projections. A key component of their forecast was the analysis of OPEC production capacity. It wrote on its website:

“This update resulted in an increase in OPEC capacity of 0.22 million barrels per day (b/d) on average in 2024, 0.37 million b/d on average in 2025, and 0.31 million b/d on average in 2026, with similar increases to OPEC surplus capacity given limited changes to our estimates of actual OPEC crude oil production.”

The EIA sees OPEC capacity increasing from what it previously predicted. Given the number of OPEC members acknowledging they cannot meet their quotas, it suggests the organization may be facing shrinking capacity. Indeed, the organization’s surplus capacity is controlled by a few members.

The key to price forecasting is the size of the surplus. For 2026, analysts are predicting one of the largest production surpluses in years, although the most recent studies are narrowing the size of the surplus. A December 10^th article by Bloomberg included this chart of International Energy Agency (IEA) data, showing a four-million-barrel-per-day (mmb/d) surplus. However, in the IEA’s December report, it cut the projected surplus from 4.09 to 3.84 mmb/d, a reduction of 250,000 barrels per day. The agency noted that this was its first surplus reduction since May and was due to a stronger world economy and lower supply from sanctioned nations. We note that the International Monetary Fund has increased its growth forecasts for numerous countries, and the latest U.S. GDP estimate shows growth exceeding 4%.

IEA sees 2026 oil surplus ballooning to nearly double this year’s surplus.

Even with the reduced surplus, the IEA’s 2026 projection suggests oil prices will be under pressure from rising global inventories, unless economic growth proves even stronger and supply growth is lower than projected. The Bloomberg article citing the IEA’s surplus projection noted that the average of 2026 oil price forecasts from five banks is about $59 a barrel for Brent. The five banks - Bank of America Corp., Citigroup Inc., Goldman Sachs Group Inc., JPMorgan Chase & Co., and Morgan Stanley – call for prices ranging from $56 to $62 a barrel.

The banks are more optimistic about global demand and more conservative about supply growth, as they foresee a 2026 surplus of roughly 2.2 mmb/d, about the same as this year. The EIA, however, sees a surplus of 4.14 mmb/d next year, which leads it to predict that WTI will fall from $65.43 a barrel in 2025 to $51.42 in 2026, with a low of $50.68 a barrel in 3Q2026. The Brent price is expected to decline from $68.91 to $55.08 a barrel. As the EIA chart shows, its 2026 oil price forecast is below the trend from the NYMEX futures market.

EIA believes 2026 oil prices will be lower than NYMEX oil futures suggest.

A key input to the EIA forecast is its estimate for U.S. production. After domestic crude oil output rose from 12.23 mmb/d in 2024 to 13.61 mmb/d in 2025, it is forecast to drop by just 80,000 barrels per day in 2026 to an average of 13.53 mmb/d. Given that shale production is more price-sensitive, we believe the EIA may be underestimating how rapidly output may fall. A chart from Recurrent Investment Advisors shows the current financial health of shale oil producers.

Shale oil producers need higher prices to be profitable, or need to reduce activity.

As Recurrent noted, “most publicly traded Shale operators are not only failing to generate a return on capital at $55 (10% returns on equity require close to $70/bbl for most operators), but roughly 50% of the largest and most efficient public operators are failing to cover cash operating costs and maintenance capital expenditures at $55/bbl. If we include growth initiatives, interest expense, cash taxes, and a modest 10% return on capital, all Shale operators are deeply underwater.”

In an age of “financial discipline” for the oil and gas industry, expecting shale producers to maintain, let alone grow, their output with negative financial returns on capital is fanciful. We believe producers have learned that spending to sustain or increase production while losing money will be punished by shareholders. That does not mean that U.S. production will collapse overnight, but we expect a more significant production decline than the EIA anticipates.

International producers will also be sensitive to falling oil prices. OPEC leaders have already prepared the market for shifts in their plan to restore previously idled output.

In 2020-2021, when oil prices collapsed due to the COVID pandemic, all shale basins except the Permian Basin experienced flat or declining production. Those basins experienced a 170,000-barrel-per-day drop in average output between the two years, while the Permian Basin saw production grow by 275,000 barrels per day. Producers were hit with collapsing oil prices and operating challenges due to the pandemic and uncertainty about when the economy would recover.

This year, the Dallas Federal Reserve survey of oil and gas industry executives’ sentiment reflected growing pessimism due to weak oil prices and questions about global economic activity. The latest survey, reported on December 17, stated: “The company outlook index, while also still negative, improved slightly from -17.6 in the third quarter to -15.2, suggesting continuing pessimism among firms. Meanwhile, the outlook uncertainty index remained elevated and was relatively unchanged at 43.4.”

The Dallas Fed said that E&P company executives expected little change in fourth-quarter oil and gas production. The EIA expects fourth-quarter production to increase by 80,000 barrels per day, with most of the growth in Alaska and Federal waters.

The range of oil price forecasts contained in the survey was interesting. The survey said that, on average, producers expect WTI to be $62 a barrel at year-end 2026, with a range of $50 to $82 a barrel. Survey respondents said they expect WTI to average $69 a barrel in 2027 and $75 a barrel in 2030. WTI averaged $59 during the survey period.

The most telling measure of how financial discipline continues to control oil and gas industry spending was the 41^st annual survey of industry capital spending plans conducted by Barclays analysts, which continued the predecessor surveys. The conclusion of the survey, which details spending plans by region and companies, stated:

“The third year of a mid-cycle plateau, our annual E&P Spending Survey of 130 companies shows global upstream spending down 2% in ‘26 (vs. -3% in ‘25, +3% in ‘24) with NAM [North America] down 5% and Int[ernationa]l flat as a rebound in Middle East spending (+4%) is offset by weakness in LatAm [Latin America] (-1%) and Europe (-7%).” Offshore spending is expected to decline by 4% after falling by 1% in 2025. Barclays’ analysts expect the industry to rebound in 2027.

Using data from its historical surveys, the Barclays analysts prepared a chart showing how industry spending has evolved since 1980, supporting the view that the industry is in the early stages of its next long-term cycle.

The oil industry cycle can be very long.

The chart is a reminder that oil and gas, like all other commodities, tend to operate in cycles driven by price volatility due to imbalances between global production and supply. It is easy to assume the worst outlook for oil, based on market sentiment. However, one of the most interesting relationships is the performance of energy stocks and the industry outlook.

The following three charts are from mutual fund giant Fidelity. The first shows the performance of the Standard & Poor’s 500 Index sectors on December 26, along with relative performance over various periods. Note that year-to-date (YTD), energy stocks have risen 3.74%, although the fourth quarter performance has been negative. Yes, energy stocks have significantly underperformed the overall market (S&P 500). Interestingly, energy has not been the worst-performing sector this year.

Energy performed well in 2025 despite negative industry fundamentals.

Fidelity also produced a chart showing how sectors tend to perform during the history of the business cycle. Energy has outperformed during the late phase of the business cycle.

How market sectors typically perform during the business cycle.

Fidelity also has a chart showing its view of the current position of major economies within the business cycle. Because there is considerable uncertainty about the stages of the business cycle and where major economies are located, these charts should be viewed as illustrative rather than definitive. Do note, however, that many of the major oil-consuming countries are in the Late stage of the business cycle.

Major economies are assumed to be in the late phase of the business cycle.

There is little doubt that the sentiment about oil prices, industry spending, and future activity is negative. However, energy stocks are telling a more optimistic view. A lesson we learned from years as an energy analyst on Wall Street is that one needs to assess as much information as possible before drawing conclusions. The oil industry has many levers that can alter the conventional wisdom. Be aware of them, because assuming the conventional wisdom is correct can be a huge mistake.