Energy sector

Although energy stocks underperformed in 2024, global supply-and-demand conditions indicate that crude-oil prices are likely to remain in an elevated range in 2025, setting up a positive backdrop for profitability—and potentially stock prices—in the sector.

Four reasons for a positive energy outlook (especially for energy producers and equipment and service companies):

• Strengthening global demand for energy
• Increased geopolitical risk
• A tight rein on supply by the Organization of Petroleum Exporting Countries (OPEC) 
• A wave of new investment in international and offshore production

Energy stocks lagged early in 2024

In the summer of 2024, expectations that the U.S. Federal Reserve would cut its key policy interest rate contributed to increased demand among investors for stocks with high growth potential, particularly those in the information technology and communication services sectors. The market rotation led to dampened enthusiasm for energy stocks, despite the sector’s strong business fundamentals. The sector’s lackluster performance comes after a -1.33% return in 2023.

A supportive environment for oil prices

Looking ahead, constrained global supply and steadily growing global demand for crude oil provides a supportive environment for oil prices and the corporate profitability of many energy companies. Oil prices are expected to remain healthy and conducive to energy companies’ corporate profitability—likely in the $70 to $90 per barrel range—barring any major changes in the environment, such as a global recession.

The key drivers of oil prices in 2025 include:

• Rising global demand
• Slowing U.S. supply growth as shale drilling matures
• The production restraint of OPEC as key member Saudi Arabia seeks to maintain high oil prices
• Elevated geopolitical risks due to ongoing wars in the Middle East and Ukraine

Year to date through November 2024, the price of West Texas Intermediate (WTI) crude oil—a proxy for domestic crude prices—has remained range-bound at a historically elevated level between $66 per barrel and $87. The price of WTI began 2024 at about $72 per barrel and stood at that level at the beginning of November, after peaking at about $87 per barrel in early April and hitting a low of roughly $66 per barrel in early September. At all these price levels, however, crude-oil sales allow most oil producers to be quite profitable.

Upside and downside risks

Overall, the risk of increasing geopolitical tension in the Middle East could lead to rising oil and global natural gas prices, especially if production from key producers, such as Iran, Saudi Arabia, United Arab Emirates, Qatar, or Iraq, is disrupted by regional security issues. On the downside, weakening global economic growth, particularly in the U.S. or China, could lead to slowing demand for oil and natural gas. Longer term, however, increasing investments in energy production will be needed to meet what we believe will be rising oil and gas demand in the coming years and decades.

The outcome of the recent U.S. election should not have a significant impact on oil markets. The Trump administration will likely want to keep oil prices at moderate levels to limit inflation, and the administration has little ability to increase U.S. oil and gas investment in production. If the administration loosens permits on federal lands, it could modestly increase oil and gas supplies over the longer term in areas such as the Gulf of Mexico. Trump may be likely to take a more hawkish stance on Iranian oil exports, which could elevate political tensions in the Middle East, but he will not want to drive oil prices up for political reasons—so his approach to Iran is likely to be measured.

While some argue that Trump’s "drill baby, drill" campaign mantra is bearish for oil prices, the outlook may be more neutral. Modest, if any, increases in U.S. production could be offset by declines in Iranian production.

Regarding U.S. natural gas, in our view, Trump’s election victory is positive in the longer term because he is expected to lift the Biden Administration’s moratorium on new U.S. liquified natural gas facilities, which could significantly boost demand for U.S. natural gas later this decade.

What to watch: Energy equipment and services stocks

Looking across the sector, the outlook for oil and gas equipment and services, a group that should benefit from multiple years of growing investments needed to support rising demand for oil and gas, remains optimistic. These are the companies that provide the essential equipment and services to produce oil and gas, such as the rigs, crews, and technology needed to drill and complete a well.

Many market participants may be underestimating the capital investment needed to meet the world’s growing demand for oil and gas, as well as the upside and duration of the upcoming business cycle for oilfield services firms. Moreover, there have been several years of low investment in international and offshore markets, which is only recently beginning to reverse course. Generally speaking, it takes several years for longer-cycle international and offshore spending to recover, and the equipment and services industry is still in the early innings of this particular cycle.

As oil producers seek to boost investment in production, they boost spending on energy equipment and services. In the next several years, continued growth is expected in U.S. energy spending and even more so in non-U.S. spending, led by national oil companies in the Middle East. International and offshore oilfield spending takes longer to ramp up than in the U.S., given that projects often take three to five years to develop. As production growth from U.S. shale slows and supply from Russia remains at risk, other regions of the world, including the Middle East, Latin America, and Africa, will likely need to ramp up production to meet global demand for oil and natural gas.

Oilfield services firms have the best prospects for growth that we’ve seen in a decade, as demand for their expertise ramps up. Meanwhile, these companies have largely reduced headcount and capacity, and are now experiencing solid pricing power. Overall, the oilfield services industry is known for its high profit margins, which means that when demand and pricing are strong, earnings can grow rapidly.

The outlook for energy is bright

During the past decade, the energy sector has matured and become profitable. It is a competitive, capital-intensive sector that tends to rise and fall with the broader economy. But many companies now generate positive cash flow and allocate capital back to shareholders through dividends and share buybacks.

We prefer to invest in companies that can generate competitive returns on capital but trade at discounted valuations, and those that have some sort of competitive advantage, have healthy or improving balance sheets, and that take a disciplined approach to capital allocation. There are many energy companies with these attributes in the fund and, given the sector's favorable business conditions and reasonable stock valuations, the outlook for energy in 2025 is promising.