Energy sector

Kristen Dougherty is portfolio manager of Fidelity Advisor^® Energy Fund

Energy stocks have achieved solid gains so far in 2025, but lagged the strength of the broad-based S&P 500^® index, due largely to headwinds from weaker crude oil prices and volatile natural gas prices. Crude-oil prices have fallen in spite of healthy global demand and ongoing elevated geopolitical risk because producers in the Organization of the Petroleum Exporting Countries (OPEC) have increased supply more quickly than the market expected. However, by increasing that supply, OPEC is eating away at the last and largest source of global spare capacity in oil production, which I believe will set the sector up for a more durable next up cycle in oil prices over the intermediate term. Natural gas prices have been volatile in 2025, as U.S. production has held up better than I expected, given the reduction in drilling of new wells. Going forward, I expect new demand for liquid natural gas (LNG) exports to provide a larger global market for this U.S. production, and longer-term demand is likely to be driven by the build-out of data centers to power artificial intelligence capabilities.

2025: Energy stocks fared well, but lag the broader market

The broad U.S. stock market performed well in 2025, as measured by the S&P 500^® index, driven in large part by investor enthusiasm for the growth in AI capabilities and infrastructure among companies in many industries, including the potential for productivity improvement and the required spending on data centers to support it. While this trend can boost energy companies, they are not the primary beneficiaries. As a result, the energy sector lagged the strong outcome of the S&P 500^® index in 2025.
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Year-to-date price return

Energy sector dynamics: More U.S. policy balance, production efficiency and a foundation for growth

In 2025, an intense focus on climate change and the resulting push toward renewables abated, allowing for a more balanced approach by U.S. policymakers, one that is based on energy diversity, security, and affordability. The tone has shifted from when the industry will experience peak demand for oil, to whether the industry will experience it. This has implications across the value chain in the energy sector, giving upstream producers more confidence to plan long-term projects, and midstream companies more visibility to support those projects with infrastructure. In 2026, I expect more offshore projects to be sanctioned, and more pipeline routes to be proposed, with a greater degree of policy support than the industry has experienced in the recent past.

The energy-supply mix has been fundamentally changed by the addition of U.S. shale, which has evolved from an emerging-growth technology play into a very mature, repeatable manufacturing process. U.S. oil and gas producers have become much more efficient in how they drill and complete shale wells, and they are now able to produce at a notably higher level using a much smaller base of equipment. In 2026, I expect production efficiency to further improve, but the magnitude of the improvement to moderate, as best-in-class operators start to see diminishing returns and smaller operators exhaust their highest-quality inventory. 
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U.S. crude & natural gas production vs. rig count

The marginal cost of discovering, producing, and transporting a barrel of crude oil has been falling in recent years, thanks largely to the addition of U.S. shale sources and success driving efficiencies from them, but that falling cost has created a headwind for the per-barrel price of oil. In the long term, oil is a highly liquid global commodity. Lower per-barrel prices limit producers’ investment in short-cycle resources, bringing down supply and ultimately balancing the market, until there is once again a tailwind for the price per barrel.

In 2026, I expect this cycle to start to turn, and the marginal cost of oil to start rising again, as low-cost producers in OPEC work through their spare capacity, U.S. shale producers see efficiency moderate and acreage-quality erode, and global integrated energy companies see the need to invest more heavily in early-stage exploration, which is expensive. I believe these developments provide a foundation for the next up cycle in the price of oil, which is a key factor in corporate profitability in the sector. Companies with a low cost structure or that have a contracted business model are well-positioned to succeed in this environment, in my view.

Investment theme: Exposure to growth in AI and power demand

Looking ahead, one key question for the energy complex is how and when the rising demand for power to support data centers used intensively by AI will drive cash flows across the value chain in energy. In many cases, market expectations have differed from where I expect to see the cash flow benefit. Within the upstream segment, higher use of data centers will drive higher demand for natural gas, but that demand will grow over time as the data center build-out evolves. In the near term, demand for natural gas will be influenced by winter weather much more than by data centers. Within the midstream segment, the growth of data centers will require significant infrastructure build-out, but these are multiyear projects, only some of which will come to fruition even with a more supportive policy environment at the federal level. Within oilfield services, many companies are looking to adapt their business model from providing mobile power to a remote oilfield to providing it to a data center, but the terminal value of that business model is unclear when grid-supplied power remains more efficient.

Vistra and Baker Hughes are two portfolio holdings I think will benefit from the growth of AI and the rising demand for power more than the market expects. As an independent power producer, Vistra is on the front lines of generating the power that will be required, and the stock’s valuation does not yet fully reflect the higher power prices that I expect in its markets. I consider Vistra, an out-of-benchmark fund holding, to be well-positioned to benefit from growing demand for power in its markets and difficulty adding supply, given the constraints of accessing utility-scale gas turbines.

As an oilfield services provider, Baker Hughes has bolstered the industrial side of its business and, in my view, is well-positioned to provide equipment linked to the growth of natural gas for use in power generation. Its equipment ranges from smaller-scale gas turbines to gas processing and compression equipment that forms the backbone of gas infrastructure. While I don’t know which specific pipeline route will survive permitting, I believe natural gas distribution infrastructure broadly will require refreshed investment to support growth in demand for power, and the equipment provided by Baker Hughes will be in significant demand.

The long-term outlook is shaping up to be attractive

While I believe global oil prices are likely to remain range-bound in 2026 due to phased-out OPEC increases and steady global demand, I think the energy sector can continue to make progress developing long-term projects with attractive economics, eking out short-term efficiencies, returning capital to shareholders, and setting the stage for the next up cycle. I plan to continue to focus on companies that I believe can ride out short-term volatility and that can build a differentiated business model even in a commodity-linked industry. As of year-end, I see many energy companies that are well-positioned to achieve a strong through-cycle return on capital and that trade at a modest valuation, and I will continue to invest in them.