By: Jon Costello

It has been a while since I wrote an update on Cheniere Energy (LNG), which we’ve held in the HFIR Energy Income Portfolio since January 2021. The company recently reached an important milestone and has begun a new phase of growth. How it executes this next phase, as well as prevailing macro natural gas market conditions over the coming years, will have a significant bearing on its stock’s performance.

Cheniere’s track record of execution and strong financial position make it the conservative way to obtain exposure to LNG over the coming years. More than 95% of the company’s production volumes through the mid-2030s are under long-duration sale-and-purchase agreements (SPAs) with a 15-year weighted-average remaining life. Those contracts alone are expected to deliver more than $20 per share of run-rate distributable cash flow (DCF) regardless of where global LNG prices settle. Share repurchases and production growth are set to increase DCF from $20 per share to $30 per share.

Cheniere shares exceeded our published $180 price target in November 2023. DCF growth going forward places fair value at approximately $330.

With Cheniere shares trading at $272, investors who own the name should stay put as management’s execution builds value. They should consider trimming once the shares reach $300, at which point the stock would trade at roughly 90% of fair value.

Investors looking to buy or add to the name should wait for a pullback after the shares’ run from $190 to $272 over the past four months.

20/20 Vision Now Complete

On February 26, 2026, Cheniere completed its 20/20 Vision capital allocation plan. The plan had been announced in September 2022 and served as a framework for allocating the $20 billion in DCF management expected to be generated over the next five years.

Due to consistently outstanding execution, the company completed the plan ahead of schedule. Its forecasted $20 billion in DCF had been generated and allocated to debt repayment, share repurchases, dividends, and growth. It also achieved its targeted DCF run rate of $20 per share.

True to form, Cheniere didn’t rest on its laurels after completing its plan. It immediately launched a new five-year plan that featured an upsized repurchase authorization of $10 billion and a $30-per-share run-rate DCF target on a 175 million share count, implying a 17% lower share count due to repurchases.

I expect this new plan to be completed, and for its completion to drive Cheniere shares to my fair value estimate, which is 21.3% above the current share price.

The 2026-2030 Plan has Begun

Cheniere’s recent financial and operating performance speaks to its ability to achieve its 2030 plan, as it continued to execute superbly on all fronts.

In 2025 alone, the company repaid $652 million of consolidated long-term indebtedness. It repurchased 12.1 million shares for $2.7 billion, including 4.8 million at lower prices in the fourth quarter for $1.0 billion. During the year, it allocated 52% of DCF to share repurchases. Quarterly dividends of $0.555 per share—$2.22 per share annualized—came to $451 million, and growth capex reached $2.6 billion for CCL Stage 3 commissioning.

Looking ahead, the company’s 2026-2030 framework features more of the same capital allocation execution. The board’s $10 billion share repurchase authorization, which is comprised of the $1.2 billion remaining under the previous June 2024 authorization plus an additional $9 billion, represents a more than doubling of potential repurchases, with $9 billion of new capacity versus the prior $4 billion program.

Assuming an average share price of $280, $10 billion of repurchases will retire roughly 36 million shares, bringing the share count from approximately 210 million today to approximately 174 million by 2030. The repurchases increase DCF per share by 21%. Growth projects, namely Sabine Pass Liquefaction (SPL) Expansion and Corpus Christi Liquefaction (CCL) Expansion, would represent DCF upside if they proceed. I expect the repurchases, along with the cash flow generated by the growth projects, to enable the company to achieve its $30-per-share target.

SPAs Provide Cash Flow Stability

Cheniere’s contracted SPAs form the backbone of its investment thesis. According to the company’s latest investment presentation, approximately 95% of total anticipated production from the SPL and CCL projects is contracted through the mid-2030s.

These agreements lock in cash flow through the next decade. The contracted cash flow floor they create is set to deliver more than $20 per share of annual DCF today. The integrity of cash flow is underpinned by creditworthy counterparties, which include investment-grade global buyers such as Shell (SHEL), BP (BP), TotalEnergies (TTE), KOGAS, CPC Corporation, and others. These buyers pay Cheniere fixed take-or-pay fees regardless of whether they lift the cargo.

Meanwhile, non-contracted cargoes capture spot price spreads between global JKM and TTF LNG pricing and domestic U.S. Henry Hub natural gas pricing. Spot exposure adds upside in tight LNG markets and removes upside in weaker markets, but it doesn’t impact the cash flow floor provided by long-term SPAs. If macro conditions in the LNG market push prices higher, spot exposure could accelerate Cheniere’s path toward its $30-per-share DCF target.

Balance Sheet Strength Adds Safety

Liquidity at year-end 2025 was ample, totaling $8.8 billion, including $1.1 billion in cash, $485 million in restricted cash, and $7.2 billion in credit facility availability. Long-term debt stood at $22.5 billion. Sabine Pass Liquefaction retired the full $500 million of its 5.875% 2026 Senior Notes between December 2025 and February 2026.

Net debt increased by roughly $1.5 billion in 2025 as Cheniere drew down cash to fund $2.7 billion in buybacks and $2.6 billion of growth capex. Leverage remained conservative throughout the year. With full-year 2025 Adjusted EBITDA at $6.9 billion versus $6.2 billion in 2024, its net-debt to EBITDA ratio fell modestly, from 3.1x in 2024 to 3.0x in 2025.

The credit rating agencies have a favorable view of Cheniere’s balance sheet. S&P Global Ratings upgraded Cheniere Energy, Inc. and Cheniere Energy Partners (CQP) from BBB to BBB+ with stable outlooks in November 2025. Cheniere Corpus Christi Holdings was upgraded from BBB to BBB+ with a positive outlook in October 2025. The upgrades reflect the company’s enhanced operating quality following the commissioning of CCL Stage 3 and improved cash flow visibility.

Three DCF Scenarios

Cheniere’s 2026-2030 capital plan has clear implications for its stock. The following three scenarios illustrate the potential upside and downside. Each features assumptions pertaining to management’s execution, the macro backdrop, and the company’s financial performance.

The contracted long-term SPAs provide a cash flow base. Changes from the base depend to a significant degree on marketing activities conducted by Cheniere Marketing International (CMI), Cheniere’s in-house marketing and trading arm. CMI sells uncontracted LNG volumes into the spot and short-term markets, capturing the spread between Henry Hub feedstock prices and international LNG prices.

My base scenario follows management’s guidance, with CMI’s margin at $2.50 per MMBtu, both SPL and CCL Expansion final investment decisions (FIDs) by 2027, and full deployment of $10 billion. The bear scenario shrinks CMI’s margin to $1.50 per MMBtu, defers both Expansion FIDs past 2030, and deploys only $5 billion of the $10 billion buyback. The bull scenario maintains the same FID assumption, increases CMI’s margin to $3.00 per MMBtu, and accelerates repurchases to 2028.

The base scenario, at an 11x DCF multiple, supports a share price of $330. I expect such a scenario to provide long-term holders of the name an opportunity to exit at a higher price.

The bull scenario at an 11x DCF multiple implies a price of $363, for 33.5% upside. A more conservative bull scenario using a 9x multiple implies a price of $297, 9.2% above the current price and just below my planned trim level.

A bear scenario at an 11x DCF multiple supports $264, 3% below the current price. However, a more severe bear scenario using a 9x multiple supports a $216 share price, representing 20.6% downside. The stock price declines in this scenario due to multiple compression, as DCF per share is roughly flat with 2026.

The table below walks through the bear scenario math, the most adverse of the three scenarios.

Risk-reward at $272 features 21.3% upside, with downside ranging from negligible at flat multiple to material at full margin compression.

Applying analogous bridges for the base and bull scenarios produces the DCF per-share figures shown in the scenario table below.

At $272, the call is to hold. My base scenario puts fair value at $330, implying roughly 21% of upside that share buybacks should help deliver over the next 18 to 24 months. Current holders of the shares should consider trimming at $300, or at roughly 90% of fair value, taking, say, 20% to 30% of their position off the table, and accelerate trimming above $325, where the stock would already reflect near-perfect operational and financial performance. However, I wouldn’t be likely to exit the shares completely at any level, as Cheniere’s contracted cash flows and ongoing buybacks should continue to grow per-share value over a five-year period, and perhaps beyond.

For investors looking to add to their position, consider entering around $240. At that level, Cheniere trades at approximately 11x current run-rate DCF and 8x the $30 DCF target. This multiple would be at the low end of the historical range for high-quality contracted midstream operators. The $216 price in the bear scenario at a 9x multiple is 10% below $240, while the $330 price in the base scenario is 37% above. That 4-to-1 upside-to-downside is the kind of setup that I believe justifies adding in size rather than nibbling.

Downside Risk

Given all the operational and macro-level risks in the outlook, it is important to consider the various ways my fair value estimate can fall short. Four bearish variables, in particular, could cause Cheniere shares to undershoot my estimates in the scenarios above.

The first variable is multiple compression. At $272 per share, Cheniere trades at roughly 12.5x its full-year 2026 guidance midpoint DCF of approximately $21.90 per share ($4.6 billion ÷ 210 million shares). High-quality, contract-protected midstream peers trade at DCF and EBITDA multiples in the 8x to 11x range. Cheniere’s 15-year weighted-average remaining life on its SPAs and its relatively high return on capital support a multiple at the high end of the range. Still, company-specific or sector-wide multiple compression would provide a headwind for the share price.

The second bearish variable relates to Cheniere’s post-2030 SPA roll-off schedule. The company does not disclose details other than the 15-year weighted-average life of its contracts. However, this statistic suggests the company is exposed to repricing risk as contracts renew after 2030. If contracts roll off in a softer global LNG market, both fixed-fee renewals and CMI margins are at risk of repricing downward.

A subtle disclosure trend in the 2025 10-K reinforces roll-off risk. Cheniere states in its 2025 10-K that approximately 90% of total anticipated production from the SPL and CCL projects is contracted through the mid-2030s. This is down from 95% in the 2024 10-K. The likely explanation for the decline is that the 10-K denominator reflects in-construction CCL Stage 3 capacity for which long-term SPAs have not yet been signed. As growth capex delivers new production volumes, this percentage could drift lower until expansion-related SPAs catch up. The bull scenario on Cheniere therefore depends in part on management’s ability to commercialize SPL Expansion and CCL Expansion volumes ahead of the early-2030s roll-off, execution that has been strong but cannot be guaranteed.

However, I’m not overly concerned about roll-offs in Cheniere’s case. For one, recent contract signings point to upside, not downside, on the pricing front. Cheniere’s long-term deals with Galp (GLPEY), Equinor (EQNR), Foran Energy, and others, signed between 2022 and 2025, locked in higher fixed fees than the older contracts they replaced. As a result, the portfolio’s average pricing is increasing, not declining. The bearish premise assumes a deterioration that these contract wins appear to contradict.

Furthermore, Cheniere’s main competitor is potentially in trouble. Venture Global (VG) is in arbitration with BP, Shell, and other major customers over cargoes VG diverted to spot markets instead of delivering to its customers under contract. The damages claimed run into the billions, and the situation poses financial risks for VG while also diminishing its standing as a reliable supplier. After VG’s actions, I suspect LNG buyers looking to lock in post-2030 volumes will be willing to pay a premium for proven operating and delivery records. Cheniere has an impeccable track record in both areas, which should result in higher fixed fees in new SPAs.

Lastly, the math holds in the moderate bear scenario. Even after applying the bear adjustments shown in the bridge above—CMI margin compression, spot-pricing weakness, and a fixed-fee discount on early-vintage SPA renewals—DCF lands at $24 per share. At a 9x multiple, which is low for contracted infrastructure operators, the shares would trade at $216, or 21% below today’s $272. Meanwhile, the base scenario produces $330 at 11x, or 21% above the current price.

That said, Cheniere investors should know that the moderate bear scenario detailed above isn’t the potentially deepest downside. An extremely bearish scenario, in which the CMI margin declines to $1.00 per MMBtu in a structurally oversupplied 2027-2028 market, $5 to $7 billion of repurchase capacity is redirected to growth capex, the CCL Stage 3 ramp is delayed by six to nine months, and SPAs are renegotiated at, say, 15% below current fees, reduces DCF to $18 to $20 per share. At an 8x multiple, the implied price is $144 to $160, or a 41% to 47% decline.

While I think it’s highly unlikely that all these stressors occur simultaneously, it’s not entirely implausible, particularly amid severe global economic deterioration. Still, the moderate bear remains my central downside scenario and is part of the reason why I’ll consider trimming above $300.

The third variable that would cause Cheniere shares to undershoot my fair value estimate is the timing of the SPL Expansion FID. The project’s FERC application and DOE non-FTA application remain pending. A 12- to 24-month completion slip puts $4 to $6 per share of DCF at risk, which is the mid-decade catalyst for a bullish outcome.

A fourth bearish variable is a sustained rise in U.S. natural gas prices. Cheniere is largely insulated on its long-term contracts because customers pay the gas cost as a pass-through, but sustainably higher Henry Hub prices, which natural gas bulls believe will be driven by data center demand, home heating recovery, and LNG export growth, could reduce earnings on spot-market sales by $50 to $150 million annually and, more importantly, make new U.S. LNG contracts less competitive against lower-cost global supply, such as that produced by Qatar. Those new contracts are what the bull case depends on to fund expansion.

Beyond the four bearish variables above, four specific developments would cause me to consider trimming or selling Cheniere shares more aggressively. If the company were to repurchase less than $2 billion of stock in 2026, the path to a 175-million-share count would extend longer, and management’s commitment to its buyback pace would come into question. If Cheniere signs a new long-term SPA at $2.00 per MMBtu or below—which would be roughly 25% below current pricing—it would signal that the prices the company can lock in for contracts rolling off after 2030 are lower than the bull case assumes. If the completion date of CCL Stage 3 Trains 5-7 slips past March 2027, the company’s 2027 EBITDA would be at risk of declining below my estimate. And if regulators delay an authorization of the next major expansion past year-end 2027, 20 MTPA of growth gets pushed into the early-to-mid 2030s. Any one of these outcomes alone would dim my view of the company’s prospects. Two or more would prompt me to consider selling.

Conclusion

Cheniere is the conservative way to own LNG. The contracted floor delivers more than $20 per share of run-rate DCF today, and the buyback math drives DCF per share to roughly $30 by 2030. At $272, investors should consider holding and potentially trimming above $300.

We entered Cheniere on January 25, 2021, at $63.82 in our HFIR Energy Income Portfolio. Our position has generated a 334.6% total return and now stands at a 6.0% weighting in the portfolio. Outstanding execution in operations, deleveraging, distributing capital to shareholders, and a strong contracted cash flow floor drove our gains. I expect the same factors to continue sending the shares to $300. At that point, depending on the macro backdrop, I’ll consider trimming my position and holding the rest as the framework continues to work.

Link to HFIR Energy Income Portfolio on RunPlutus.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of LNG either through stock ownership, options, or other derivatives.

I’ve been thinking a lot about how to position and when—or even if—to sell oil-related holdings after their surge in response to the conflict in Iran. Aside from investing a portion of the distributions received, the HFIR Energy Income Portfolio has had no trading activity over the past 15 months. But its daily performance looks like this:

I’d be crazy not to consider trimming after such a rapid surge in the portfolio. The trick, as always, lies in the timing.

Physical Fundamentals Justify the Premium

Since the U.S.-Israeli strikes on Iranian nuclear and military infrastructure began on February 28, Brent crude has surged from roughly $80 per barrel to over $112, or more than 50% in a single month. On Monday, March 30, WTI settled above $100 for the first time since July 2022. The IEA and other experts have characterized the disruption to flows through the Strait of Hormuz as the largest supply disruption in the history of the global oil market.

The risk premium on crude oil is no longer based mostly on market anticipation. Iran’s Islamic Revolutionary Guard Corps closed the Strait to most commercial shipping on March 4. A selective reopening on March 26 now permits transit for ships flagged to five nations, namely China, Russia, India, Iraq, and Pakistan, but the net reduction in flows is estimated at roughly 11 million barrels per day. For context, that strait normally handles approximately 21 million barrels per day, or about 20% of global petroleum liquids consumption.

Energy equities have followed the surge in oil. The XLE is up approximately 40% year-to-date through March, outperforming the S&P 500 by over 32 percentage points. This is the widest gap ever recorded in a single quarter. Fourteen of the 22 XLE constituents rallied more than 10% in March alone.

The instinctive conclusion is straightforward: higher oil prices justify higher equity valuations, and the disruption is real this time. But looking at history, I’m more inclined to believe that some de-risking may be in order.

The Pattern That Repeats: War Premiums Collapse

The risk, as I see it, for holders of energy equities arises due to the historical pattern of collapsing risk premiums once supply risks fade. The pattern is for oil prices to peak at maximum uncertainty, not necessarily maximum disruption. Prices then collapse once markets realize the worst-case scenario either will not materialize or has already been priced in.

Historical analogs follow a similar pattern.

Gulf War, from 1990 to 1991. Iraq’s invasion of Kuwait drove oil prices sharply higher as markets priced in a prolonged supply shock. Once it became clear that a U.S.-led coalition would restore flows, oil collapsed before the conflict itself had fully resolved. The peak occurred when fear was highest, not when fundamentals were most impaired.

Libya in 2011. The civil war removed roughly 1.5 million barrels per day from global supply. This was an actual, physical disruption, and prices spiked accordingly. Yet Saudi spare capacity and global supply adjustments filled the gap faster than expected, and the rally faded.

Russia-Ukraine in 2022. This is perhaps the most relevant recent analog prior to today. Oil surged above $120 per barrel amid fears of massive, sustained supply losses from one of the world’s largest exporters. Those fears proved to be dramatically overstated. Russian barrels were rerouted, demand adjusted, and oil prices declined even as the war continued. Markets consistently overestimated the persistence of disruption.

These episodes reflect a structural feature of the oil market. Markets tend to discount probabilities. The oil market has tended to embed worst-case scenarios into prices early on, leaving limited room for further upside. Historically, supply has generally been more flexible than assumed, adjusting to disruptions through spare capacity, inventory drawdowns, and rerouting. Meanwhile, higher prices reduce consumption, particularly in emerging markets, while speculative positioning amplifies both the rally and the inevitable unwind.

In all these previous episodes, the geopolitical risk premium was not a stable component of oil prices. It was a temporary overlay that disappeared abruptly once uncertainty abated.

This Episode Breaks the Historical Mold

Today’s disruption differs from previous episodes in important ways, with important implications for portfolio positioning.

First, this is a chokepoint disruption, not a producer outage. Past disruptions, such as those involving supply losses in Libya, Iraq, and even Russia, also led to production losses. In those situations, the global system had enough spare capacity to offset the production losses.

By contrast, the Strait of Hormuz is a transit artery. Disruption here affects flow, not just supply, and rerouting is far more complex. There is no pipeline bypass for 21 million barrels per day of seaborne crude, condensate, and refined products.

Second, the disruption has actually materialized. In previous episodes, markets priced for a disruption that never fully occurred. Here, the Strait was physically closed for weeks, and the selective reopening excludes most Western-allied shipping. The 11 million barrels per day net reduction dwarfs the scale of previous disruptions. This is not a risk premium on a theoretical anticipated threat, but a premium on an ongoing event.

Third, the system’s shock absorbers are weaker. Before this disruption, OPEC’s deployable spare capacity stood at 1.5 to 2.5 million barrels per day. This spare capacity was concentrated almost entirely in Saudi Arabia and the UAE. This spare capacity represents a fraction of the volumes currently disrupted. More importantly, the strategic value of this spare capacity is diminished when low-cost drones can credibly threaten the infrastructure that produces it. The vulnerability of concentrated spare capacity in the Middle East to military threats is a structural shift the market has not fully priced in.

Consider further that U.S. shale production has plateaued at roughly 12.7 million barrels per day over the past several months. Capital discipline, depleting Tier-1 acreage, and muted drilling response mean the U.S. is no longer the swing supplier it was in the 2014 to 2019 timeframe. In fact, the EIA is forecasting a slight decline in U.S. output in 2026.

Fourth, escalation risk is nonlinear. Previous conflicts were localized events. By contrast, today’s situation involves direct military strikes on a major regional power, the killing of its leadership, and retaliatory missile and drone strikes on U.S. bases and allied Gulf states. Diplomatic efforts have thus far failed, with Iran rejecting a U.S. 15-point proposal on March 25 and its parliament stating it will not negotiate under coercion. The pathway from here includes infrastructure targeting, further shipping disruptions, and broader regional spillover.

Fifth, normalization takes longer than the market assumes. Even in a peace scenario, the physical process of restoring transit through the Hormuz Strait will be measured in months, not days. Empty vessels need to be repositioned into the Strait and then routed back to destination points. Safety buffers, such as unsanctioned oil-on-water and SPR draws, are being exhausted. Cumulative Middle Eastern production losses are projected to reach as much as 1 billion barrels even under an optimistic mid-April normalization, effectively killing the surplus narrative that had characterized pre-crisis balances. And restarting production from shut-in fields takes months. For instance, Kuwait has publicly stated that it expects its own fields to take 3 to 4 months to fully resume operations. Restarting production from less technologically sophisticated fields carries the risk of damaging reservoirs after a prolonged shutdown. Clearly, this massive global system of mindboggling complexity will not straighten itself out overnight.

Resolving the Tension: What the Outcomes Look Like

This is where I think investors risk making the wrong call. In moments of fear and uncertainty, there is a temptation to focus on binary outcomes and make binary trading decisions. Investors may opt to either stay fully invested, betting on continued escalation, or exit entirely, betting on historical precedent. Both approaches ignore the wider distribution of potential outcomes.

At the moment, several such outcomes strike me as likely.

Scenario A: Negotiated de-escalation within 60 to 90 days (40% to 50% probability). A diplomatic resolution or a sustained ceasefire leads to the reopening of the Strait. In this scenario, I would expect oil to decline, but not to pre-crisis levels. Even during de-escalation, the normalization of physical flows will take months, cumulative supply losses will have reset global balances, and an enduring political risk premium of $10 to $20 per barrel will likely persist in light of the Strait’s demonstrated vulnerability. Given all the factors at play to date, I expect Brent in the $80 to $90 per barrel range. At those prices, energy equities would give back a portion of their first-quarter gains but would find support above pre-crisis levels. This remains the most likely single outcome, but I’ve reduced its probability from my initial estimate because the normalization timeline alone, which includes months of vessel repositioning, field restarts, and stock rebuilding, will make a clean, rapid unwind unrealistic.

Scenario B: Prolonged partial disruption (35% to 45% probability). The selective reopening of the Strait persists. Some barrels flow, but at a higher cost and with insurance premiums. Oil stabilizes above $100 per barrel and at times heads toward $120 for several quarters. In this scenario, the likelihood of broader economic damage from the outage increases. Markets and stock prices would discount a weakening economy. Energy equities would likely hold their gains and trade sideways. This is the scenario markets are increasingly pricing in, and the one whose probability I’ve revised upward. The structural factors in play all support a more persistent disruption than historical analogs would suggest.

Scenario C: Full escalation and sustained closure (10% to 20% probability). The conflict widens, infrastructure is targeted, and the Strait returns to full closure. Oil is sustained above $130, which is the price at which I estimate demand curtailment will begin on a broader scale in more developed economies, which consume most of the world’s oil. Energy equities re-rate further before the global economy buckles under the strain of higher energy prices, at which point they would decline from their highs. This scenario represents the tail risk.

What to Do: Reduce Position Size, Not Exposure

The appropriate response is not to exit all energy investments in full. It is to de-risk while maintaining meaningful exposure. The key point is that, despite the structural arguments for a higher floor, current prices still reflect a premium that is at risk of rapidly diminishing. The historical pattern of overshoot remains intact, even if the downside in the current situation is less extreme.

I would recommend trimming overall energy equity exposure by approximately 10% to 15% at current levels. This is not a defensive retreat, but a recognition that the market is pricing a sustained disruption with limited margin for error. The objective is to reduce exposure to a potential normalization of the risk premium while retaining long-term participation in a structurally tighter market.

For energy specialists, holding cash seems prudent. I have already raised the HFIR Energy Income Portfolio’s cash position to 4%, and I’m considering increasing it to the 15% to 20% range. This cash can be deployed back into the energy sector in the event commodity and/or stock prices decline. Alternatively, it can be deployed more widely into other sectors if oil prices run away to the upside and the rest of the market declines.

What to Trim First

After deciding to de-risk, an investor must determine what to sell first. I would focus on names with the highest beta to spot oil prices. These stocks have rallied most aggressively and carry the most downside if oil corrects.

The first candidates for trimming are lower-quality E&Ps with high oil torque. Devon Energy (DVN) and APA Corporation (APA) are two such examples that come to mind. These are widely held stocks that have led the XLE, with a 44% gain in March alone. They are currently among the E&Ps most exposed to a risk premium unwind. These stocks have re-rated on pricing that may not persist.

Second, I would consider lightening up on integrated majors that have benefited from multiple expansion. Exxon Mobil (XOM) and Chevron (CVX) are more defensive but have still moved meaningfully. Investors should consider trimming these, though less so than high-beta independent E&Ps. The integrated majors offer dividend support on the downside, but the margin of safety has narrowed.

What to Hold More Confidently

Of course, not all energy equity segments carry the same risk profile. Some segments are better positioned regardless of how the conflict resolves.

Midstream companies remain well-positioned for long-term holding, given their recent price gains. Pipeline operators and MLPs, including my longtime favorite Enterprise Products Partners (EPD), Energy Transfer (ET), and MPLX (MPLX), have lower direct commodity price sensitivity. Their revenue is primarily fee-based and contract-driven. Midstream has outperformed through the conflict but with less volatility, and its relatively high yield provides a floor. These names form the core of income-oriented energy portfolios because they earn their profits through volume rather than price.

Natural gas-levered equities. I increasingly suspect the LNG angle in the current situation is underappreciated. Qatar’s LNG exports transit the Strait of Hormuz, and disruption to those flows has tightened global LNG markets. North American natural gas producers and LNG exporters operate entirely outside the disruption zone. Cheniere Energy (LNG) is one such example. These companies benefit from the crisis without bearing the risk of its resolution.

Canadian producers are another longstanding favorite of mine, and the structural case for holding them has strengthened beyond the geographic argument I would have made a month ago. Names like Canadian Natural Resources (CNQ), Suncor (SU), and Cenovus (CVE) are geographically insulated from Hormuz risk while benefiting from the combination of sustained higher oil prices and long-lived reserves. The demonstrated vulnerability of Middle Eastern supply infrastructure to military threats permanently increases the strategic value of reserves in politically stable countries with pipeline egress. Canada is the most obvious beneficiary. The market has not fully absorbed this structural shift. Furthermore, pipeline capacity out of Western Canada has improved in recent years and could improve further if political momentum for increased exports builds.

Signals to Trim More or Reverse Course

Historically, it has been prudent to exit energy stocks not when the war ends, but earlier, when the market decides the worst case is off the table. I would watch for these signposts:

Brent sustains below $100 per barrel. If Brent falls below $100 per barrel and fails to reclaim that level within a week, the risk premium is likely to deflate over time. This may be the market’s way of signaling that de-escalation is being priced in. It may be a cue to trim further.

Full Strait reopening or a credible diplomatic framework. Any formal agreement or a credible ceasefire with multinational guarantees would remove the core thesis for elevated prices. In this scenario, I would expect oil to gap down $15 to $20 in a matter of days.

Physical flow normalization. This requires tracking tanker traffic through the Strait. If Western-flagged vessels resume transiting, the supply picture will change materially before official announcements. However, even after a political resolution, the physical normalization of flows will lag by weeks to months. Vessel repositioning, insurance repricing, and cautious operator behavior will create a prolonged tail.

Narrative saturation. Investors should be on guard for moments of maximum complacency. This will be when the consensus shifts to the view that oil will remain far above $100 per barrel indefinitely and that the world has entered a new pricing regime. This will also be when the historical pattern of collapse becomes most likely. It is when the downside risk to E&P stocks is at its highest.

Brent breaks above $130 per barrel and holds. In this scenario, oil prices enter the region of demand curtailment. The market is likely pricing in a full escalation, or Scenario C above. At that point, I would sell my E&P holdings more aggressively, as oil and E&P stock prices will eventually retreat as demand is increasingly curtailed. However, depending on prices at the time, I may add to midstream and LNG names that would benefit from a longer-term dislocation.

Conversely, strategic hoarding is a leading indicator for reversing course, and not trimming. Watch for countries announcing export bans on refined products or accelerated SPR building programs. This behavior, which is already emerging, signals that governments expect a prolonged disruption and are competing for physical barrels. It is bullish for both crude oil and refining margins, and it extends the timeline for any normalization of global balances.

Conclusion

History is clear that war-driven oil rallies are unstable and tend to unwind as uncertainty declines. This episode is different in degree: the disruption is real, the chokepoint is critical, and the system’s capacity to absorb the shock is limited. These factors raise the pricing floor, but they do not eliminate the well-worn historical pattern.

Current prices already reflect a prolonged disruption. The upside from here is incremental, while the downside—though less severe than in past episodes—remains meaningful. That is sufficient to justify reducing exposure at the margin.

I intend to trim high-beta oil exposure by 10% to 15%. I will favor high-quality midstream positions, LNG, and Canadian producers, and I will adjust further as market signals indicate whether the risk premium is beginning to unwind or being reinforced.

Analyst’s Disclosure: Jon Costello has a beneficial long position in the shares of EPD, MPLX, ET, LNG, CVE, SU either through stock ownership, options, or other derivatives.

By: Jon Costello

As a capital-cycle investor, the chemical sector piqued my interest in the second half of last year. We began investing in the space late last year.

Since then, chemical stocks have started to recover, with further gains likely if the recovery continues. What were potential three- or four-baggers a few months ago can still double or more from their current prices.

As we made our investments, I published a series of articles outlining my views on the sector, its cyclical properties, and my favorite investment prospects. This article provides a review of my macro and micro theses for the cyclical chemical sector.

Part I: The Chemical Sector: Olefins and the Rest

The chemical sector is in its longest downturn in recent history. For many chemical companies, earnings have been on a downward path since 2021. As demand remains tepid amid abundant supply, the industry faces several headwinds, both cyclical and structural. However, opportunities are there for investors who understand the risks and potential upside.

After reviewing the industry, I have found a few crucial points for investors navigating the sector in search of bargain opportunities.

One is that opportunities are absolutely there for the taking. Anyone who looks at the past earning power of the typical industrial or commodity chemical company and compares it to today’s market cap and enterprise value can appreciate that most of the sector is cheap. Many chemical stocks trade at obscenely low multiples of mid-cycle earnings. Interestingly, this isn’t the case in the energy sector, where most stocks discount a sustained recovery. But even using extremely conservative valuation assumptions, I believe multi-baggers exist in chemicals for investors who can identify opportunities, size their positions appropriately, buy on weakness, and stomach the inevitable volatility that arises in cyclical downturns.

A second crucial point is that cyclical forces will bring about a recovery. No one can precisely time when this will occur, though I believe a recovery is underway for some chemical sub-sectors.

For example, some particularly cyclical chemical sub-sectors are experiencing low prices that will likely lead to supply curtailments. Eventually, inventories will get worked down, prices will increase, and margins will grow. Meanwhile, in areas that may remain weaker for longer, low-cost producers are available. These are the companies that are most likely to survive the downturn and thrive in the ensuing upcycle. These are the kinds of opportunities investors should try to identify.

Such low prevailing prices raise the question of whether the sector’s low valuations are justified. This is another crucial point worth fleshing out, namely, that olefin producers are cheap for good reason. This is a large segment of the sector by market cap, and it often tops the buying lists of many generalist bargain hunters. Companies such as Dow (DOW), LyondellBasell (LYB), and Westlake (WLK) are at risk of a far more brutal downturn than their non-olefin peers. Their stocks are right to be low and will likely remain so, as their profits are at risk of moving even lower for years. Any recovery is likely to be fleeting.

This isn’t necessarily the case for non-olefin producers, though I suspect that many have been tarred too negatively with the olefin brush. Investors can therefore divide the chemical sector into olefins and “everything else.” The former are to be avoided altogether, and I discuss why below. The latter is where mispricings can be found.

The Factors Driving the Olefin Glut

Olefins are hydrocarbons that contain at least one carbon-to-carbon double bond. The main olefins are ethylene, propylene, and butenes. They’re made by steam-cracking ethane, propane, naphtha, and other hydrocarbons. Olefins serve as the building blocks for polyethylene, polypropylene, and various intermediaries. Polyethylene and polypropylene are the building blocks of plastics.

Investors in chemical companies should be aware that overinvestment has severely diminished the prospects for returns in the olefins market.

The culprit behind the oversupply is investment by the integrated oil majors to expand their downstream chemical operations. Their investments have been focused mainly on expanding production of ethylene, polyethylene, polypropylene, and aromatics. The onslaught of new supply threatens to lower the margins and returns on capital for olefin producers for years to come.

Since 2015, the annual production capacity of light olefins—ethylene and polyethylene—has increased by more than 50%, from approximately 230 million tons to 430 million tons. The growth outpaced real global GDP, which grew by roughly 25% over the same period.

Source: Oilchem, GlobalData, ICIS, and Wood Mackenzie.

The surge in investment came as the narrative about the future of gasoline and diesel demand turned negative. Virtually all the majors bought into the idea that demand for their biggest-selling refined products would peak and begin to decline in the 2030s. Oil and gas executives who knew this narrative was flawed were pressured to accept it through political and regulatory dictat, corporate governance, lawsuits, and shareholder pressure. Many industry participants grew concerned that EV penetration, fuel economy improvements, and biofuel blending mandates would slow gasoline and diesel demand over time. As a result, refining would no longer be a reliable growth engine. Sticking to these “sunsetting” products implicitly meant embracing excess supply and structurally low margins.

Petrochemical production, on the other hand, was expected to grow. Rising living standards and global urbanization would drive demand for plastics and other petrochemical products above the GDP growth rate. With demand expected to rise, global majors sought to convert their hydrocarbon feedstocks into chemicals rather than gasoline or diesel. In doing so, they figured they could create more value per barrel of crude oil feedstock. Adding to petrochemicals’ allure was surging production of light oil and NGLs in U.S. shale basins, which promised years of growing chemical feedstock at ultra-low prices. Structurally lower feedstock prices held the prospect of boosting margins relative to competitors on the global stage.

As usual in the oil industry, nearly all participants embraced the same strategy: favoring investment in chemicals over gasoline and diesel. Thus, a synchronized global petrochemical capacity buildout was unleashed. Polymer inventories bulged, prices fell, and petrochemical margins were destroyed.

The economics are plain to see. For example, Shell’s (SHEL) new polyethylene complex in the U.S. has missed its original return targets thanks to cost overruns and weak polyethylene pricing.

The Integrated Majors’ Petrochemical Buildout

The integrated oil majors’ expansion in petrochemicals over the past few years has been unprecedented.

ExxonMobil (XOM) expanded its Baytown, Texas, refinery by adding new chemical units that sourced Permian NGL feedstock. The expansion represented an investment of $2 billion and included a 350,000-ton-per-year olefin unit and a 400,000-ton-per-year performance polymer unit.

More concerning for the chemical market, ExxonMobil plans to continue its Gulf Coast petrochemical buildout to convert light crude oil and NGLs from U.S. shale into higher-value products. The company plans to spend $20 billion over ten years beginning in 2023.

Shell built its Pennsylvania Petrochemicals Complex outside Pittsburgh. The complex is a massive ethane and polyethylene production operation designed to use locally produced Marcellus and Utica ethane to produce plastic. Its capacity is 1.6 million tons of polyethylene per year. Shell estimates spending $14 billion on the project.

TotalEnergies (TTE) commissioned a one-million-ton-per-year ethane steam cracker for $2 billion. The facility is integrated with Total’s refinery platform. In 2023, the company added a new 625,000-ton-per-year polyethylene unit at its Bayport, Texas, platform for approximately $1.4 billion.

Chevron (CVX) and Phillips 66 (PSX) entered into a 50/50 joint venture to partner with QatarEnergy to build a 2.1 million-ton-per-year ethane cracker and two one-million-ton-per-year polyethylene units in Orange County, Texas. Both are set to start up in 2026. The estimated investment for the project is $14.5 billion.

Saudi Aramco has explicitly adopted a “liquids to chemicals” strategy to maximize the profitability of each barrel of oil it produces. Aramco aims to convert 4 million barrels of crude oil per day into petrochemical feedstocks by 2030. As of 2025, it is around halfway there.

Altogether, Aramco’s investments to date include large-scale crackers and mix-feed steam crackers, which are likely to add more than 10 million tons per year of petrochemical production capacity.

All these—and many other—projects around the world amount to a structural supply headwind that will keep global chemical margins depressed and prevent cycles from the swings they have undergone throughout their history.

China’s Petrochemical Buildout

Over the past few years, China has carried out the most extensive petrochemical buildout in history, amounting to roughly 20 million tons per year at a cost of tens of billions of dollars. Multiple “crude to chemicals” facilities were built on the coast with state support. The objectives in the capacity buildout were to replace plastic imports with domestic production, keep refineries profitable as domestic gasoline and diesel demand slowed due to increasing EV adoption, and bind foreign crude suppliers, such as Saudi Aramco, more closely to China through long-term feedstock deals.

China doesn’t have the benefit of low feedstock costs, but it does benefit from low electricity costs and a lax regulatory environment compared to most global manufacturing regions.

The buildout—which is still ongoing—has been driven by state-owned enterprises, domestic private companies, and foreign operators. The list includes ExxonMobil, CNOOC, Shell, PetroChina, Sinopec, and Aramco. It has led to China’s olefins capacity exploding from approximately 45 million tons per year in 2015 to 145 million tons per year in 2025. To make matters worse for the chemical industry, the country is planning an additional 40 million tons per year of supply through 2030.

China is now the price maker in olefins. However, the country is now beset by overcapacity. But the structural oversupply has increased pressure for exports. This is why low-cost Chinese olefins are flooding the market and may continue to do so for years. So far, the country has not exhibited restraint, even amid persistently low prices, despite calls to rein in “disorderly competition”. China’s continued growth in the sector threatens to put global chemical margins under pressure for years.

Conclusion

Olefin economics are set to be challenged for years. While overcapacity amid lower-than-expected demand has led to a global oversupply, supply is set to continue coming online. China’s production is set to grow steadily through 2030, as shown below.

Source: Reuters, Sept. 22, 2025.

If China’s demand fails to rise by the amount of added supply, excess supply will be exported.

Only plant closures can prevent a glutted market on a permanent basis. There are signs that the downturn has forced some closures, but nowhere near enough to alleviate the oversupply over the longer term.

The upshot is that investors must avoid olefins and stick to other chemical sub-sectors. To help sketch a lay of the land, the next section breaks down the chemical industry into its sub-sectors. Each sub-sector has its unique economics. I believe the brief descriptions can help an investor get their bearings as they attempt to scan the chemical sector for bargain opportunities.

Part II: Chemical Industry Sub-Sectors

There are plenty of chemical stocks to choose from outside the olefins. The chemical industry is comprised of a diverse array of companies that run the gamut in terms of cyclicality, returns on capital, competitive advantages, and other factors.

The sector can be broken into sub-sectors presented as follows. This list is not exhaustive, and some companies operate in multiple sub-sectors. I hope it helps a beginner in the sector find areas within their circle of competence where bargains can be found.

Petrochemical Feedstocks. These are the core building blocks of other compounds. They’re made from crude oil—specifically, the lightest grade, naphtha—and NGLs such as ethane and propane. These feedstocks are used to make the olefins ethylene and propylene, as well as the aromatics benzene, toluene, and xylene. Olefins and aromatics, in turn, are used to make various polymers and solvents. Methanol is another petrochemical building block. It makes formaldehyde and acetic acid, among other compounds.

The key drivers of production are feedstock-product spread, such as the spread between ethane and naphtha. As a global market, product flows are also influenced by changes in inventories and prices across different global trading hubs.

Petrochemicals are highly cyclical. Their prices tend to swing with those of crude oil and NGLs.

Polymers and Resins. These products are formed from petrochemical feedstocks. Polyethylene and polypropylene are plastics used in packaging and consumer goods. PVC is used in construction, while PET is used in beverages. Polystyrene is also used in packaging. Various resins are used in automobiles and electronics.

Like petrochemical feedstocks, profitability depends on spreads between feedstocks and products, as well as the state of global inventories. Recycling plays a role in supply, which reduces the need for petrochemical feedstocks in production. The U.S. Gulf Coast is advantaged due to the presence of large refineries and its proximity to production centers in the U.S. shale basins. Longtime HFIR Energy Income Portfolio holding, Enterprise Products Partners (EPD), is engaged in polypropylene through its downstream PDH units.

Public petrochemical, polymer, and resin manufacturers include Dow, Inc. (DOW), LyondellBasell (LYB), and Westlake Corp. (WLK).

Inorganics and Minerals. This group includes a broad spectrum of chemicals, including chlor-alkalis, chlorine, soda ash, titanium dioxide, and carbon black. Feedstocks for these chemicals are generally mined, so the economics underlying each product differ. Soda ash—previously known from our Genesis Energy (GEL) holding, which recently divested of its soda ash operation—is dependent on the prices of natural trona and other synthetic feedstocks. Titanium dioxide is a pigment used in coatings and plastics. Its economics are tied more closely to housing, construction, and automobile production activity. Carbon black tracks rubber demand as a crucial component in tire production.

Public companies include Tronox (TROX), Kronos Worldwide (KRO), Chemours (CC), and Olin (OLN).

Industrial Gases. Oxygen, nitrogen, hydrogen, helium, and specialty gases are included in this subset of chemicals. As gases, these products are advantaged by long-term take-or-pay contracts, high switching costs, and their mission-critical reliability across their various uses. Industrial gases tend to have more favorable economics than other chemical sub-segments. Their demand is driven by steel and chemical manufacturing, healthcare, and electronics—all of which depend on gases for their production. Capital intensity tends to be high, but contract structures lock in attractive returns.

Public companies include Linde (LIN), Air Products & Chemicals (APD), and Air Liquide.

Fertilizers and Crop Nutrients. Natural gas prices drive the economics of these products. Ammonia, urea, phosphate, and potash industries have generally consolidated into semi-oligopolistic supply sources. Demand is impacted by weather, planting acreage, inventory levels, and export restrictions. New projects tend to be large, so these products are also impacted by the start of capacity additions. Due to price volatility, a producer’s place on the cost curve, as well as its logistics, dictates profitability.

Public companies include: CF Industries (CF), Nutrien (NTR), Mosaic (MOS), and Yara.

Agrochemicals. These are synthesized from other chemicals and include herbicides, insecticides, fungicides, seed treatments, and emerging biological compounds. This sub-segment is heavy on intellectual property and devising new formulations of existing products. Product life cycles, patent cliffs, and regulatory regimes all play a part in product economics. Pricing power and high returns tend to rest with the innovators, while generics producers compete on cost and scale.

Public companies include: Corteva (CTVA) and FMC (FMC).

Specialty Chemicals. This is a broad, fragmented category of diverse chemicals that include performance additives, surfactants, catalysts, mining chemicals, and oilfield chemicals. Calumet’s (CLMT) legacy operations can be found here. Many specialty chemicals are involved in lubrication, corrosion resistance, foaming, and other uses. As such, they tend to add value to other processes and products. They also involve greater innovation and lower commodity-price dynamics. Some specialty chemicals possess significant pricing power. Producers differentiate their products through the cadence of innovation, management of products that make up a chemicals portfolio, technical service, and qualification standards.

Public companies include: Eastman Chemical (EMN), Celanese (CE), Huntsman (HUN), and DuPont (DD).

Coatings, Adhesives, Sealants, and Elastomers (CASE). Producers of these products use solvents, additives, and titanium dioxide to make paints, protective coatings, adhesives, and sealants. Demand is tied to construction, automobile manufacturing, aerospace, and industrial activity. Pricing depends on a company’s ability to pass through fluctuating feedstock costs, as well as regulatory and sustainability trends. Companies compete based on their scale and ability to adjust product applications.

Public companies include: Sherwin-Williams (SHW), PPG Industries (PPG), Axalta (AXTA), and RPM International (RPM).

Consumer and Personal Care Ingredients. This sub-segment includes companies in flavors, fragrances, and nutrition. They incorporate surfactants, preservatives, emollients, conditioning polymers, enzymes, and fragrance compounds into products involved in home goods, personal care, food and beverage products, and nutrition. This sub-sector benefits from relatively stable demand, long customer relationships, and technical formulations that increase switching costs. Scale and innovation enhance economics, and pricing discipline influences margins.

Public companies include: International Flavors & Fragrances (IFF), Symrise, Givaudan, and Croda.

Electronics and Semiconductor Chemicals. These are high-barrier-to-entry products with rigorous purity specifications and significant qualifications for their use. Demand is tied to wafer-fab equipment cycles and other technology cycles. The production process typically requires deep process know-how and the supply of ultra-pure inputs, both of which earn premium financial returns. Customers tend to be sticky, and cyclicality is relatively low. Intellectual property development supports competitive advantages.

Public companies include: Entegris (ENTG) and DuPont (DD).

Performance Materials and Advanced Materials. These are specialized engineering plastics, composites, and silicones. Nylons, PBT, and PC blends, epoxies, and carbon fiber matrices. They serve the automobile manufacturing, electronics, medical, construction, and energy industries. A product’s value depends on its weight, thermal and electrical performance, durability, and regulatory compliance. There is often a risk of supply chain constraints, but margins tend to be durable.

Public companies include: Hexcel (HXL), Huntsman (HUN), and Wacker Chemie.

Rubber and Tire Chemicals. Synthetic rubbers are the largest part of this sub-sector. They rely on the supply and price of butadiene and styrene feedstocks. Additives include antioxidants, accelerators, and process oils. Tire demand is the ultimate driver of price, which is influenced by automobile production, miles driven, and freight activity. A producer’s profitability depends on petrochemical feedstock prices and capacity additions.

Public companies include: Cabot (CBT), Orion S.A. (OEC), PCBL Chemical, and Lanxess (LNXSY).

Part III: The Current Downturn and Prospects for a Recovery

As the global chemical industry works through one of its worst downturns in decades, sales volumes have declined for several years, utilization rates have fallen below 80%, and margins across a broad swathe of producers are hovering around cash cost. For many producers, conditions are akin to a deep recession, even though broader GDP continues to grow.

The downturn has caused earnings of the more cyclical chemical companies to decline for three years in a row, with their stock prices following suit. Expectations of continued earnings weakness keep many of the stocks at multi-year lows.

This business and stock price performance begs the question of whether cyclical chemical companies represent an attractive buy at a low point of their cycle. And if so, how should an investor time an investment? Should they take the plunge now or wait for a macro recession to push chemical stocks even lower?

With full acknowledgement that the downturn has longer to go and chemical stocks are likely to remain weak, I believe equity valuations in a large part of the sector are sufficiently attractive to buy now for a multi-year holding period.

The fact of the matter is that downcycles end; this one will, too, like all the cycles that have preceded it. The inevitable upturn will deliver far higher stock prices and outsized returns for those who invest today, in the depths of the downturn.

Investors seeking to position for an upturn should understand the supply-and-demand factors that led to the current downturn, what will drive the transition to an upcycle, and where to look for opportunities throughout the sector.

Chemical Value Chains

When selecting stocks, investors should view the chemical sector not as a single entity but as a set of “value chains” with their own supply-and-demand dynamics.

Chemicals move across a manufacturing chain that adds value at each step. Starting from raw materials, the industry’s products are developed into base chemical building blocks, then intermediates, then polymers, and lastly, formulated and specialty products. Formulated/specialty products are then sold to end users. There are dozens of core platform value chains. The further down a chain you go, the more specialized and less commodity-like the companies tend to be, and the greater the number of companies that exist to add value from precursor chemicals.

The diversity of value chains makes the chemical sector unique among cyclical commodity sectors. For one, the moves of a single commodity do not determine sector-wide economics the way energy producer results are heavily influenced by oil and natural gas prices, and copper or gold mining results by metal prices.

A chemical operation’s economics are dictated first by the particular value chain in which the company resides and second, by where it stands on that chain.

The existence of multiple value chains means that industry economic cycles differ across chains, as each has distinct supply/demand dynamics, logistical requirements, customer behavior, return characteristics, and so forth.

This isn’t to say that GDP recessions don’t depress earnings in the chemical sector. Of course, recessions lower earnings, and as such, remain a risk. However, a macro recession is not necessary to trigger a downturn in a chemical value chain. Furthermore, a GDP upturn isn’t necessary to spur a recovery in a value chain. Chemical value chain downturns and recoveries can and do occur independently of macro recessions. So investors can sit on their hands waiting for a macro recession to arrive and completely miss out on participating in a full cycle that could deliver outsized returns by buying in the downturn and selling during the recovery.

Factors Driving the Downturn

Today’s downturn in the chemical sector is clearly not being driven by a classic GDP recession. Instead, it’s the result of a nasty combination of overbuilt global capacity, weak industrial end-markets in Europe and parts of Asia, and a long destocking cycle that has reduced orders below end-use demand. The result has been a prolonged downturn that feels like a recession within the industry, even though the broader economy continues to grow steadily.

Just as a GDP recession wasn’t necessary to cause the downturn, a GDP upswing won’t be necessary to drive a recovery. Historically, chemical downturns have ended when inventories in a value chain have normalized and high-cost capacity has been rationalized. Demand does not have to be strong; it simply has to tick higher from the depressed levels specific to a value chain during the downturn. In fact, in the early stages of a chemical recovery, demand is significantly below mid-cycle levels. One of the reasons timing a bottom is so difficult is that recoveries begin during times of still relatively weak demand while supply is still adjusting downward. There is no obvious “all clear” signal, such as a visible surge in demand.

Global Demand Weakness

Demand has been weak across various chemical value chains for various reasons. Tepid industrial demand in major economies has reduced activity in several demand-driving sectors, including construction, autos, electronics, packaging, and consumer durables. This demand weakness has affected various chemical value chains in different ways and to varying degrees. Still, most have seen their sales volumes decline significantly over the past two to three years.

European demand has been particularly bad. The contraction of Europe’s manufacturing base in recent years has reduced demand for polymers, intermediates, coatings, and engineering plastics. At the same time, European chemical producers have suffered an industrial crisis brought about by high energy costs, unfavorable policies, and weak manufacturing activity, all of which have eroded the industry’s competitiveness on the global stage.

In North America, where the macro backdrop is better relative to other regions, higher interest rates and slower housing activity have weighed on value chains for nylon, isocyanates, PVC, and packaging-linked products.

In China, a drawn-out property bust and weak heavy-industry activity have cooled demand for construction-related and freight-dependent value chains.

Another important cause of weak global chemical demand has been an unusually long restocking phase. During Covid and its immediate aftermath, chemical end users over-ordered and built excess inventories in response to supply-chain chaos and rising prices. However, once conditions normalized, buyers flipped to a hyper-conservative posture, drawing down inventories and ordering only what they needed. This behavior persisted much longer than the typical quarter or two seen in a typical recession. The result is that apparent demand has fallen below actual end-use demand for an extended period, amplifying the downturn in volumes and capacity utilization.

Persistent Oversupply

This downturn has been unusually stubborn because the global chemical industry massively overbuilt capacity during the last cycle, particularly in olefins, as covered above.

While olefins are likely to be mired in a downturn for years, other value chains face varying supply situations. In some, new production capacity continues to ramp, reinforcing pressure on trade flows and export prices. Even as demand stabilizes and destocking runs its course, the sheer amount of capacity, especially in Asia, caps pricing power and keeps margins low.

Until enough high-cost capacity exits the system—or demand grows long enough and fast enough to absorb it—the industry will remain in a low-return state. For example, the vinyl and polyester chains are in this group. In other chains, however, supply rationalization has been ongoing for years, and inventories are closer to normalizing.

What Will Spark an Upturn?

The industry’s own adjustment process will end this downturn.

First, inventories across the various chemical value chains need to be normalized. In many chains, this process is well underway. After several quarters of aggressive destocking, order patterns are gradually reverting to more normal behavior, even as demand remains weak.

Second, production capacity must be rationalized. Rationalization can occur in various ways. High-cost assets are shuttered, marginal projects are delayed or cancelled, balance-sheet-strained operators ratchet back on capex, high-growth companies shift to capital preservation, and the industry consolidates. The extent of supply rationalization varies across different value chains, but the process is clearly advanced, particularly among the most stressed commodity producers.

Third, end-user demand will have to grow modestly from a depressed base. Demand tends to grow along with GDP. It will receive an additional boost once destocking is complete. Even if global industrial activity muddles through with low-single-digit growth, chemical producer revenues and margins will stabilize. Any growth will result in positive operating leverage and higher earnings. Even a slight improvement in the volume environment, combined with a smaller base of production capacity and normalized customer inventories, is enough to lift capacity utilization and margins for the survivors. Once utilization and margins rise, a new upcycle can begin.

The Path Ahead

The recovery from this downturn is unlikely to be “V-shaped.” It will more closely resemble a long, uneven climb out of a trough, marked by gradual improvement with sharp divergence between winners and losers.

Global Volumes

On a global basis, volumes are likely to grow modestly over the next few years. A combination of lower interest rates, slowly improving housing and auto markets, and normalized inventory behavior should support low-single-digit demand growth in many chemical value chains.

Given the cyclically low conditions in which many value chains currently operate, modest growth should be enough to prevent conditions from deteriorating further. Even modest growth from today’s depressed capacity utilization levels is likely to translate into meaningful operating leverage, especially for companies that have structurally lowered their costs and rationalized their product portfolios during the downturn.

Pricing and Margins

A recovery in pricing and margins will lag the volume growth, particularly in commodity chemical products traded globally. Olefin chains are the poster child for this dynamic. With so much capacity in Asia, olefin margins will likely remain under pressure for years, while export prices will remain highly competitive.

Other overbuilt, trade-exposed chains will undergo a similar pattern. The initial phase of the recovery is therefore more about volume stabilization and cost absorption rather than a rapid snap-back in prices and margins. Over time, as capacity remains low and demand grinds higher, pricing power will slowly return. However, this is likely to be a multi-year process rather than a quick reset. Some value chains are better positioned to exercise pricing power than others, even among pure commodity producers.

Regional Divergence

There will be stark regional divergences among chemical producers. Producers in the U.S. and the Middle East benefit from structural feedstock advantages and access to global markets. Consequently, they are poised to emerge from the downturn stronger as high-cost European assets are closed or repurposed.

Asia will remain the swing region in many commodity chemicals. New capacity in China will continue to set the marginal barrel in olefins and several other bulk chemical value chains. Investors should expect trade flows and market shares to continue shifting in favor of low-cost regions.

Europe will continue to lose competitiveness in the global chemical market. High-cost European producers are structurally disadvantaged compared to their U.S. and Middle Eastern competitors, which benefit from lower-cost feedstock and less onerous regulations. Energy price spikes and policy uncertainty in Europe have forced several producers to cut utilization, idle production facilities, consider permanent closures, or relocate their operations to countries where they can regain competitiveness. European chemical producers will be forced to migrate toward specialty chemicals, formulations, and niche value chains where they can justify higher costs with innovation, service, and customer proximity. Falling European production is one of the main supply-side factors set to balance various chemical chains in the longer term.

Corporate Strategy

Corporate strategy among chemical producers will reflect the new reality. For one, the growth-at-scale era is probably over. Management teams now emphasize profitability, resilience, and selective growth rather than total volume growth.

Capex plans are being pruned, discretionary “green” projects are being pushed out or rephased, and capex decisions are being viewed through the lens of balance-sheet capacity rather than growth expectations.

Mergers and acquisitions will focus on portfolio upgrades instead of size. Companies will continue exiting structurally challenged commodity assets and add higher-returning specialties. The companies that execute this pivot with discipline are likely to compound value as the cycle turns.

Where to Invest in the Sector

The industry will emerge from this downturn leaner and meaner than it has been in many years. A new upcycle will bring improved margins and higher returns on capital. For several years, industry players are likely to remain disciplined before memories of the downturn fade and more aggressive producers start to build out capacity.

Investors should favor low-cost, feedstock-advantaged producers in supply chains that are regionally constrained, as well as formulation/specialty businesses with genuine pricing power. These franchises are most likely to emerge from their respective value chain recessions with greater market share, stronger balance sheets, and enhanced earning power.

An investor should also focus in areas where demand growth can fill capacity over time. As long as capacity utilization remains cyclically low—as is likely in olefins—returns to shareholders will remain depressed. Producers with high costs and weak balance sheets are higher risk than lower-cost, stronger competitors. However, the survivors among these producers also possess the greatest upside torque to a recovery.

Structurally higher supply may persist in many chemical value chains for some time. Others appear to be on the cusp of a recovery, where the volume and destocking shock has largely run its course. Despite divergent fundamentals across value chains, the prospect of structural oversupply in some chains has worsened investor sentiment toward the sector as a whole, including value chains with stronger recovery prospects. The indiscriminate selling of chemical stocks has created attractive opportunities. Investors should look to invest in low-cost, regionally advantaged, and niche franchises where mid-cycle earning power is being mispriced off trough conditions.

As for what investors should avoid, top of the list is any value chain characterized by structural oversupply. Investors should also avoid high-cost European commodity chemical operations unless they can demonstrate the ability to shift toward higher-margin products.

Lastly, a macro GDP recession is all but certain to reduce chemical demand. Lower demand will cause earnings and stock prices to fall across the sector. However, well-positioned companies in value chains that are already in advanced stages of their downcycle will experience less severe conditions during a recession and undergo more robust recoveries once economic growth returns. Given the risks posed by a recession, investors should favor companies with strong balance sheets that can survive further deterioration in end-market demand.

While recessions are always a risk, market valuations for many chemical producers are currently so depressed that I believe investors can still earn attractive returns over a three to five year holding period, even if a recession intervenes. The key will be to hold positions in the companies most likely to survive, and to avoid investing in the weaker names.

With the cycle mechanics in place, the most useful next step is to ground them in precedent—how prior downturns resolved, and what signaled the inflection.

Part IV: Lessons from Past Chemical Cycles Applied to Today’s Stocks

Many investors are waiting for the onset of a macro GDP recession before investing, even though prices are at bargain levels. They’re doing so to sidestep a selloff that may happen during a recession, or to time their investment at the bottom in anticipation of the subsequent upturn.

Although a recession may happen and likely push chemical stocks lower, investors should consider initiating a position in chemical stocks now.

Recessions are only clear in hindsight and are nearly impossible to predict accurately. Investors waiting for a recession before buying these stocks might miss out on the profits to be had in the eventual recovery.

Second, the industry has already experienced a brutal multi-year downcycle that has impacted the supply side in a macro recessionary manner.

Third, cyclical chemical stock prices are so low that even if they fall further during a recession, the long-term returns they will generate are likely to be satisfactory.

Fourth, and most importantly, the industry’s historical pattern has been to decline and recover in the absence of a macro recession. In fact, each value chain within the industry has its own unique cycles.

My previous article covered the key economic factors that cause downturns and recoveries. This article will present historical examples of chemical cycle downturns and recoveries, both of which occur on a timetable distinct from the broader GDP changes. Once investors realize how some of the harshest chemical downturns have been resolved within the value chains themselves—often while headline macro data is neutral or only slightly positive—they might consider taking the plunge into some beaten-down chemical stocks today.

Titanium Dioxide: Overbuild, Environmental Crackdown, and Forced Discipline

Titanium dioxide is a particularly volatile chemical value chain. The market’s cycles since 2011 show how bad conditions can get within the titanium dioxide chain, even as global macro GDP expands, and how an upturn can begin without a GDP increase.

In 2011, the titanium dioxide market experienced a spike in prices after severe supply rationalization in response to the 2008-2009 recession. The industry reacted predictably to higher prices: it expanded capacity. This time, China took the lead.

Also predictably, the capacity buildout went too far. While the global economy continued to grow, the excess capacity created in 2012 and 2013 caused a sharp drop in titanium dioxide prices in 2014.

The industry downturn worsened in 2015, with operating rates dropping to the mid-60%. Prices declined sharply, making 2015 one of the worst margin years in decades for titanium dioxide producers.

From the peak of the titanium dioxide cycle in 2011 through the lows of 2015, global GDP grew steadily. The industry’s downturn and eventual stabilization were part of an intra-sector adjustment process.

In this case, the adjustment process was triggered by a glut in major producing regions, which caused a decline in global titanium dioxide prices. In China, prices dropped below producer cash costs, forcing formerly expansionist producers to adopt supply discipline.

Adding to the Chinese industry’s woes were stricter environmental enforcement measures. These measures were implemented to address rising pollution levels resulting from the low-cost production process favored by Chinese titanium dioxide producers.

Chinese producers aiming for rapid expansion in response to rising prices adopted a cheaper but problematic “sulfate” production process. This method is older, simpler, and relies on widely available technology.

The alternative method, the “chloride” process, is more expensive and technologically advanced. This process yields a higher-quality product that commands a premium price.

The problem with the rapid growth of the sulfate process is the pollution it causes. The process produces large amounts of acidic liquid waste and other harmful byproducts, including carbon dioxide. Global regulators have cracked down on sulfate plants that couldn’t afford upgrades to cut pollution. They have generally supported replacing the sulfate process with the chloride process. Today, about 55% of titanium dioxide is made using the sulfate process, mostly in China. Newbuild capacity, both inside and outside China, mainly uses the chloride process.

In 2015, about 98% of Chinese titanium dioxide was produced through the sulfate process. The pollution issue was addressed with regulations such as discharge permits, mandatory inspections, and pollutant tax systems for producers using the sulfate process.

Chinese authorities also stopped approving new sulfate plants and required older ones to relocate or shut down. These measures impacted the Chinese industry but had only a minor effect on overall Chinese titanium dioxide production. Consider that in 2015, China produced a total of 2.7 billion tons of titanium dioxide annually. Brokerage reports at the time estimated that only 112,000 tons of the country’s sulfate production was shut down.

Nevertheless, the reduction of capacity and the outlook for fewer newbuild projects helped pave the way for a market recovery.

While Chinese production retrenched during the 2014-2015 downturn, high-cost Western titanium dioxide production capacity was exiting the field. Older European and North American sulfate plants were curtailed or permanently closed. Weaker assets were shuttered, and producers redirected their focus toward selling higher-value titanium dioxide grades to enhance returns.

The supply adjustment process continued through 2016 while demand remained steady. Demand from coatings and plastics end-users didn’t boom, but the supply reduction amid stable demand helped global inventories normalize, and Chinese exports slowed from manic levels during the boom.

The market’s recovery began in earnest in 2017. That year, titanium dioxide prices and producer margins increased to mid-cycle levels. Not the levels seen during the 2011 euphoria, but levels at which the surviving assets could earn their cost of capital.

Throughout the entire cycle, titanium dioxide producer stocks mirrored the market’s progress. Over the 2014 to 2017 cycle, Tronox Holdings shares plunged by 90% before staging a full recovery, as shown below.

Meanwhile, Kronos shares fell 75% before rebounding and then surged 474% from their lows during the 2017 upcycle.

The lesson from the titanium dioxide cycle is clear: the cycle turned not because of an acceleration in global economic growth, but because enough capacity had exited the market while modest volume growth quietly absorbed the remainder. Economic growth in the major global demand centers over this period remained steady, as shown below.

Source: Our World in Data.

Investors who sat on their hands due to concerns about a looming recession missed out on the opportunity to earn outsized returns over a multi-year holding period. The key was to hold, focus on intrinsic value over price, and avoid getting too emotionally involved in the dramatic short-term swings to which titanium dioxide stocks are prone.

Nitrogen Fertilizers: The Export Retrenchment Playbook

The nitrogen fertilizer value chain experienced a similarly unique cycle. In the mid-2010s, the global nitrogen supply complex expanded capacity across ammonia, urea, and UAN. New projects came online, and U.S. producers increased their investments in both brownfield and greenfield projects to displace imports.

By 2016, the outcome was familiar. Spot prices for key nitrogen products plummeted, marginal producers couldn’t cover their cash costs, and nitrogen-related stocks behaved as if the farm economy had fallen off a cliff, even though the demand backdrop was nowhere near a 2008-style collapse. The 2016-2017 dip in U.S. nitrogen fertilizer prices is shown below.

Source: Elaine Kub, “High Fertilizer Prices: History and Future,” Progressive Farmer. Dec. 15, 2021. Red-dotted circle added by author.

AdvanSix (ASIX) made its debut as a standalone public company into this storm, with its October 2016 spinoff from Honeywell (HON). The company has significant exposure to nitrogen through its production of ammonium sulfate, a widely used nitrogen-based fertilizer.,

Like the titanium dioxide market, the nitrogen market did not need an official macro recession to be stabilized. Its adjustment mechanism was a retrenchment in global exports. As nitrogen prices in China fell below marginal cash cost, Chinese urea exports declined. Higher-cost Chinese producers were forced to reduce exports because their economics no longer supported pushing volumes into the seaborne market.

The recovery that ensued provided a tailwind for ASIX’s business results and stock price in its debut as a public entity.

Once again, the nitrogen market recovery was not driven by a significant demand surge or a massive agricultural boom. It was driven by steady, unexciting demand, combined with fewer tons dumped onto the market by the swing exporters. These exporters removed uneconomic capacity from the export pool.

Meanwhile, in the U.S., domestic capacity ramped up as imports fell and global trade flows reshuffled to reflect the new cost curve. ASIX’s stock price rebounded as its ammonium phosphate business improved amid market adjustments.

The situation highlights that when low-cost production along a chemical value chain is concentrated in a specific region, such as China or the Middle East, the key signals for the cycle are not GDP but export volumes, netbacks for marginal producers, and the willingness of swing producers to flood the market despite poor economics. This was true in past examples, and it is still true today.

Nylon and Engineered Resins: Demand Shock Plus Overbuild

ASIX’s other main business segment, its nylon 6 production, has experienced its own unique cycles since the company came public.

When oil prices plunged in 2015 and into 2016, the prices of key nylon feedstocks also collapsed. Meanwhile, weak textile demand caused a margin squeeze for many producers. The pricing and demand downturn for nylon 6—also known as “polyamide 6” or “PA6”—is shown in the chart below.

Source: Wood Mackenzie, Domo Chemicals, “The past, future and present of the polyamide industry.” Jan. 4, 2019.

Heading into 2017, nylon 6 demand firmed amid rising automotive demand. The market grew tighter, and prices shot higher.

Then in 2019, two adverse shocks hit the market in succession. First, regulatory changes to emissions testing in Europe disrupted auto production and supplier ordering patterns. Second, expansion projects already underway in key intermediates did not stop as demand wobbled.

The third shock was delivered by the Covid downturn in 2020. This was the most severe. Global auto production fell off a cliff, freezing nylon-6 demand.

The outcome was a deep sector-specific recession characterized by awful spreads between products and their feedstocks, aggressive price cuts, and producers forced to reconsider what “mid-cycle” prices and margins could realistically be. Not surprisingly, the downturn pummeled ASIX’s financial results. Its stock price followed suit.

A marked pickup in auto demand did not drive the recovery that began at the mid-2020 lows. Instead, the adjustment process involved normalizing automobile build rates from low levels, digesting the projects already in the pipeline, and adopting a much more cautious approach to future capacity expansion. The industry realized that its former growth assumptions were too optimistic and that its capital intensity had to come down.

Tying Historical Precedents to Current Conditions

Today, chemicals are in a deep profit recession driven by persistent oversupply and weak pricing power, not a collapse in volumes. China is playing the familiar role of serial overbuilder and exporter across titanium dioxide, intermediates, nylon, olefins, and other products. Europe is being forced to rationalize as the high-cost producer, as high energy and carbon costs shove plants off the cost curve. End-market demand in housing, autos, and consumer durables is soft but hardly apocalyptic.

History shows that the cure for the current downturn is already embedded in the system: the destruction of marginal capacity, the cancellation of growth projects, and a gradual rebalancing of trade flows. The bad news is that this process is painful. The good news is that a macro shock is not required to start the healing.

Titanium dioxide and similar intermediates are experiencing classic titanium dioxide dynamics, characterized by heavy overbuilding, concentrated Chinese capacity, and significant environmental and regulatory pressure. The path out will look like the last titanium dioxide cycle, featuring closures of smaller Chinese producers, supply rationalization among high-cost Western assets, and modest demand growth playing its usual role. This time, the market will benefit from broad tariffs on Chinese products. Reduced Chinese supply to major importers will bolster the competitive position of the three non-Chinese producers that dominate half the market. The key will be to watch where enforcement tightens and where capacity that was assumed to be permanent starts to disappear.

The parallels between the previous nylon 6 cycle and the current one are obvious. At present, the auto and construction end markets are soft but not collapsing. Chinese capacity and exports have added incremental supply pressure to the market’s softness. The fix will be a combination of demand normalization, the selective exiting of capacity, and underutilization outside China. The pain is already visible in spreads and nylon 6 producer earnings. Notably, a formal recession did not trigger this downturn. Producers simply must reduce capex and remove marginal assets from operation. As they do, the market will rebalance.

A nylon 6 recovery will depend on demand returning to normal in autos and construction, as well as selective capacity shutdowns outside China. It will also require pricing discipline among U.S. producers. A new boom won’t be necessary to trigger a recovery, just a rebound from low activity levels and more cautious capital spending.

What to Watch on Supply

Investors in the chemical sector should monitor changes in capacity and capacity utilization, as well as capex plans among global producers. It will be important to determine whether announced closures in Europe and marginal Asian regions are actually occurring and whether they’re not mere talking points on quarterly earnings conference calls.

Investors will also want to make sure new projects are being outright canceled rather than pushed back a year. They should track whether management teams are truly pivoting from growth narratives to balance sheet repair and cash preservation. When management teams and boards of directors stop emphasizing their secular growth stories and start behaving as if capital is scarce, the likelihood increases that the cycle will resolve on its own.

Investors in chemical producers in the midst of a cyclical downturn should also monitor export volumes and exporter netbacks. The core issue will be whether the volume of Chinese exports flowing into key demand regions is tracking higher, beginning to roll over, or in decline. Additionally, they should determine whether netbacks for Western exporters are stabilizing and improving, or whether these market participants continue to fight for low-margin orders in competitive markets.

Any signs of tariffs, anti-dumping cases, or other trade barriers that alter the economics of dumping are also relevant. For titanium dioxide and nitrogen 6, the implementation of tariffs will signal whether a more typical industry retrenchment is underway in the chemical chains where swing exporters dominate the marginal barrel or ton.

Regarding demand, investors should not simply label it as “weak” or “strong.” Instead, they need to assess whether a chemical value chain cycle is deteriorating or stabilizing. Have order books stopped getting worse? Are signs of restocking replacing hand-to-mouth purchasing behavior? Is there any evidence that customers are accepting price increases in parts of the value chain? All these factors are more important to a cycle’s progress than the latest macro GDP print.

Importantly, chemical stock prices will turn higher before the fundamental upswing is evident in the data. The market will begin to price in the cyclical inflection from downcycle to upcycle when it believes growth capex is effectively dead, enough capacity has been removed, and most of the earnings damage is behind the sector.

Conclusion

Investors waiting for a macro GDP downturn before buying well-positioned chemical stocks at their current bargain prices are ignoring the mechanics that drive the chemical value chain cycles. Many need more pain for the marginal producers, more canceled projects, and more discipline from management teams that spent the last cycle believing their own growth decks. The key for investors is to determine how advanced a value chain is in its adjustment process.

Investors should identify chains where the adjustment process is in later stages, but stock prices don’t reflect this reality. They should invest in the companies best positioned to survive the downturn and thrive in the subsequent upturn. They should also have a grasp on these companies’ normalized earning power during recovery. Everything else is noise—even the stock price. The focus should be on securing a bargain purchase price, not precisely timing a recovery.

We’ve made our picks over the past few weeks and covered some of our new holdings in our articles. We remain on the hunt for attractive prospects. Investors seeking to play a potentially highly profitable capital cycle should consider joining us in initiating positions in their favorite chemical names now. For those interested in going deeper, Chemours, AdvanSix, and the Titanium Dioxide pure-plays are discussed below.

Part V: Chemours: A Capital Cycle Play with Big Upside

Chemours (CC) was formed on July 1, 2015, as a spinoff of DuPont’s (DD) more cyclical businesses. Chemours operates in three businesses: Thermal & Specialized Solutions (TSS), Titanium Technologies (TT), and Advanced Performance Materials (APM). In 2024, the company generated $5.8 billion in sales and $786 million in Adjusted EBITDA. This year, it is on track to earn approximately $750 in Adjusted EBITDA. It has an enterprise value of $5.6 billion. Its Adjusted EBITDA run-

Chemours Overview

Chemours shares have been on a steady decline since 2023, as shown below. The shares are currently priced at a discounted valuation characteristic of a cyclical trough.

The selloff has coincided with the decline in Adjusted EBITDA. This year’s estimated $750 million is down nearly half from the $1.4 billion generated in 2021.

The decline was driven by the ongoing three-and-a-half-year downturn in Chemours’ two cyclical operating segments. These segments have been hit by weak domestic housing and construction markets, Chinese overcapacity, and, most recently, tariffs. The three segments’ annual Adjusted EBITDA contribution since 2014 is shown in the chart below.

When combined, Chemours’ cyclicality is evident.

Given the strong likelihood of a recovery in Chemours’ fundamentals over the next three years and the significant upside potential in its shares amid such a recovery, the time is right for aggressive investors to consider Chemours’ stock for long-term purchase.

Long-term investors in the company must be familiar with its operating segments, their EBITDA generation potential, and their challenges.

Thermal & Specialized Solutions (TSS)

This segment represents Chemours’ refrigerants and thermal-management portfolio. Its core brands are Opteon refrigerants and foam blowing agents, as well as legacy Freon hydrofluorocarbon (HFC) and chlorofluorocarbon (CFC) products. TTS’s end markets are air-conditioning and refrigeration for automobiles and buildings, foam insulation for buildings, and aerosol propellants for niche applications.

The TSS segment is currently Chemours’ profit engine, with strong margins that I believe are both insulated from cyclical forces and are sustainable. The segment’s demand drivers are climate change regulations coming into effect, air conditioning replacement cycles, and new construction.

This segment is a leading beneficiary of a movement by governments to force a refrigerant technology transition away from HFCs and to refrigerants with low global warming potential. In the U.S., the AIM Act is phasing down the production and consumption of HFCs. The leading replacement has been hydrofluoroolefins (HFOs), and Chemours, along with Honeywell, holds a patented duopoly with its Opteon HFO product.

In the third quarter, TTS generated $560 million in sales, a 20% year-over-year increase. The increase was driven by 8% higher volumes and 11% higher prices. The Adjusted EBITDA margin came in at a historically healthy 35%. An 80% increase in Opteon sales drove the performance. Sales of the product now account for more than 75% of TSS segment sales. The impact of Opteon’s growth is illustrated in the table below, which depicts TTS’s third-quarter results.

Source: Chemours’ Q3 2025 Earnings Press Release, Nov. 6, 2025.

Clearly, Opteon’s growth is more than offsetting the shrinkage in Chemours’ legacy Freon and foam volumes, as expected.

Titanium Technologies (TT)

Chemours’ Titanium Technologies segment houses its Ti-Pure titanium dioxide pigment business. Titanium dioxide is a whitening agent and opacifier in paints, cosmetics, and other goods. Chemours is the second-largest producer of titanium dioxide in the global market, which is dominated by four firms. This segment is extremely cyclical, and its downcycle has been responsible for crushing Chemours’ Adjusted EBITDA. However, I believe the titanium dioxide market is near its cyclical trough, and drill more deeply into the topic in a later section below. As the cycle turns upward, it will drive most of Chemours’ Adjusted EBITDA recovery over the coming years.

The TT segment’s demand drivers include pigment demand from the paints and coatings, plastic, paper, automotive, architectural, and construction industries.

In the third quarter, TT generated sales of $612 million but only $25 million in Adjusted EBITDA, representing a 4% margin, due to an 8% decline in global titanium dioxide prices and a 2% decline in the segment’s sales volumes.

Advanced Performance Materials (APM)

This segment is Chemours’ high-end fluoromaterials portfolio. Its main products are Teflon fluoropolymers and coatings, Viton fluoroelastomers, Krytox specialty lubricants, and Nafion ion-exchange membranes.

Its products are used in semiconductors and advanced electronics, automotive applications, and energy transition applications such as hydrogen electrolysis and fuel cells.

APM is less cyclical and enjoys sustained higher margins. However, it is Chemours’ smallest Adjusted EBITDA contributor and is currently being negatively impacted by sluggish industrial end-user demand.

In the third quarter, the segment generated $311 million of sales and $14 million of Adjusted EBITDA. Volumes were down 15% year-over-year.

Investment Thesis

Chemours is a basic long-term capital-cycle play. Its investment thesis is comprised of three main parts, discussed in turn below.

Part 1: HFO Demand Growth

The first part of Chemours’ investment thesis pertains to its TSS segment. The U.S. is undergoing a large-scale transition from HFCs to HFOs. HVAC regulations began requiring the use of HFOs on January 1, 2025. Light automobiles are also already mandated to use HFOs. Medium and heavy-duty automobiles are required to switch by 2028, and industrial HFO uses are being phased in through 2028.

The switch to HFOs will boost TTS Adjusted EBITDA for years. Chemours’ HFOs are priced multiple times higher than its legacy Freon product. For example, auto makers pay $75 to $80 per kilogram of HFO versus $15 to $35 per kilogram of the legacy product. Royal Refrigerants, an online retailer, lists a 25-pound tank of Opteon for automotive use at $890, or $35.60 per pound. It lists a 30-pound tank of automotive Freon at $338, or $11.27 per pound. The improved pricing on HFO translates into more than a 20% increase in Adjusted EBITDA margin for the TTS segment.

As HFOs are more widely adopted and/or as macro demand for the product increases, Chemours will benefit from the additional Adjusted EBITDA. Chemours should be able to grow its TSS revenue at a high single-digit percentage rate. The segment’s Adjusted EBITDA is likely to grow at a rate more than twice that.

Also notable is that as Chemours’ Freon sales have declined, the company has been left with an inventory oversupply of lower-priced product. This has created a temporary drag on the company’s financial results. That drag is dissipating, which will help improve comparable quarterly results going forward.

I estimate that Adjusted EBITDA margins from Opteon sales are in the low-40s%, which is high for the chemical industry. Adjusted EBITDA will therefore receive a significant boost as sales volumes increase.

Assuming a conservative 5.0% annual sales growth from the TTS segment over the next two years, and that the segment generates a 36% Adjusted EBITDA margin, its EBITDA contribution in 2028 would be $830 million.

Part 2: Titanium Dioxide Recovery

As I discuss below, I believe the titanium dioxide market is poised for a cyclical recovery. The TT segment’s Adjusted EBITDA contraction is responsible for the lion’s share of Chemours’ Adjusted EBITDA decline over recent years, so a recovery will likely drive Chemours’ combined Adjusted EBITDA significantly higher.

The TT segment also experienced unexpected downtime due to production outages in the U.S. and Mexico. These outages have been resolved.

The TT segment is working through internal cost reductions that management has billed as structurally reducing costs by $125 million. However, cost savings will likely exceed that amount by a significant margin. Management expects that these initiatives, combined with Chemours’ technological advantages in titanium dioxide production, will make the company one of the lowest-cost producers globally, based on production cost per ton.

Chemours needs only a modest swing in the titanium dioxide cycle to realize a significant boost in the TT segment’s Adjusted EBITDA. Assuming TT revenues revert to a mid-cycle level of $2.5 billion and the company achieves its 10-year average Adjusted EBITDA margin of 20%, the segment will generate $500 million in Adjusted EBITDA. As the cycle inflects higher, Adjusted EBITDA will increase further. In fact, Adjusted EBITDA increases can exceed TT’s historical recovery trends if the segment’s cost-reduction initiatives prove successful.

Part 3: “Other” (An APM Recovery & Data Center Cooling Technology)

A cyclical recovery in Chemours’ APM segment’s end markets will also contribute materially to Chemours’ Adjusted EBITDA recovery over the coming years.

In the third quarter, APM generated $311 million in sales and earned $14 million of Adjusted EBITDA, for a 5% margin. Volumes fell 15% from the previous year. Since 2014, APM’s Adjusted EBITDA margin has averaged 12%, so an improvement in volumes and Adjusted EBITDA stands to add more than $100 million to Adjusted EBITDA annually, for a total normalized segment Adjusted EBITDA contribution of approximately $200 million.

Data center cooling technology is more of a wild card in Chemours’ investment thesis. Nevertheless, it is important because of the significant value it would represent for the company if widely adopted.

For decades, Chemours has demonstrated its ability to innovate, roll out the innovations at scale, and profit as they are commercialized. The company’s newest focal point for innovation is its data center cooling technology.

Chemours has developed a proprietary fluid for two-phase immersion cooling in data centers. Since data center processing speed is directly correlated with heat levels, continued advances in processing will drive increased needs for data centers to dissipate heat. In fact, rising costs for heat reduction will become a major limiting factor on data center growth. Immersion cooling is a promising cooling technology in which data center hardware is submerged in a non-conductive fluid that absorbs heat more efficiently than air.

Chemours is a leader in developing these fluids through its expertise in HFOs. Only it and Honeywell control the patents needed to scale up this immersion cooling technology.

The issue with this technology stems not from its viability, which is proven, but rather from the timing of its implementation. Data centers must be specifically designed to accommodate the technology, so the challenge for a wide-scale rollout will be to partner early with data center owners and developers. At the moment, it appears that a rollout isn’t likely until 2028. As a result, the technology’s economics and long-term potential remain a mystery. Still, Chemours has partnered with digital infrastructure providers and manufacturers to prepare for a rollout.

I won’t take a stab at rendering an Adjusted EBITDA estimate for Chemours’ data center cooling business due to all the unknowns. Instead, I’ll regard the business as a valuable call option to the company’s intrinsic value. What is clear, however, is that the effort has considerable upside potential for Chemours, with minimal downside.

PFAS Liabilities and Other Risks

The ugly part of Chemours is its “per- and polyfluoroalkyl substances,” or “PFAS” liability. This should be front and center for any investor in the company.

PFAS is a class of chemicals known as “forever chemicals” because they don’t break down easily. DuPont began using PFAS in the production of Teflon in 1946. By the 1960s, DuPont knew the chemical was toxic to animals and accumulated in human blood. DuPont’s West Virginia manufacturing plant discharged PFAS into the air and water in the Ohio River Valley, the source of drinking water for more than 70,000 people.

Chemours was saddled with part of DuPont’s PFAS legal and financial burden when it was spun off from DuPont. As such, it is responsible for shouldering a portion of the remediation and other costs.

In 2021, Chemours, DuPont, and DuPont’s agriscience spinoff, Corteva (CTVA), entered into a settlement to resolve legal disputes and established a cost-sharing arrangement to support future PFAS liabilities. The terms of the settlement are spelled out in this press release, a key part of which is excerpted below:

Source: Chemours Press Release, Jan. 22, 2021.

The most recent PFAS development occurred in August, when Chemours, DuPont, and Corteva agreed to an $875 million settlement with the State of New Jersey over PFAS and other environmental claims. Chemours will pay 50% of the approximately $500 million present value of the settlement over 25 years.

In a separate case, a federal judge ordered Chemours to stop unlawful PFAS discharges from its Washington Works facility into the Ohio River, highlighting ongoing reputational and compliance risk.

The greatest uncertainty regarding PFAS litigation stems from personal injury and landfill-related claims if regulators pursue waste operators and manufacturers. There is no reliable way to estimate this potential liability at the moment.

PFAS is therefore an overhang on Chemours’ stock price, and potentially also on its capital allocation. Its most recent financial statements estimate a PFAS environmental remediation liability of $607 million and an accrued litigation liability of $207 million, for a total liability of $814 million as of September 30. In my analysis, I have assumed an obligation of $1.4 billion, which I believe is conservative.

Another risk to Chemours stems from the lapse of its refrigerant patents. Most of the patents that protect its Opteon business will remain in force into the early 2030s. The company is working on new formulations to extend its protection, but there is no guarantee of success.

Chemours also faces execution risk if it continues to add HFO production capacity as planned and demand fails to pan out as the company expects.

Valuation

The Chemours investment thesis hinges on the company’s Adjusted EBITDA margins inflecting upwards over the coming years, as illustrated in the chart.

The TTS segment margins should increase from additional high-margin HFO sales, while the TT and APM segment Adjusted EBITDA should increase more significantly as their respective cycles turn.

I don’t know when APM and TT’s cycles will turn with any precision, but I’m highly confident that, first, they will turn, and second, that Chemours’ stock will move higher well in advance of the upturn. The return upside from Chemours’ current depressed stock price is simply too large for the shares not to move aggressively upon the first glimmer of a sustained recovery.

Chemours is currently trading at an EV/Adjusted EBITDA valuation of approximately 7.5-times, at the high end of its historical range.

Using the Adjusted EBITDA estimates for 2028 for each operating segment, as discussed in my investment thesis above, I expect Chemours to earn roughly $1.5 billion in Adjusted EBITDA before corporate expenses. Applying a 7.0-times EV/Adjusted EBITDA ratio and assuming $3.5 billion of net long-term debt, a PFAS obligation net present value of $1.4 billion, $250 million of corporate overhead, and 150 million shares outstanding, Chemours shares are worth $27 per share, which implies 125% upside from their current price of $12.

In a bull scenario that assumes robust growth of the TTS segment and cyclical-high Adjusted EBITDA from the APM and TT segments (specifically, TTS’s Adjusted EBITDA reaches $925 million, TT reaches $800 million, and APM reaches $250 million), corporate overhead of $250 million, net long-term debt of $3.5 billion, and a PFAS liability of $1.4 billion, Chemours’ Adjusted EBITDA would be $1.7 billion. At a slightly lower EV/Adjusted EBITDA valuation of 6.0-times to account for a cycle-high discount, Chemours’ stock would be valued at $36, for 200% upside.

In a downside scenario that assumes 2028 Adjusted EBITDA of $1.2 billion, a 6.5-times EV/EBITDA multiple, $3.5 billion in net long-term debt, and a $2.5 billion PFAS obligation, the shares would trade at $14, still above today’s price of $12. The margin of safety between price and value that exists in an adverse scenario is one of the reasons I like the shares below $14.

Chemours investors should also keep in mind that the shares have further upside if the immersion-cooling initiative pans out. For perspective, an additional $200 million of Adjusted EBITDA would increase Chemours’ valuation to $35 per share, and $44 per share in the bull scenario sketched above.

Conclusion

The Chemours thesis has some “hair,” to be sure. Shareholders must gauge the PFAS risk and its impact on the company’s valuation. However, the issue has weighed on Chemours’ market valuation in the past. It continues to do so, and even if it persists, it’s unlikely to prevent the shares from rallying amid a cyclical recovery. Consider, for example, that in the 2017-2018 timeframe, Chemours shares traded above $50 at a 6.5-times EV/EBITDA valuation on $1.4 billion of Adjusted EBITDA.

This time around, I believe a price above $30 is achievable in the next three years, for a compound annual total return of 37% for investors buying today at $12. Such a return should be more than satisfactory for aggressive investors who have the patience to hold through the inevitable volatility in the share price. Given these returns, I believe investors should consider buying Chemours shares today.

Part VI: AdvanSix: An Opportunity to Buy at Cyclical Lows

AdvanSix (ASIX) was spun off from Honeywell on October 1, 2016, to create a company that could focus on pursuing its unique growth strategy. ASIX occupies a low-cost position in several niche chemical products. The company’s products face an oversupply and weak demand, which is removing capacity. Prices are currently unsustainable, and ASIX is positioned to thrive once conditions improve.

The stock has trended lower since hitting its last cyclical peak in 2022.

Stocks like ASIX generate the highest returns when they’re bought at cyclical lows, when industry conditions and investor sentiment are in the dumps. That’s where ASIX is today, which makes its stock an attractive long-term buy.

ASIX Overview

ASIX operates an integrated chemical manufacturing chain with five production sites across the U.S. The company converts cumene, ammonia, sulfur, and other feedstocks into nylon 6 resin, caprolactam, ammonium sulfate, and various phenol and acetone-based intermediates. Through its vertical integration, it captures value at each step of the production chain, lowering unit costs and improving margins.

Nylon 6 & Caprolactam

Nylon 6 and caprolactam account for approximately 41% of ASIX’s revenue. The split is 23%/18% between nylon and caprolactam. Plant nutrients account for 30% of revenue, while various chemical intermediates account for the remaining 29%.

Approximately 90% of ASIX’s sales take place in the U.S. Its customers operate across U.S. industry in construction, fertilizer, agrochemicals, plastics, solvents, packaging, adhesives, and electronics. Its U.S.-centered operations provide an additional competitive advantage from lower transportation costs and logistical advantages relative to global competitors selling in the U.S. ASIX’s U.S. weighting renders it exempt from the reciprocal tariffs that have negatively impacted its domestic competitors, most of which are large, diversified chemical companies.

ASIX’s products are derived from the chemical chains illustrated in the graphic below.

Source: AdvanSix 2024 10-K.

Nylon 6 is used to make fibers for textiles, automotive parts, carpets, clothing, and engineering plastics such as gears and bearings. Its strength and heat resistance make it an effective electrical insulator, while its durability makes it suitable for packaging.

Caprolactam is the key feedstock to nylon 6. ASIX is the global low-cost caprolactam producer, which confers a durable competitive advantage as long as end markets are not glutted, as they are today. The caprolactam market is consolidated, with the top three producers, Fibrant, BASF, and Sinopec, holding more than 30% market share.

As in other chemical segments, global supply capacity for nylon 6 and caprolactam has expanded significantly in recent years, with China leading the charge. At the same time, global demand has been weak. The combination of rising supply and tepid demand led to price declines. Low prices for both caprolactam and nylon 6 have driven margins and capacity utilization lower since 2023. ASIX provided the following data on the nylon market in its third-quarter earnings call presentation.

Source: AdvanSix Q3 2025 Earnings Presentation, Nov. 7, 2025.

The removal of high-cost supply will drive an initial recovery. The recovery will progress as capacity utilization rates increase.

The outlook is more constructive over the longer term. Nylon 6 and caprolactam are expected to grow at a mid-single-digit rate through the early 2030s, driven by higher demand for auto parts, plastics, electronics, and textiles.

Ammonium Sulfate

The Raschig process by which ASIX produces nylon 6 throws off significant volumes of ammonium sulfate, which the company sells as fertilizer. Ammonium sulfate is nitrogen-rich, providing plants with the nitrogen and sulfur they need to grow.

Ammonium sulfate’s near-term outlook is brighter than nylon’s, as end markets are not glutted. Ammonium sulfate is also expected to grow in the mid-single-digit percentage range over the coming years, driven by higher demand from agriculture. Agricultural demand from year to year depends on crop prices and planting intensity.

Sulfate demand has remained robust even in recent quarters. ASIX is currently transitioning its product toward “granular ammonium sulfate,” which is easier to spread, slower-releasing, and has higher sulfur content than common substitutes. Due to its various benefits, the granular product is sold at a premium.

By the end of 2025, ASIX will have transitioned 72% of its ammonium sulfate production into higher-margin granular form. The company has dubbed the transition to granular its “SUSTAIN” program. The program is aimed at increasing the company’s granular ammonium sulfate capacity by 200,000 tons, which fetches a premium of $75 per ton. The premium stands to increase ASIX’s mid-cycle Adjusted EBITDA by more than $15 million annually.

ASIX’s SUSTAIN program has consumed most of its growth capex in recent years. The project is slated for completion in 2026, and capex should decline in 2027 and beyond.

Chemical Intermediates

In addition to ammonium sulfate, ASIX’s nylon 6 manufacturing process throws off various chemical intermediates that the company also sells. These products include phenol, acetone, and other co-products. Growth from these chemical intermediates is expected to track in the low single digits over the coming years.

ASIX benefits from structurally higher acetone prices and margins attributable to U.S. antidumping tariffs. Imports have declined from 230,000 tons in 2018 to 64,000 tons in 2024, driving acetone-propylene spreads from $0.10 per pound to a sustainable range of $0.15 to $0.20 per pound. The larger spread stands to add approximately $30 million to ASIX’s mid-cycle Adjusted EBITDA.

Undergoing a Cyclical Downturn

To appreciate the extent of the downturn in which ASIX finds itself, consider that in 2022—which can be used as a benchmark for a high-margin year—ASIX generated $1.9 billion in revenue and $308 million in Adjusted EBITDA, for a margin of 15.9%.

Conditions deteriorated dramatically beginning in 2023. That year, a 22% decline in selling prices amid flat volumes sent revenues down to $1.53 billion. Adjusted EBITDA fell to $154 million, for a 10% margin. In 2024, revenue was flat while Adjusted EBITDA declined to $142 million, resulting in a 9.4% margin.

The downturn has persisted in 2025. In the first nine months of the year, ASIX reported $1.16 billion in revenue—down 2% from the 2024—and $132 million in Adjusted EBITDA, for a margin of 8.8%. Moreover, margins have trended lower. In the third quarter, ASIX’s Adjusted EBITDA margin declined further, to 6.6%. The culprit of the margin decline was lower nylon 6 volumes. Looking ahead, the fourth quarter is the company’s seasonally weakest. Prices remain low, so margins will remain weak.

ASIX’s capex has been high in recent years to fund its SUSTAIN program investments. Capex is slated to remain high in 2026, then decline in 2027 and presumably thereafter, as shown in the slide below.

Source: AdvanSix Q3 2025 Earnings Presentation, Nov. 7, 2025.

Once ASIX completes its growth projects, it will benefit from increased operating cash flow and lower capex, boosting free cash flow. The higher profit margins, returns on capital, and free cash flow resulting from ASIX’s recent capex hold the prospect of pushing the company’s profitability above previous cyclical highs over the coming years.

Despite the higher capex, ASIX has remained free cash flow positive in 2025. The $32.3 million in free cash flow it has generated year-to-date, after adjusting for working capital changes, is equivalent to $1.20 per share.

ASIX’s balance sheet is strong, with $250 million drawn on its revolving line of credit and equity of $824 million.

Attractive Investment Characteristics

ASIX shares trade at a 4.5% dividend yield at their current price of $14.40. The dividend is sustainable even at today’s market conditions, which are characteristic of a cyclical low. At its current trailing-twelve-month Adjusted EBITDA of $142 million, the company should be roughly cash flow neutral in 2026, assuming the $110 million of capex indicated in management’s guidance. The company’s $0.16-per-share quarterly dividend should be safe barring a further deterioration in end-market conditions.

The company’s competitive position is superb, albeit in a pure commodity market. ASIX benefits from its position as the leading global low-cost producer of caprolactam and Nylon 6. It derives its competitive advantage from its integration of the entire nylon 6 chemical production chain. ASIX’s competitive advantage is durable because its foreign competitors are unable to replicate its production configuration, logistics, and cost advantages. The upshot is that ASIX occupies a dominant position with BASF in U.S. caprolactam and nylon 6 production. The company’s status as a low-cost producer enables it to remain profitable at lower prices than its competitors while also running at higher capacity utilization rates.

ASIX is also competitively advantaged as a low-cost ammonium sulfate producer. It owns and operates the largest production facility in the U.S.

The company derives another competitive advantage from low natural gas supply costs. Natural gas is a raw material in the production of caprolactam and ammonium sulfate, as well as a source of energy for the company’s production facilities.

At the moment, the ammonium sulfate market is relatively healthy. The segment will serve as ASIX’s profit center as the domestic nylon 6 market works off its oversupply.

ASIX’s relatively small size in its industry and its attractive, sustainable, low-cost position in niche chemical markets in which producers earn attractive full-cycle returns on capital make it an attractive acquisition candidate. If the stock stays at its current price, I believe an acquisition at a significant premium is likely.

Valuation

Given ASIX’s trailing-twelve-month Adjusted EBITDA of $142 million and an enterprise value of $770 million, its shares currently trade at 5.5-times EV/Adjusted EBITDA—at a low point in the nylon 6 cycle. This low multiple fails to discount any improvement in the company’s financial results going forward, despite the likelihood of a cyclical recovery.

On a normalized mid-cycle Adjusted EBITDA of $200 million, ASIX trades at an EV/Adjusted EBITDA multiple of 3.9-times. A proper valuation at that point would apply a 6-to-8-times multiple, for a stock price of $30 to $45 per share. The lower bound of this value range is equal to the company’s book value per share and stands more than 100% above the current stock price.

I estimate that ASIX can generate cycle-high Adjusted EBITDA in the $250 to $300 million range. On that figure, the stock trades at a 2.8-times EV/Adjusted EBITDA.

Cycle-high Adjusted EBITDA is also consistent with earnings per share of $4.70 and free cash flow per share of $5.10. Applying a ten-times multiple puts the cycle-high share price at around $50. Such a price is consistent with ASIX’s previous cyclical high price achieved in 2022. That year, the company earned Adjusted EBITDA of $308 million and diluted earnings per share of $5.92.

At five-times cycle peak Adjusted EBITDA, ASIX shares would trade at approximately $40, versus the current price of $14.30.

Another way to look at ASIX’s equity value is that the company’s book value per share stands at $30.45. Assuming it can earn a mid-teen return on capital—as it has in the past—then earnings per share would be approximately $4.50, which is also consistent with a mid-$40s share price at a ten-times P/E.

Risks

ASIX investors risk having to sustain a prolonged downturn in nylon 6. They should therefore be ready to endure lower prices as the nylon 6 cycle bottoms out. Importantly, the company’s heavy weighting in the domestic market, its products’ low-cost positions on their respective cost curves, and its strong balance sheet mean that it will survive the ongoing downturn and benefit disproportionately when the upcycle arrives.

The cycle will eventually turn. High-cost nylon 6 supply is currently operating at a significant loss. As such, it will have to be rationalized through facility closures, idling, and consolidation. Prices are so low that even low-cost producers—including ASIX itself—are moderating volumes and lowering their capacity utilization. Clearly, the current market dynamics are unsustainable for the industry, which makes an upturn all the more probable.

Among the other risks for ASIX investors would be an unexpected falloff in fertilizer demand and significantly higher-than-expected capex, which would reduce free cash flow.

Conclusion

ASIX shares will turn higher well before the recovery in its end markets is clear. Nearly every investor has AI at their fingertips, so the ability to detect a turn in the macro is more widely available than it’s ever been. The only reliable edge an investor can have is time arbitrage over the course of a capital cycle. Since the duration of the downturn is not knowable—its turn is only discernible in hindsight—owning shares in low-cost producers is paramount to a successful investment outcome. This is what an investor obtains with ASIX.

In capital cycle investing, the best times to buy are when the outlook is bleak. ASIX investors should adopt a three-year investment horizon and be prepared to hold until the recovery takes effect. Short-term paper losses are part of the process. But the massive returns on offer for those who can buy make them well worth the temporary inconvenience.

Now is a good time to buy beaten-down cyclical chemical names, and ASIX is one of the best.

Nylon is one expression of the cycle. Titanium dioxide is another—often more volatile, and often faster to reprice once supply finally tightens.

Part VII: A Titanium Dioxide Market Recovery Appears Imminent

The titanium dioxide market is in a historic downturn that has gone on for three-and-a-half years. Over that period, the negative cyclical forces have gone a long way toward reducing supply to today’s tepid demand conditions. In the process, they’ve set the stage for a recovery.

The titanium dioxide market’s brutal downcycle has forced significant changes, improving its macro outlook. The downcycle flushed out weak industry players, forced larger players to operate in a more disciplined manner, reduced producers’ inventories, brought about anti-dumping regimes in key importing regions, and curtailed production capacity to a point where even a slight demand uptick will drive titanium dioxide prices higher.

These and other market changes have laid the groundwork for a cyclical recovery over the next few quarters, assuming demand remains flat or improves. If the worst of the downturn truly is in the rearview mirror, the industry should enter the 2026 contract season with tighter supply and better pricing prospects than many headlines suggest. If prices or volumes show any indication of ticking higher, their stocks are likely to surge in anticipation of a recovery.

Temporary Factors Drove Third-quarter Weakness

Third-quarter results are in for the major titanium producers, Tronox, Kronos Worldwide, and Chemours. The results show that market conditions during the quarter were far weaker than these companies had expected earlier in the year. Notably, several of the most significant factors contributing to the weakness were temporary in nature.

For one, Venator’s insolvency caused it to liquidate its titanium dioxide at below-market prices. The surge in supply amid tepid demand led to prices declining more than expected. The situation was particularly acute in Europe, where Venator and Kronos have a significant presence. In their third-quarter earnings conference calls, the management of the major titanium dioxide producers alluded to the fact that this inventory liquidation will persist through the end of the year. Once it has run its course, however, the supply-demand picture will tighten, and prices are likely to rise.

Aside from Venator, other distressed global producers have dumped their titanium dioxide inventory onto the market regardless of price. Prices can recover once this excess supply is absorbed.

Each of the major market participants has slimmed down its inventory levels, consistent with late-cycle behavior in commodity cycles. Lower inventories tend to shorten the remaining duration of the downturn. Any uptick in demand in these conditions can cause prices to surge.

Another temporary negative factor that depressed the market in the third quarter was India’s stay of anti-dumping tariffs on titanium dioxide. The stay allowed low-priced Chinese producers to surge their exports to India. The supply surge weakened Asian titanium dioxide prices, with negative knock-on effects on the global market.

Fortunately, India’s stay was imposed by a court on procedural grounds. As such, it’s likely to be reversed over the coming weeks. India is the second-largest importer of titanium dioxide, so import tariffs will strengthen supply and benefit producers outside China.

Another temporary negative during the quarter was the downstream destocking by customers in the coatings industry. These customers cut their titanium dioxide orders deeper and earlier than usual. However, Tronox management indicated that order patterns have already begun to normalize in the fourth quarter. Once the working capital adjustment among downstream customers is complete, demand for titanium dioxide feedstock can improve.

The Supply Side Will Drive the Recovery

Commodity market recoveries begin when supply has fallen in line with or below demand. The titanium dioxide market appears to have reached this point.

The main factor behind the market’s recovery potential is the unprecedented amount of global production curtailments. Literally every producer of size has either permanently shut down or idled capacity. Furthermore, the production facilities in operation today have cut back on volumes.

All in all, several management teams have cited 1.1 million tons of production curtailments in a global market that stands at approximately 10.0 million tons per year. The supply adjustment bodes well for prices going forward. It gives me the confidence to state that a recovery isn’t a matter of “if,” but of “when.”

The second most important factor driving a recovery in the titanium dioxide market is the imposition of anti-dumping measures. These measures have been enacted in the U.S., the European Union, Brazil, Saudi Arabia, and elsewhere. The measures are intended to increase the industry’s competitiveness relative to Chinese competitors, which benefit from low coal-based electricity costs, lower labor costs, and more lax environmental regulations. Chinese producers also receive government subsidies that make them even more price-competitive on the global stage.

The anti-dumping measures are having a significant impact. In the U.S., Section 301 tariffs have reduced titanium dioxide imports to 90,000 tons per year in a market that consumes one million tons per year. Meanwhile, anti-dumping measures imposed by the EU, Brazil, and Saudi Arabia are set to protect a market that consumes a combined 1.2 million tons per year.

Anti-dumping measures put in place to date have eliminated approximately 800,000 tons per year of low-cost titanium dioxide from the global market. To illustrate their impact, Tronox included this slide in its investor presentation. While the measures don’t eliminate Chinese imports, they do significantly reduce them.

Source: Tronox Q3 2025 Earnings Presentation, Nov. 6, 2025.

Since the anti-dumping measures are all being applied at the same time, they’re putting a major dent into Chinese dumping. This will be a major factor in a titanium dioxide price recovery.

With fewer export channels, titanium dioxide inventories are piling up in China. Higher inventories are depressing domestic prices and forcing a supply rationalization that includes permanent closures of production facilities and consolidation among weaker producers. The reduction of low-cost supply will benefit the titanium dioxide market for years.

Another positive development that will hasten a recovery is Venator’s insolvency. Venator, which declared insolvency in May, had been the fifth-largest global titanium dioxide producer in a market where the top five producers accounted for more than 50% of global output. Venator’s exit whittles down the number of dominant producers to four. The removal of the fifth-largest producer will allow the remaining four to gain share. Kronos is particularly well-positioned. It is the best positioned to win market share from Venator’s exit from Europe and has acquired Venator’s 50% interest in the U.S. Louisiana Pigment Company.

Venator’s exit will reduce the urgency among the remaining major producers to undercut each other based on price. In effect, it’s a step toward oligopoly in the industry, just as trade measures are removing a large share of the lowest-cost supply. The market can enter 2026 with far more favorable competitive dynamics for producers than it entered 2025.

Another positive outcome from the downcycle has been that large titanium dioxide buyers increasingly favor larger producers as suppliers. After more than three years of reliability issues, insolvencies, and supplier plant shutdowns, buyers are committing to the “Big Three” outside of China, namely, Chemours, Tronox, and Kronos. These dominant producers are insulated against broader market turbulence through their partial or full vertical integration. They operate in multiple regions, can better meet customers’ product specifications, and can swing volumes across their various plants.

The shift toward the larger producers will enable them to emerge from the current downturn with greater market share and better line of sight regarding contract volumes and duration.

Altogether, these factors are likely to drive titanium dioxide prices higher. Even a low-to-mid-single-digit price increase will push the major producers’ operations into positive free cash flow territory. At that point, their survival will no longer be in question, and their stock prices should trade significantly higher.

Risks

These are among the most volatile stocks in the market, so investors should expect significant price swings. Positions should be sized to withstand the inevitable large selloffs, which I expect to be severe, yet temporary, before a market recovery carries the entire group much higher.

For Kronos and Tronox, dividends are at risk if the market doesn’t turn higher over the coming quarters. Buyers of these stocks should not count on the continuation of dividends.

From a fundamentals perspective, the largest risk is a decline in titanium dioxide demand from today’s already weak level. Several demand variables could cause volumes to decline and force further retrenchment among global titanium dioxide producers. Foremost among these risks are a falloff in U.S. housing activity and a deepening European economic contraction.

Lastly, a recovery could be put at risk if policies in importing nations dilute the impact of anti-dumping measures.

Conclusion

Titanium dioxide is a cyclical market that is possibly probing its cyclical trough. Investors looking to play a recovery from a deep cyclical downturn should consider the titanium dioxide producers. In order of risk, from lowest to highest, investors should consider Chemours, Kronos, and Tronox. The list is reversed in terms of upside potential from current prices. A basket approach, in which an investor holds all three at whatever weighting makes sense, is also worth considering.

The cyclical trough is the time when sentiment among market participants and observers is at its lowest, and headlines about the industry are the scariest. It’s also the hardest time to step up and buy. Nevertheless, I’m confident that it is only a matter of time before the titanium dioxide cycle inflects. When it does, long-term investors who can hold through the selloffs and make it to the other side will be amply rewarded with multi-bagger returns.

With the market backdrop set, we can move to a higher-beta expression of the same cycle, where company-specific actions can magnify the recovery.

Part VIII: Tronox: Improving Prospects in 2026 and Beyond to Drive Shares Higher

Tronox is a recovery play on the titanium dioxide market with added kickers from company-specific developments. I’ve followed the company’s ups and downs since 2012, and I believe this is a good time to initiate a long position.

Today, finds itself in one of its industry’s most protracted downturns. The downturn’s length is attributable to aggressive new Chinese competitors and tepid global demand. Tronox’s revenues have trended lower since 2021, tracking the downturn in the titanium dioxide market.

Historically, the company has exhibited some of the most extreme cyclical price swings of any company I know. The chart below illustrates how closely its share price follows the ups and downs of titanium dioxide prices. It depicts the market’s swings that occurred from 2010 to 2021.

Sources: Venator May 2023 Investor Presentation, Yahoo! Finance Oct. 28, 2025. Black-dotted lines and highlights added by author.

Today, I believe Tronox is in another cyclical trough. While the duration of the trough can’t be known with any degree of precision, improvements within the company are set to boost EBITDA and cash flow in 2026, which, in turn, should support its stock price. By the time the titanium dioxide market shows signs of a recovery, I expect Tronox shares to be bid far above their current price.

Investment Thesis

Tronox’s investment thesis has three parts.

First, protectionist anti-dumping measures are likely to benefit titanium dioxide producers outside of China in 2026.

Second, Tronox’s cost reduction initiatives will boost EBITDA and cash flow in 2026. Third, the titanium dioxide market will recover once inventories are depleted and demand returns, driven by increased construction spending and growing GDP.

Third, after the company’s EBITDA and cash flow improve in 2026, I expect the titanium dioxide market to recover in 2027. Even a mild recovery will turbocharge the stock’s upside move.

I expect these factors to send Tronox shares more than 100% above their current price over the next two years, and even higher over subsequent years. Tronox is most appropriate for long-term holding, and investors must be prepared to stomach the inevitable volatility during their holding period.

Titanium Dioxide Market and Protectionist Measures

Titanium dioxide is the primary pigment used to whiten paints, coatings, and plastics. Its demand is tied to activity in construction, housing, automobile manufacturing, and to broader GDP.

The titanium dioxide market is dominated by four firms, which combined account for around 50% of the global market. These are the China-based LB Group, Chemours, Tronox, and Kronos. Smaller operators based in China and Europe account for most of the remainder of the market. Chinese production accounts for approximately 60% of total global production.

The titanium dioxide market is expected to grow significantly through 2030, as shown in the chart below.

Source: Grand View Research.

LB Group, based in China, is the world’s largest producer of titanium dioxide. It has grown market share at the expense of its three Western competitors. Its low-cost electricity and labor, coupled with relatively lax regulatory requirements, give it a competitive advantage. However, increasing trade protection measures in the EU, Brazil, Saudi Arabia, and the EAEU (comprised of Russia, Kazakhstan, Belarus, Armenia, and Kyrgyzstan) have sought to level the playing field between the Chinese producers and their global peers. In the U.S., while titanium dioxide imports haven’t been targeted directly, they are subject to the 25% “Section 301” tariff overseen by the U.S. Trade Representative.

Most titanium dioxide tariffs have been enacted throughout 2025. The measures have already been effective. By May 2025, China’s titanium dioxide exports had already fallen by approximately 20%.

Additionally, titanium dioxide markets in consuming countries are set to improve, with lower supply amid stable demand set to increase prices. Before protectionist measures are implemented, major titanium dioxide buyers tend to front-load their purchases from low-cost producers that will be subject to tariffs. These purchase orders dampen demand after the protectionist measures are enacted. Eventually, however, they are likely to boost prices for producers outside of China. I expect the market to benefit from the measures in 2026 and beyond. If Chinese product has fewer export destinations, LB Group’s margins could come under pressure at home, further weakening its competitive position in the global market.

Cyclical Forces Will Facilitate a Recovery

Excess production amid international tariffs has caused excess titanium dioxide product to flow to the U.S and Japan. Even with tariffs, these countries’ producers can be undercut by Chinese imports, particularly in the standard rutile titanium dioxide grades. However, domestic producers of premium and specialty grades tend to face far less competition from foreign sources. Higher inventories have pushed prices lower. Tronox

The titanium dioxide market will recover in time. Cyclical forces are already at work. Most producers have idled their high-cost plants. Tronox idled its Botlek pigment site in the Netherlands, which accounts for approximately 8% of its production. Chinese producers have idled some capacity amid weak market conditions.

I don’t have any special insight into when this cycle will turn, but I am certain of two things. First, these stocks are best bought for long-term holding when the outlook is at its most grim. Second, the first indication that the market is improving will send these stocks surging, as investors jump on the “all clear” bandwagon.

When the cycle turns and titanium dioxide prices rise, Tronox benefits from being one of the few vertically integrated titanium dioxide producers. It sources approximately 85% of its raw materials used in titanium dioxide production internally.

Vertical integration has advantages and disadvantages in titanium dioxide production. The biggest disadvantage is that mining tends to be a low-return business. But the advantages are considerable. When titanium dioxide prices are high, the prices of the product’s feedstock, ilmenite and rutile, also increase. Raw material price increases put downward pressure on margins for non-integrated producers at the time when their margins should be approaching cyclical highs. Due to Tronox’s vertical integration, its margins and fee cash flow are poised to increase significantly more than those of its competitors during upcycles, facilitating debt reduction and dividend increases.

EBITDA Growth Likely Ahead

Tronox shares are typically valued in the market based on EV/EBITDA multiples. At its cyclically low EBITDA, it trades at 8.5-times EV/EBITDA. EBITDA guidance was revised lower in the company’s second-quarter conference call.

Tronox’s EBITDA is set to increase in 2026. In late 2024, management launched a cost-savings program intended to reduce operating costs by $125 to $175 million in 2025. As of Tronox’s second-quarter earnings conference call on July 31, management was confident it would meet the goal. The cost savings should translate into higher EBITDA in 2026, assuming titanium dioxide pricing doesn’t fall significantly from current levels.

Other factors are likely to boost 2026 EBITDA. Tronox is upgrading its mining operation by moving feedstock production from lower-quality to higher-quality mines in 2026. The switch will increase EBITDA by $50 million and reduce capex by approximately $100 million. Meanwhile, the Botlek plant idling will further reduce operating costs and capex by more than $20 million.

Source: Tronox May 2025 Investor Presentation.

Altogether, I expect Tronox to generate EBITDA of $600 million in 2026, a 38% increase from the $435 million in management’s 2025 guidance. At $600 million in EBITDA, Tronox’s current valuation would represent a 6.2-times EV/EBITDA, which is very low for a company with cyclically low EBITDA. Over the coming years, Tronox shares can benefit from significantly higher EBITDA and margin expansion.

Another way to view the stock’s current valuation is that virtually no improvement in the titanium dioxide market is priced into Tronox’s shares. This makes it even more likely that when the market turns, the shares will surge higher.

Risks

Tronox shares have significant risk. As such, they should be sized at a small level relative to a portfolio. The most significant risk stems from leverage.

The company’s net long-term debt stands at 4.8-times management’s guided full-year 2025 Adjusted EBITDA. This is high, though the EBITDA figure reflects a depressed titanium dioxide market. I expect it to recover beginning in 2026.

Source: Tronox Q2 2025 10-Q.

Tronox faces a maturity wall in 2029. If the titanium dioxide market hasn’t recovered by then, it could face difficulty refinancing its debt.

On September 15, Tronox priced a $400 million offering of 9.125% Senior Secured Notes due 2030. The notes were offered at par.

The main risk to Tronox shareholders stems from a global recession that sends titanium dioxide prices significantly lower. Tronox could be forced into bankruptcy. There is precedent for such an outcome, as the company declared bankruptcy in 2009.

Conclusion

Tronox has also seen some insider buying this year, which adds support to a recovery thesis. The company has already cut its dividend once this year, reducing the quarterly dividend from $0.125 to $0.05. I don’t expect additional cuts given the improving EBITDA outlook in 2026.

With a lot of bad in the rearview mirror—and priced into the stock—and a little good about to come in 2026, I believe Tronox shares are poised to outperform significantly. Looking beyond 2027, a recovery in its end markets could deliver multi-bagger returns. Investors should consider initiating a position now and adding to it on weakness.

Part IX: Kronos Worldwide: Set to Rebound from a Cyclical Trough

Kronos Worldwide (KRO) is experiencing a brutal downturn in the titanium dioxide industry. Lower sales prices and volumes have caused its earnings and cash flow to go negative for multiple quarters over the past few years, including the recently reported third quarter.

The downturn began in 2022, when higher feedstock costs for titanium dioxide producers coincided with weakening demand from major customers. Since then, Kronos and its peers have experienced declining and weak free cash flow.

The weakness was caused by excess supply amid tepid demand. In this environment, KRO’s sales prices struggled to keep pace with rising per-ton costs.

Operating conditions have intensified recently for the entire titanium dioxide industry, prompting additional retrenchment among producers during the third quarter. However, the clear takeaway is that current margins are unsustainable. It is only a matter of time until the market recovers.

Low prices have already led to unprecedented curtailments in global production volumes. The industry’s production capacity has declined. Titanium dioxide inventories are low. Anti-dumping tariffs have removed the primary source of low-cost supply. These and other factors are likely to usher in higher prices. Eventually, producers will have to increase their production volumes, at which point operating leverage will inflect higher.

I expect cyclical factors to usher in a cyclical recovery in 2026. Kronos is likely to enter that period with a strengthened competitive position and enhanced profitability potential relative to its peers. Recovering profits and cash flow will send its shares higher.

Third-Quarter Results Illustrate Trough-Like Operating Conditions

Third-quarter results illustrated the ugly effects of negative operating leverage. The company’s lower sales volumes and lower prices, amid its high fixed-cost structure, squeezed gross margins and cash flow.

EBITDA declined to close to zero. Year over year, it declined from $123 million to $0.6 million. The decline was mostly due to a large one-time gain in the third quarter of 2024 not being repeated, as well as an inventory cost drag unlikely to recur in future quarters.

Unabsorbed fixed costs were the largest non-temporary factor. These are the variable and fixed costs included in the cost of producing titanium dioxide, which grow larger as production capacity declines and less production is spread across a still-high fixed cost base. The breakdown of year-over-year EBITDA changes is illustrated below.

Large unabsorbed fixed costs will reverse from an EBITDA headwind to a tailwind as the company cuts fixed costs and increases capacity utilization. A lower fixed cost base and higher capacity utilization spread lower costs over more units.

Management attributed the company’s poor third-quarter results to significant excess supply in Europe and weak demand from the North American housing sector. These macro factors caused titanium dioxide buyers to hold off on building inventory. The inventory remained at the industry level, pushing down prices. In response to the weak demand and prices, Kronos idled production.

Titanium dioxide prices declined further over the subsequent months, partly due to one-time events such as Venator’s post-insolvency inventory liquidation. Consider that at the beginning of 2025, KRO’s average titanium dioxide selling prices were 2% higher than the year-ago level. After the tariff disruptions in April, conditions turned for the worse. Prices fell as titanium dioxide buyers postponed purchases until tariff uncertainty cleared. In the first nine months of 2025, weak demand led to a 6% year-over-year decline in titanium dioxide prices.

In the third quarter, lower prices and production volumes caused KRO’s operating cash flow, adjusted for changes in working capital, to fall to negative $3.5 million. After $9.5 million in capital expenditures during the quarter, free cash flow was negative $13.0 million. This ugly performance is typical for an industry approaching its cyclical trough.

I expect the company’s cash flow picture to improve over the coming quarters. Lower costs attributable to idled plants and reduced SG&A, coupled with a modest price improvement, will likely enable the company to generate flat to higher free cash flow in early 2026.

Buying Amid the Cyclical Trough

All it takes is a glance at KRO’s stock chart to determine where we are in the titanium dioxide cycle.

The three-and-a-half-year downturn begs the question of whether conditions will inflect from bearish to bullish. And if so, when?

I remain confident that the titanium dioxide cycle will inflect positively, just as it has for nearly a century. I don’t know precisely when, but the preponderance of data on the state of the industry in the third quarter points to an imminent recovery. I discussed the potential for recovery in the titanium dioxide market in my previous article.

Historically, KRO’s shares have rebounded off their cyclical trough after the company reversed its production capacity curtailments.

Kronos may be close to that moment today. In the third quarter, the company operated at 80% of capacity, significantly below its historical normal rate. For example, in the 2015 downturn, KRO’s capacity utilization bottomed out at 86% before the market recovered, and the stock quintupled over the next two years. During the next downturn, in 2020, KRO’s capacity utilization once again bottomed at 86%. In the more recent 2023 downturn, its capacity utilization bottomed at 65%.

The 2023 downturn is instructive. KRO’s stock turned higher once the company announced an increase in capacity utilization. In fact, the third-quarter earnings announcement was the catalyst that sent the shares surging higher.

The chart below shows KRO’s stock price right before the third-quarter earnings announcement hit. Notice the rally that ensued afterward.

The same dynamic was at play in all past recoveries in Kronos’ stock, and I expect the next one to play out in a similar fashion.

In each case, recovering capacity utilization triggered a strong rebound in the stock price, as investors anticipated the implications of the operating leverage inflection on earnings and cash flow during a titanium dioxide market recovery. I expect a similar dynamic to play out again with Kronos at some point over the next few quarters.

Risks

Kronos shares are at risk from continued weakness in the titanium dioxide market. The company could cut its dividend if conditions don’t improve, so the shares should not be bought for their yield. Offsetting this risk is the fact that the entire titanium dioxide industry is under severe strain. Production is dominated by large players, all of whom are curtailing output.

Due to the risks, aggressive investors should consider a small investment in KRO. The shares clearly have multi-bagger potential, so even a small investment can have an outsized impact on a portfolio’s returns over the coming years.

Conclusion

Kronos and its peers in the titanium dioxide market are probing the troughs of the market cycle. These are the most difficult times to buy, but they can also be the most lucrative. Investors interested in a depressed cyclical play with big upside potential should consider Kronos shares. If conditions improve over the coming quarters, as I expect, the shares offer some of the greatest upside in the stock market.

Part X: Conclusion

The cyclical chemical sector is cheap today for reasons that are real. Many are still experiencing conditions of overcapacity, weak demand, and prolonged destocking. But the cure for cyclical pain is already underway. Inventories are normalizing, high-cost supply is exiting, capital spending is being cut, and operating leverage is beginning to reassert itself. These conditions typically mark the very early stages of an upswing.

Ultimately, success in cyclical chemical investing requires appreciation for the sector’s nuances. The chemical sector is not a single trade, but a collection of distinct value chains governed by cost curves and capital cycles. Understanding where each chain sits in its cyclical adjustment process helps clarify when a recovery is likely to begin, how durable it may be, and when to exit as margins peak. Investors who remain disciplined, focus on fundamentals, and endure the inevitable volatility can position themselves for substantial gains as the cycle turns.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of ASIX, CC, KRO, TROX, EPD, GEL, CLMT, HON either through stock ownership, options, or other derivatives.

In the second half of 2025, much of the chemical sector was valued as if it would never recover, with stock prices so low that any sign of a cyclical rebound would trigger a rally. The situation provided investors seeking large long-term returns with an attractive opportunity.

Since we invested in the space in the second half of 2025, chemical stocks have started to recover.

Further gains are likely if the recovery continues. What were potential three- or four-baggers a few months ago can still double or more from their current prices.

For investors seeking to understand the cyclical chemical sector, this article reviews several of my macroeconomic and company-specific investment theses.

A cyclical recovery is likely in the chemicals sector, as each subsector undergoes its own adjustments between supply, demand, and prices. Although the timing of a recovery is uncertain, chemical stock prices had declined to levels that made prospects for doubling in the next two or three years promising.

I published four articles on the chemical sector and why I believe it is undervalued in these three articles:

A Titanium Dioxide Market Recovery Appears Imminent

The Chemical Sector Overview: Olefins And The Rest

Chemical Sector Macro 2: The Current Downturn And Prospects For A Recovery

Chemical Sector Macro 3: Lessons From Past Cycles Applied To Today’s Stocks

Characteristics of the Current Downturn

For much of the chemical industry, the downturn started in 2021. Many companies saw utilization drop below 80%, and margins hover around cash costs. Within the industry, it felt like a recession, even though overall GDP kept growing. Meanwhile, investors who had faced years of losses abandoned the sector and sold their stakes.

This unique circumstance—where the overall economy grew but chemical subsectors were stuck in a cyclical downturn—created an opportunity. Many investors and sell-side analysts were waiting for a recession to hit before purchasing the more cyclical chemical stocks. A recession would lower prices, but it would also speed up the sector’s recovery by forcing a supply adjustment. If, on the other hand, a recession failed to materialize, a strong rally could be in the cards.

The chemical sector’s downturn had three overlapping drivers:

1. A global capacity buildout. This was most pronounced in olefins.

2. Weak industrial end markets in key regions. Europe’s high energy costs, restrictive regulations, and shrinking manufacturing base have hurt global chemical demand. Weakness in China’s property and heavy industry. A downturn in North America’s housing and construction markets. These factors all contribute to weak end-user demand.

3. An abnormally long destocking phase. During the post-Covid supply chain chaos, buyers over-ordered. The resulting inventory excess caused buyers to become more cautious, ordering just enough to manage their bloated inventories. This pattern lasted longer than the typical one or two quarters usually seen in the industry’s inventory cycles. As apparent demand dropped below actual end demand, the weakness in volume and utilization became even more apparent.

These factors led many investors to abandon the entire sector of cyclical chemical stocks. What I believe many overlooked was that, although all stock prices were low, the outlook for individual companies and their stocks was more complex.

For one, downturns and recoveries in the sector occur across distinct value chains, each with its own capital cycle, specific supply-and-demand dynamics, logistical constraints, customer inventory practices, and pricing strategies. As a result, investors who can determine which subsectors or value chains are poised for a recovery can identify high-return candidates.

Next, the sector had to be divided into two groups: value chains that were structurally challenged, and those that were cyclically depressed.

Structurally challenged value chains were parts of the chemical sector where capacity was overbuilt but was politically, strategically, or economically difficult to reverse. The overcapacity keeps prices too low, putting many producers at risk of bankruptcy.

Olefins are the poster child. The subsector saw massive investment from international oil and gas majors in large-scale cracker and polymer units. Overbuilding was most severe in China and North America. Structural overcapacity means that recoveries can be fleeting because new foreign supply keeps arriving once regional prices rise to levels that make imports profitable. Getting a handle on “mid-cycle earnings” for companies stuck in such an environment can be impossible, rendering appraisals of intrinsic value suspect.

I consider companies operating in structurally challenged niches to be uninvestable.

Outside the more structurally challenged subsectors were the areas of potential opportunity. In many cases, the negativity toward structurally challenged sectors led investors to sell across all chemical subsectors, including those that are structurally viable but cyclically depressed.

Cyclically depressed value chains can adjust supply to long-term demand in a way that leads to a sustainable cyclical upturn. These chains experience bankruptcies, production shutdowns, consolidation, and capital starvation, which bring supply into line with reduced demand. The eventual price recovery drives the next upturn.

Given the bargain prices on offer, this subset of chemical names was ripe for long-term investment.

Finding the Best Mispriced Opportunities

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By: Jon Costello

Chemours (CC) was formed on July 1, 2015, as a spinoff of DuPont’s (DD) more cyclical businesses. Chemours operates in three businesses: Thermal & Specialized Solutions (TSS), Titanium Technologies (TT), and Advanced Performance Materials (APM). In 2024, the company generated $5.8 billion in sales and $786 million in Adjusted EBITDA. This year, it is on track to earn approximately $750 in Adjusted EBITDA. It has an enterprise value of $5.6 billion.

Chemours Overview

Chemours shares have been on a steady decline since 2023, as shown below. The shares are currently priced at a discounted valuation characteristic of a cyclical trough.

The selloff has coincided with the decline in Adjusted EBITDA. This year’s estimated $750 million is down nearly half from $1.4 billion generated in 2021.

The decline was driven by the ongoing three-and-a-half-year downturn in Chemours’ two cyclical operating segments. These segments have been hit by weak domestic housing and construction markets, Chinese overcapacity, and, most recently, tariffs. The three segments’ annual Adjusted EBITDA contribution since 2014 is shown in the chart below.

When combined, Chemours’ cyclicality is evident.

Given the strong likelihood of a recovery in Chemours’ fundamentals over the next three years and the significant upside potential in its shares amid such a recovery, the time is right for aggressive investors to consider Chemours’ stock for long-term purchase.

Long-term investors in the company must be familiar with its operating segments, their EBITDA generation potential, and their challenges.

Thermal & Specialized Solutions (TSS)

This segment represents Chemours’ refrigerants and thermal-management portfolio. Its core brands are Opteon refrigerants and foam blowing agents, as well as legacy Freon hydrofluorocarbon (HFC) and chlorofluorocarbon (CFC) products. TTS’s end markets are air-conditioning and refrigeration for automobiles and buildings, foam insulation for buildings, and aerosol propellants for niche applications.

The TSS segment is currently Chemours’ profit engine, with strong margins that I believe are both insulated from cyclical forces and are sustainable. The segment’s demand drivers are climate change regulations coming into effect, air conditioning replacement cycles, and new construction.

This segment is a leading beneficiary of a movement by governments to force a refrigerant technology transition away from HFCs and to refrigerants with low global warming potential. In the U.S., the AIM Act is phasing down the production and consumption of HFCs. The leading replacement has been hydrofluoroolefins (HFOs), and Chemours, along with Honeywell (HON), holds a patented duopoly with its Opteon HFO product.

In the third quarter, TTS generated $560 million in sales, a 20% year-over-year increase. The increase was driven by 8% higher volumes and 11% higher prices. The Adjusted EBITDA margin came in at a historically healthy 35%. An 80% increase in Opteon sales drove the performance. Sales of the product now account for more than 75% of TSS segment sales. The impact of Opteon’s growth is illustrated in the table below, which depicts TTS’s third-quarter results.

Source: Chemours’ Q3 2025 Earnings Press Release, Nov. 6, 2025.

Clearly, Opteon’s growth is more than offsetting the shrinkage in Chemours’ legacy Freon and foam volumes, as expected.

Titanium Technologies (TT)

Chemours’ Titanium Technologies segment houses its Ti-Pure titanium dioxide pigment business. Titanium dioxide is a whitening agent and opacifier in paints, cosmetics, and other goods. Chemours is the second-largest producer of titanium dioxide in the global market, which is dominated by four firms. This segment is extremely cyclical, and its downcycle has been responsible for crushing Chemours’ Adjusted EBITDA. However, I believe the titanium dioxide market is near its cyclical trough, as explained in a previous article available here. As the cycle turns upward, it will drive most of Chemours’ Adjusted EBITDA recovery over the coming years.

The TT segment’s demand drivers include pigment demand from the paints and coatings, plastic, paper, automotive, architectural, and construction industries.

In the third quarter, TT generated sales of $612 million but only $25 million in Adjusted EBITDA, representing a 4% margin, due to an 8% decline in global titanium dioxide prices and a 2% decline in the segment’s sales volumes.

Advanced Performance Materials (APM)

This segment is Chemours’ high-end fluoromaterials portfolio. Its main products are Teflon fluoropolymers and coatings, Viton fluoroelastomers, Krytox specialty lubricants, and Nafion ion-exchange membranes.

Its products are used in semiconductors and advanced electronics, automotive applications, and energy transition applications such as hydrogen electrolysis and fuel cells.

APM is less cyclical and enjoys sustained higher margins. However, it is Chemours’ smallest Adjusted EBITDA contributor and is currently being negatively impacted by sluggish industrial end-user demand.

In the third quarter, the segment generated $311 million of sales and $14 million of Adjusted EBITDA. Volumes were down 15% year-over-year.

Investment Thesis

Chemours is a basic long-term capital-cycle play. Its investment thesis is comprised of three main parts, discussed in turn below.

Part 1: HFO Demand Growth

The first part of Chemours’ investment thesis pertains to its TSS segment. The U.S. is undergoing a large-scale transition from HFCs to HFOs. HVAC regulations began requiring the use of HFOs on January 1, 2025. Light automobiles are also already mandated to use HFOs. Medium and heavy-duty automobiles are required to switch by 2028, and industrial HFO uses are being phased in through 2028.

The switch to HFOs will boost TTS Adjusted EBITDA for years. Chemours’ HFOs are priced multiple times higher than its legacy Freon product. For example, auto makers pay $75 to $80 per kilogram of HFO versus $15 to $35 per kilogram of the legacy product. Royal Refrigerants, an online retailer, lists a 25-pound tank of Opteon for automotive use at $890, or $35.60 per pound. It lists a 30-pound tank of automotive Freon at $338, or $11.27 per pound. The improved pricing on HFO translates into more than a 20% increase in Adjusted EBITDA margin for the TTS segment.

As HFOs are more widely adopted and/or as macro demand for the product increases, Chemours will benefit from the additional Adjusted EBITDA. Chemours should be able to grow its TSS revenue at a high single-digit percentage rate. The segment’s Adjusted EBITDA is likely to grow at a rate more than twice that.

Also notable is that as Chemours’ Freon sales have declined, the company has been left with an inventory oversupply of lower-priced product. This has created a temporary drag on the company’s financial results. That drag is dissipating, which will help improve comparable quarterly results going forward.

I estimate that Adjusted EBITDA margins from Opteon sales are in the low-40s%, which is high for the chemical industry. Adjusted EBITDA will therefore receive a significant boost as sales volumes increase.

Assuming a conservative 5.0% annual sales growth from the TTS segment over the next two years, and that the segment generates a 36% Adjusted EBITDA margin, its EBITDA contribution in 2028 would be $830 million.

Part 2: Titanium Dioxide Recovery

I’ve written that the titanium dioxide market is poised for a cyclical recovery. The TT segment’s Adjusted EBITDA contraction is responsible for the lion’s share of Chemours’ Adjusted EBITDA decline over recent years, so a recovery will likely drive Chemours’ combined Adjusted EBITDA significantly higher.

The TT segment also experienced unexpected downtime due to production outages in the U.S. and Mexico. These outages have been resolved.

The TT segment is working through internal cost reductions that management has billed as structurally reducing costs by $125 million. However, cost savings will likely exceed that amount by a significant margin. Management expects that these initiatives, combined with Chemours’ technological advantages in titanium dioxide production, will make the company one of the lowest-cost producers globally, based on production cost per ton.

Chemours needs only a modest swing in the titanium dioxide cycle to realize a significant boost in the TT segment’s Adjusted EBITDA. Assuming TT revenues revert to a mid-cycle level of $2.5 billion and the company achieves its 10-year average Adjusted EBITDA margin of 20%, the segment will generate $500 million in Adjusted EBITDA. As the cycle inflects higher, Adjusted EBITDA will increase further. In fact, Adjusted EBITDA increases can exceed TT’s historical recovery trends if the segment’s cost-reduction initiatives prove successful.

Part 3: “Other” (An APM Recovery & Data Center Cooling Technology)

A cyclical recovery in Chemours’ APM segment’s end markets will also contribute materially to Chemours’ Adjusted EBITDA recovery over the coming years.

In the third quarter, APM generated $311 million in sales and earned $14 million of Adjusted EBITDA, for a 5% margin. Volumes fell 15% from the previous year. Since 2014, APM’s Adjusted EBITDA margin has averaged 12%, so an improvement in volumes and Adjusted EBITDA stands to add more than $100 million to Adjusted EBITDA annually, for a total normalized segment Adjusted EBITDA contribution of approximately $200 million.

Data center cooling technology is more of a wild card in Chemours’ investment thesis. Nevertheless, it is important because of the significant value it would represent for the company if widely adopted.

For decades, Chemours has demonstrated its ability to innovate, roll out the innovations at scale, and profit as they are commercialized. The company’s newest focal point for innovation is its data center cooling technology.

Chemours has developed a proprietary fluid for two-phase immersion cooling in data centers. Since data center processing speed is directly correlated with heat levels, continued advances in processing will drive increased needs for data centers to dissipate heat. In fact, rising costs for heat reduction will become a major limiting factor on data center growth. Immersion cooling is a promising cooling technology in which data center hardware is submerged in a non-conductive fluid that absorbs heat more efficiently than air.

Chemours is a leader in developing these fluids through its expertise in HFOs. Only it and Honeywell control the patents needed to scale up this immersion cooling technology.

The issue with this technology stems not from its viability, which is proven, but rather from the timing of its implementation. Data centers must be specifically designed to accommodate the technology, so the challenge for a wide-scale rollout will be to partner early with data center owners and developers. At the moment, it appears that a rollout isn’t likely until 2028. As a result, the technology’s economics and long-term potential remain a mystery. Still, Chemours has partnered with digital infrastructure providers and manufacturers to prepare for a rollout.

I won’t take a stab at rendering an Adjusted EBITDA estimate for Chemours’ data center cooling business due to all the unknowns. Instead, I’ll regard the business as a valuable call option to the company’s intrinsic value. What is clear, however, is that the effort has considerable upside potential for Chemours, with minimal downside.

PFAS Liabilities and Other Risks

The ugly part of Chemours is its “per- and polyfluoroalkyl substances,” or “PFAS” liability. This should be front and center for any investor in the company.

PFAS is a class of chemicals known as “forever chemicals” because they don’t break down easily. DuPont began using PFAS in the production of Teflon in 1946. By the 1960s, DuPont knew the chemical was toxic to animals and accumulated in human blood. DuPont’s West Virginia manufacturing plant discharged PFAS into the air and water in the Ohio River Valley, the source of drinking water for more than 70,000 people.

Chemours was saddled with part of DuPont’s PFAS legal and financial burden when it was spun off from DuPont. As such, it is responsible for shouldering a portion of the remediation and other costs.

In 2021, Chemours, DuPont, and DuPont’s agriscience spinoff, Corteva (CTVA), entered into a settlement to resolve legal disputes and established a cost-sharing arrangement to support future PFAS liabilities. The terms of the settlement are spelled out in this press release, a key part of which is excerpted below:

Source: Chemours Press Release, Jan. 22, 2021.

The most recent PFAS development occurred in August, when Chemours, DuPont, and Corteva agreed to an $875 million settlement with the State of New Jersey over PFAS and other environmental claims. Chemours will pay 50% of the approximately $500 million present value of the settlement over 25 years.

In a separate case, a federal judge ordered Chemours to stop unlawful PFAS discharges from its Washington Works facility into the Ohio River, highlighting ongoing reputational and compliance risk.

The greatest uncertainty regarding PFAS litigation stems from personal injury and landfill-related claims if regulators pursue waste operators and manufacturers. There is no reliable way to estimate this potential liability at the moment.

PFAS is therefore an overhang on Chemours’ stock price, and potentially also on its capital allocation. Its most recent financial statements estimate a PFAS environmental remediation liability of $607 million and an accrued litigation liability of $207 million, for a total liability of $814 million as of September 30. In my analysis, I have assumed an obligation of $1.4 billion, which I believe is conservative.

Another risk to Chemours stems from the lapse of its refrigerant patents. Most of the patents that protect its Opteon business will remain in force into the early 2030s. The company is working on new formulations to extend its protection, but there is no guarantee of success.

Chemours also faces execution risk if it continues to add HFO production capacity as planned and demand fails to pan out as the company expects.

Valuation

The Chemours investment thesis hinges on the company’s Adjusted EBITDA margins inflecting upwards over the coming years, as illustrated in the chart.

The TTS segment margins should increase from additional high-margin HFO sales, while the TT and APM segment Adjusted EBITDA should increase more significantly as their respective cycles turn.

I don’t know when APM and TT’s cycles will turn with any precision, but I’m highly confident that, first, they will turn, and second, that Chemours’ stock will move higher well in advance of the upturn. The return upside from Chemours’ current depressed stock price is simply too large for the shares not to move aggressively upon the first glimmer of a sustained recovery.

Chemours is currently trading at an EV/Adjusted EBITDA valuation of approximately 7.5-times, at the high end of its historical range.

Using the Adjusted EBITDA estimates for 2028 for each operating segment, as discussed in my investment thesis above, I expect Chemours to earn roughly $1.5 billion in Adjusted EBITDA before corporate expenses. Applying a 7.0-times EV/Adjusted EBITDA ratio and assuming $3.5 billion of net long-term debt, a PFAS obligation net present value of $1.4 billion, $250 million of corporate overhead, and 150 million shares outstanding, Chemours shares are worth $27 per share, which implies 125% upside from their current price of $12.

In a bull scenario that assumes robust growth of the TTS segment and cyclical-high Adjusted EBITDA from the APM and TT segments (specifically, TTS’s Adjusted EBITDA reaches $925 million, TT reaches $800 million, and APM reaches $250 million), corporate overhead of $250 million, net long-term debt of $3.5 billion, and a PFAS liability of $1.4 billion, Chemours’ Adjusted EBITDA would be $1.7 billion. At a slightly lower EV/Adjusted EBITDA valuation of 6.0-times to account for a cycle-high discount, Chemours’ stock would be valued at $36, for 200% upside.

In a downside scenario that assumes 2028 Adjusted EBITDA of $1.2 billion, a 6.5-times EV/EBITDA multiple, $3.5 billion in net long-term debt, and a $2.5 billion PFAS obligation, the shares would trade at $14, still above today’s price of $12. The margin of safety between price and value that exists in an adverse scenario is one of the reasons I like the shares below $14.

Chemours investors should also keep in mind that the shares have further upside if the immersion-cooling initiative pans out. For perspective, an additional $200 million of Adjusted EBITDA would increase Chemours’ valuation to $35 per share, and $44 per share in the bull scenario sketched above.

Conclusion

The Chemours thesis has some “hair,” to be sure. Shareholders must gauge the PFAS risk and its impact on the company’s valuation. However, the issue has weighed on Chemours’ market valuation in the past. It continues to do so, and even if it persists, it’s unlikely to prevent the shares from rallying amid a cyclical recovery. Consider, for example, that in the 2017-2018 timeframe, Chemours shares traded above $50 at a 6.5-times EV/EBITDA valuation on $1.4 billion of Adjusted EBITDA.

This time around, I believe a price above $30 is achievable in the next three years, for a compound annual total return of 37% for investors buying today at $12. Such a return should be more than satisfactory for aggressive investors who have the patience to hold through the inevitable volatility in the share price. Given these returns, I believe investors should consider buying Chemours shares today.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of CC either through stock ownership, options, or other derivatives.

Editor’s Note: This article was first published to subscribers on July 2nd, 2025. Since then, HCC shares have appreciated 32.75%. All market information in the article is not updated. The original article is below.

By: Jon Costello

Metallurgical coal represents one of the most attractive long-term investment opportunities in the energy sector. I recently discussed the commodity’s long-term outlook here.

The constructive macro backdrop begs the question of how best to profit from higher coal prices, which I believe will prevail over the coming years.

The opportunities in the stock market have arisen in large part due to the negative public opinion toward coal, which has kept investors from buying coal names. This opinion is misguided.

Thermal coal will continue to be used to generate electricity. It will play a vital role in meeting the world’s growing electricity demand. Having coal as part of the energy mix increases a grid’s reliability and resiliency while reducing its cost in a manner that other energy sources cannot.

For met coal, there is no replacement for steel as the main structural component in buildings, infrastructure, automobiles, and other goods that make civilization possible.

To be sure, the pollution from burning coal is a problem that needs to be addressed. But calls for phasing out the industry entirely are misguided. Moreover, in light of the central role coal plays in sustaining modern life, its negatives should be regarded as manageable tradeoffs against the commodity’s virtues, rather than serving as a pretext for eliminating the commodity’s use entirely.

Investors who are comfortable with the prospect of coal remaining a viable energy source and input into steelmaking for decades to come can take advantage of the depressed valuations of coal stocks. The opportunity arises from three key factors: first, the discounted purchase price that an investor can obtain; second, the attractive business model possessed by certain met coal producers; and third, the long-term compounding nature of returns offered by the best-positioned met coal producers.

If I had to make one investment before being whisked away to a remote island with no internet access, it would be Warrior Met Coal (HCC). The risk/reward proposition it offers represents one of the best long-term investments in the energy space.

Warrior’s Assets

Warrior operates two large coal mines located in the Warrior Basin in Alabama. The company is also nearing the completion of a third mine in the same basin.

Warrior’s world-class economics are in large part attributable to its uniform, continuous coal seams for which the Warrior Basin is known. These geological features allow for consistently high-quality, low-cost coal production.

Warrior operates three coal mines. Its “Mine 7” produces premium Low-Vol met coal that can be sold for little to no discount from regional benchmark prices. “Vol” refers to the “volatile matter content,” or the gases other than carbon released during the coal’s combustion. Low Vol met coal is considered higher quality due to its greater carbon content. Low Vol coal produces more coke per ton of coal.

Mine 7 has capacity of 5.6 million short tons per year, which is equivalent to 5.1 million metric tons per year. The mine has a remaining life of 20 years.

Warrior’s “Mine 4” is an underground single longwall system that produces premium, High Vol A (HVA) met coal. The mine has a 35-year reserve life. The premium quality of the coal it produces receives a premium price to regional benchmarks. The mine’s capacity is 2.4 million short tons per year or 2.2 million metric tons per year.

Together, these two mines enable Warrior to produce one of the highest-quality product mixes of met coal in the U.S. Nearly all of its production is sold in seaborne markets.

The company’s third mine, called Blue Creek, is under development. The company provides the following project overview.

Source: Warrior Met Coal Blue Creek Project Presentation, Feb. 21, 2025.

Blue Creek will have a 40-year reserve life. Like Mine 4, Blue Creek’s coal production is of the premium HVA variety. Its coal is produced from one of the last remaining HVA reserves in the U.S.

Also like Mine 4, Blue Creek’s is a longwall mine. There are several methods used to produce coal, such as room and pillar mining, bord and pillar mining, and high-wall mining in underground operations, as well as various methods of surface mining. Longwall mining is the most efficient method for the large-scale production of underground coal reserves. The method features relatively high productivity, low labor intensity, and consistent recovery rates. These advantages translate into lower operating costs per ton and improved economies of scale.

The downside of longwall mining is the large upfront cost involved in mine development. Warrior has financed Blue Creek’s development without external financing, so the project’s large capital costs might be thought to be financially burdensome for the company. However, given Blue Creek’s expected annual incremental free cash flow contribution of approximately $550 million at a PLV price per ton of $225, the project’s expected total $1.1 billion cost represents an attractive use of shareholder capital.

Furthermore, Warrior has kept a strong financial profile throughout Blue Creek’s development. The company has maintained a net cash position since commencing development in February 2020. As of March 31, 2025, Warrior’s $154 million of long-term debt was offset by $455 million of cash and $33 million of short-term investments.

Blue Creek is expected to begin commercial production by mid-2026. Once fully ramped, it will increase Warrior’s production capacity from its current 8.0 million short tons per year annual capacity to 14.0 million short tons per year, a 75% increase. The expansion’s capacity is equivalent to 12.7 million metric tons per year.

Blue Creek’s significant size relative to Warrior’s existing assets and its low cost of production relative to its two existing mines will materially reduce Warrior’s cost of production once the mine begins to ramp up production next year. The addition of Blue Creek will lower Warrior’s already low cost of production and significantly increase its free cash flow generation capacity.

Importantly for Warrior’s shareholders, Blue Creek has been financially de-risked. The project has approximately $250 million of remaining development costs. Warrior’s $334 million in net cash is more than sufficient to complete the project. To date, management’s execution in developing the project has been stellar. While its overall cost has risen relative to management’s initial expectation of $550 to $600 million, costs increased because management was able to achieve efficiencies that expanded the project’s production capacity while lowering its ultimate unit production cost.

Warrior’s Attractive Investment Attributes

Like any commodity producer, the coal production business model has positives and negatives.

On the downside, met coal producers are price takers. These producers aren’t afforded the luxury (or curse?) of being able to hedge, as met coal lacks a developed futures market that is typically found among more heavily traded commodities. Unlike thermal coal producers, many met coal producers don’t enter into long-term sales contracts for their production. They therefore are at the mercy of spot prices. As such, a low-cost production base and strong balance sheet are paramount for surviving the industry’s recurring ups and downs.

Fortunately for met coal producers, several positive factors offset the price-taking negative. In many ways, they make the met coal producer business model superior to that of oil and gas production.

For one, large public U.S. coal producers aren’t saddled with long-term debt. These companies sought bankruptcy protection after a downturn in the 2010s and emerged with clean balance sheets. Coal is a global business due to the ease of transporting by sea, and U.S. met coal producers export most of their production to foreign markets. Even factoring in higher transportation costs borne by U.S. producers, their lack of leverage puts them at an advantage relative to their international competitors. Warrior, as the lowest-cost major U.S. met coal producer, will be the last company standing if prices remain depressed.

Met coal assets tend to be more capital-efficient than oil and gas assets, as maintenance capex consumes a relatively low proportion of operating cash flow relatively low. For example, Warrior’s Blue Creek project is expected to consume only $20 million per year of maintenance capex annually over the initial ten years of the mine’s life. For context, on a BTU-equivalent basis, Blue Creek’s production represents roughly 61,000 barrels per day of oil production. That amount of production would typically require well over $100 million to sustain on a conventional oil production base, which is multiple times more than what Warrior will spend to maintain Blue Creek’s production. Of course, lower capex per unit of output increases free cash flow.

Given the perception among many that coal will be phased out as a “sunsetting” industry, Warrior’s business model is surprisingly capital-light and sustainable. The success of its shares as an investment will hinge on management’s ability to stick to its knitting and not do anything dumb in allocating free cash flow. In recent years, Warrior’s peers returned significantly greater amounts of cash flow to shareholders while it spent capex to develop Blue Creek. I expect Blue Creek’s completion and the cash flow inflection triggered by lower capex and higher revenues to prompt a rapid and significant increase in Warrior’s dividends and share repurchases.

Warrior’s assets are competitively advantaged vis-à-vis transportation. Transportation is one of the greatest costs for a coal producer. Warrior benefits from having access to waterways that allow for transport to the port of Mobile, Alabama, where the company has a long-term agreement with the McDuffie terminal. The terminal has export capacity of 27 million metric tons per year, significantly greater than Warrior’s ultimate maximum capacity of 12.7 million metric tons per year. Warrior is one of the only coal companies using the Mobile port for export, so I assume it will continue to make attractive deals for access to McDuffie or other terminals. Warrior’s mines are 300 miles from port. Its peers are 350 miles or more from their nearest port. It is also serviced by several rail carriers offering competitive rates. Warrior can also transport its production by truck. Warrior’s domestic peers lack transportation flexibility and low cost, which pushes their cost of production per ton materially higher.

Warrior also benefits by operating two—going on three—large mines within a 50-mile radius. The lack of numerous far-flung mines allows Warrior to keep its costs lower than its domestic peers. The proximity of its assets to one another furthers its unit cost advantage.

Warrior is the lowest-cost met coal producer in the U.S. from an operating cost perspective, as shown in the following chart.

Source: Warrior Met Coal Blue Creek Project Presentation, Feb. 21, 2025.

Warrior’s low operating costs offset the higher transportation costs involved in exporting its production to foreign markets to make it competitive versus its U.S. peers.

Warrior has a multi-decade reserve life. Its more than 35 years of reserves is double that of its met coal peer Alpha Metallurgical Resources (AMR). Oil and gas producers are lucky if their proved reserves extend beyond 10 or 12 years. This may be a negative from a long-term macro perspective, as oil will enter periods in which supply is constrained and prices surge. Coal prices aren’t likely to spike due to supply constraints, but the fact that a coal producer can maintain production at a given rate for multiple decades relieves some of the pressure to make risky capital acquisition moves, such as overpriced acquisitions, which are far too common in oil and gas.

Last—but certainly not least—among Warrior’s competitive advantages is its top-notch management team. Management has kept the company conservatively capitalized since its exit from bankruptcy in 2016. It has maintained the company’s low-cost position and executed a transformative growth project. Since exiting bankruptcy, management has allocated capital superbly and generated an impressive total return for Warrior’s shareholders. I expect the outstanding performance to continue in future years.

Valuation

I expect Warrior’s free cash flow to range from a low of $300 million to a high of $1.3 billion over the next ten years. I can’t offer insight into the cadence of free cash flow in future years because I don’t know the future course of coal prices. However, I can assert with high confidence that the company will generate multiples of its current market capitalization in free cash flow over the next ten years.

Due to the negative stigma toward all things coal, all coal stocks are likely to continue trading at a discount to their intrinsic value. Given the magnitude of free cash flow that met coal companies like Warrior will generate over the coming years, they will be able to repurchase copious volumes of discounted shares.

If Warrior’s management can remain disciplined, sustain the company’s low-cost advantage, generate free cash flow, and repurchase shares, Warrior’s intrinsic value per share is likely to compound at a high rate even if the share price remains depressed on a current valuation basis. The key for an investor is to hold the shares long enough for the compounding to work in their favor. This is why Warrior is my favorite stock investment for long-term holding. It is likely to survive almost any bearish steel or coal market and will deliver tremendous value in more bullish markets. I expect all that value to be distributed to Warrior’s shareholders one way or another.

The compounding nature of Warrior’s value is demonstrated in the following table, which shows the company’s free cash flow generation at average normalized U.S. met coal prices over the next ten years.

The scenario assumes a constant met coal price of $225 per ton, which represents an average mid-cycle price. The scenario assumes Warrior’s production increases to a maximum of 12.5 million tons per year. The company allocates 30% of its free cash flow to dividends and 70% to share repurchases, while its shares trade at a 15% free cash flow yield.

The 497.8% return over ten years implies a 20.7% compound annual growth rate from Warrior’s current stock price of $45. Not too shabby for an old-economy company in a smokestack industry that traces its roots back to the 1940s.

In the immediate term, trade frictions are another factor pushing down Warrior’s stock price. The company exports almost all of its production to foreign markets, so its pricing is adversely impacted by tariffs. China’s 15% retaliatory tariffs against U.S. met coal producers hit its results worse than its peers. Despite the near-term headwind, any macro bearishness that creates a lower entry price for buying Warrior shares is bullish for today's buyers over the long term.

Due to Warrior’s status as a potential compounder, I believe its shares should not be sold unless they get ridiculously overpriced, which is unlikely to happen for a coal producer.

And for investors looking to buy cheap and sell amid a shorter-term pop, I estimate the shares are currently worth nearly $100, as illustrated in the following discounted cash flow valuation.

The scenario depicted in the table shows Warrior’s free cash flow amid average normalized U.S. met coal prices and Warrior’s production ramp over the next few years. The value implies 122% upside from the current price. Due to coal’s stigma in the investment community, I doubt Warrior’s shares—or those of any coal company, for that matter—will trade to the price implied by discounted cash flows under mid-cycle assumptions. Nevertheless, the massive discount leaves ample room for attractive returns from the current price, even if it is far below intrinsic value.

Conclusion

Warrior Met Coal should make intuitive investment sense to any bona fide value investor. If the investor can overcome the fact that their investment resides in an industry that is truly hated by the general public, prospects for outperformance over the long term are outstanding from current prices. The trick will be not to get shaken out of the shares. Warrior is one of the true set-it-and-forget-it investments. Long-term value hunters should consider buying the shares now at $45 or below.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of HCC, AMR either through stock ownership, options, or other derivatives.

We wrote an update on Whitecap here following the Q2 results.

By: Jon Costello

Note: Dollar references in this article are to Canadian dollars unless otherwise specified.

Whitecap Resources (WCP:CA) has emerged from its acquisition of Veren as a premier large-cap North American E&P.

An overview of the combined entity is shown below.

Source: Whitecap Resources May 2025 Investor Presentation, May 28, 2025.

The combined entity features a current production capacity of 365,000 boe/d, with production comprised of 54% light crude oil, 11% NGLs, and 35% natural gas. The greater scale and operating synergies brought forth by the combination will enhance the combined entity’s drilling economics and capital efficiencies.

After the combination, Whitecap’s acreage possesses a deeper core liquids drilling inventory than any Canadian E&P peer outside of the oil sands, with considerably more than 20 years of high-quality inventory. The depth of Whitecap’s inventory exceeds that of every independent public Permian E&P. Only Diamondback (FANG) comes close to matching Whitecap’s inventory depth.

Whitecap intends to grow its production by 3% to 5% per year, with production growth driven by legacy Veren’s liquid-rich Montney acreage. I expect its production to increase to more than 450,000 boe/d over the next five years, at which point it will still have decades of high-quality drilling inventory.

Whitecap has consistently built value for its shareholders, and I expect that to continue. Its management’s long-term track record of value creation is among the best among Canadian energy companies.

The chart below presents some important value metrics. Management’s record is particularly impressive considering how difficult macro oil and natural gas market conditions have been throughout long stretches of time during this period.

Source: Whitecap Resources May 2025 Investor Presentation, May 28, 2025.

The combined entity’s stock will be more desirable to large equity investors interested in a multi-year holding period than either Whitecap or Veren were on a standalone basis. The standalone entities had been stuck in the no-man’s land of Canadian E&P mid-caps in recent years. They traded at a perpetual discount to larger North American peers, irrespective of their underlying economics or growth prospects. I expect that to change with the combined entity as larger investors appreciate the wider implications of the end of U.S. shale growth and seek a reliable means of oil exposure.

The discount on Whitecap shares provides an attractive entry point for long-term investors. As the company’s strengths are borne out over the coming quarters in its operating and financial results, I expect investors to embrace the combined entity and bid its shares to a sustained higher multiple.

Whitecap Shares Have Underperformed, Creating Opportunity

Despite Whitecap’s positive attributes, its stock has underperformed Canadian large caps in recent months. The chart below plots their year-to-date performance against the Canadian E&P exchange-traded fund XEG (XEG:CA).

The low price of Whitecap shares translates into a higher dividend yield than they’ve maintained throughout the company’s recent history.

The higher yield partly reflects the likelihood of a dividend cut, though I view a cut as unlikely in 2025 and beyond if WTI averages above US$60 per barrel.

A return to Whitecap’s average dividend yield in the year before its Veren acquisition implies a stock price above $10.00, 12% above the current stock price of $8.90.

Whitecap shares remain depressed versus peers for several reasons. For one, investors face uncertainty because the company has yet to release a quarter of results as a combined entity. Larger investors, in particular, seek confirmation that management can execute at a larger scale. The shares are also dogged by lingering bearish sentiment carried over from before the combination.

Share Ideas from HFI Research

Legacy Whitecap-Veren Assets Offset One Another’s Weakness

Today’s Whitecap retains the strengths of standalone Whitecap and Veren while simultaneously diminishing their respective weaknesses as standalone operators. Consider the following:

• Whitecap’s reserves were relatively gas-weighted, while Veren’s were more heavily weighted toward higher-value liquids. The combined entity’s production mix enhances its flexibility in navigating the ever-changing commodity landscape.

• Veren’s more variable geology caused its well results to be less consistent than those of Whitecap. By the same token, Whitecap’s consistent execution was largely attributable to the more uniform nature of its geology. Operating results for the combined entity are likely to be more consistent over time. It can also be more selective about where it chooses to drill, minimizing the risk that a few sub-par wells materially hurt companywide results.

• Whitecap’s lower-decline asset base offsets Veren’s higher-decline assets. Whitecap’s liquids-rich natural gas wells reduce its AECO breakeven to less than $1.00 per MMBtu, while Veren’s deep crude oil inventory enhances the combined entity’s cash flow torque to crude oil prices.

• Whitecap’s natural gas marketing operations were a point of weakness before the combination. Veren was stronger on the marketing front. The addition of Veren’s marketing practices, combined with the company’s vast scale, can help enhance price realizations for the combined entity. For instance, its larger scale and deeper drilling inventory open the door to long-term LNG feedstock supply deals and the higher price realizations they bring.

• The combined entity is properly capitalized for its size. Whitecap’s $270 million disposition of Saskatchewan assets shortly before the acquisition closed reduced the combined entity’s net long-term debt ratio to approximately 0.8 times debt-adjusted cash flow (DACF) at US$70 per barrel WTI, assuming $2.00 per MMBtu AECO natural gas prices. The figure stands at a reasonable 0.9-times debt-adjusted cash flow at US$65 per barrel WTI. Leverage is greater than legacy Whitecap—where net debt to DACF was less than 0.5-times at US$70 per barrel WTI—but lower than legacy Veren—where net debt to DACF was above 1-time at US$70 WTI. Today, the combined entity’s leverage ratio is roughly in the middle of the range of public independent North American E&Ps.

Despite Assertions by Critics, Asset Quality is High

With the combination now complete, legacy Veren’s critics who claim that the company had poor asset quality have carried their concerns over to Whitecap. Veren’s drilling results have already invalidated these concerns, but that hasn’t quelled the bears’ critiques.

The main thrust of the bearish argument holds that disappointing results on 12 wells Veren drilled in its Gold Creek acreage in late 2024 were indicative of poor geology in acreage the company viewed as core.

In reality, the poor well results were caused by an experiment by management gone awry. Specifically, management employed a “plug-’n-perf” completion technique in response to higher recoveries achieved in previous wells that used plug-’n-perf completions. For the 12 wells in the experiment, plug-’n-perf completions represented a move away from the company’s more reliable single-point entry completion technique.

After the experiment failed and well results disappointed, management vowed to return to single-point entry completions in its third-quarter 2024 earnings conference call on October 31. Management expected the new completion technique to rectify the experimental Gold Creek well results. The market didn’t buy it. Veren shares crashed, and management was penalized with a negative stigma in the market.

The price crash set up an outstanding buying opportunity. I bought the shares for the HFI Research Energy Income portfolio at a price equivalent to $6.72 per Whitecap share. I plan to hold the Whitecap shares for several years.

At the time of management’s mishap, criticisms by Veren bears ignored evidence that the company’s well results supported management’s claims that completion techniques—and not geology—were the cause of the poor results. Gold Creek wells in close proximity to the wells with botched completions had already delivered outstanding results. Subsequent well results have strengthened the claim that completion techniques caused the mishap in the impacted area. Moreover, in the months after the poor well results and before its merger with Whitecap, Veren applied for new permits in the same area.

Despite all the available evidence that Veren’s geology was intact, as well as the fact that Veren went on to drill some of the most productive oil and liquids-producing wells in the Western Canadian Sedimentary Basin in January 2025, the bears continue to view Whitecap’s acreage as subpar.

As long as questions remain about the company’s acreage—whether valid or not—they could weigh on the share price.

To the extent the bearish concerns depress Whitecap’s share price, I believe they also represent a source of opportunity. I’ve been a buyer of the shares during their selloff in recent months.

However, as positive well results continue to come in, the market will regain confidence in the combined entity’s management and asset quality. At that point, I believe improving sentiment will deliver a tailwind to Whitecap shares that causes them to outperform.

Dividend is Sustainable Below US$50 per barrel WTI

Aside from Whitecap’s asset quality, the other contested matter among Canadian E&P investors is the sustainability of its dividend. This is another area where I believe bears are wide of the mark.

Desjardins Securities analyst Chris MacColloch—a top Canadian E&P analyst whom I respect—recently stated in an interview that a dividend cut was “a painful but necessary step” for Whitecap. The cut would be necessary because strip prices on June 4 implied that Whitecap’s dividend payout ratio would be 110% in 2026. The backwardation in the curve at the time implies an average full-year 2026 WTI price in the low-US$60s per barrel.

Whitecap shareholders should acknowledge that a dividend cut is a risk amid low oil prices. However, I believe the company is likely to sustain its current dividend unless WTI falls into the US$50s per barrel for a period of several months.

For one, management appears committed to maintaining the current dividend. The excerpt below is taken from Whitecap’s first-quarter earnings conference call on April 24, in which CFO Thanh Kang added the following to CEO Grant Fagerheim’s earlier commentary about factors likely to bolster the company’s cash flow and dividend sustainability if oil prices decline.

Source: Whitecap Resources Q1 Earnings Conference Call BamSEC transcript, April 24, 2025. Highlight added by author.

Second, MacColloch states that he assumes Whitecap’s 2026 capex will be $2.4 billion, consistent with management’s guidance. However, Whitecap plans to grow in the 3% to 5% range, so a portion of management’s 2026 capex guidance is aimed at production growth. Management can likely ratchet back capex to reduce the company’s cash flow breakeven price per barrel and support its dividend.

In its May Investor Presentation, Whitecap stated that its annual maintenance capex is $2 billion, as shown below in the red-dotted circle on the left. It also states that the dividend is sustainable down to US$47 per barrel WTI, shown on the right.

Source: Whitecap Resources May 2025 Investor Presentation, May 28, 2025. Red-dotted line added by author.

My modeling indicates that at $2.0 billion of capex, exclusive of hedges, Whitecap can fund its dividend down to US$56 per barrel WTI, assuming $3.00 per MMBtu AECO. Whitecap has hedged 31% of its production using swaps at a weighted average price of US$72 per barrel WTI. It has also hedged 9% of its production using collars with a floor of $68. Inclusive of 2025 hedges, I estimate the dividend can be covered down to US$49 per barrel WTI, which is in the ballpark of management’s estimate. Given that operating cost reductions would likely materialize at lower oil prices, management’s estimate of US$47 per barrel is indeed realistic.

The situation changes in 2026. Low oil prices and a backwardated futures curve have prevented Whitecap from hedging production for 2026. Consequently, next year, the dividend could be at risk if WTI is sustained in the mid-US$50s per barrel. Below those prices, Whitecap would likely join almost all of its peers, who also would slash their dividends in response to such low oil prices.

Even if WTI did fall to US$55 per barrel, it would probably not remain there for long. Such a low oil price would force dramatic cuts in U.S. shale production, which would put upward pressure on prices by reducing supply and may also induce action out of OPEC to stave off potential future supply issues.

This exercise simply shows that Whitecap’s dividend, while not bulletproof in every commodity environment, is sustainable down to very low levels. Its 8.2% yield therefore remains attractive among large-cap Canadian E&P stocks.

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Valuation

Whitecap shares offer a very high probability of attractive returns over a holding period of three or more years.

I estimate that Whitecap’s current stock market valuation assumes US$65 per barrel WTI and $3.00 AECO. To the extent an investor believes long-term oil prices will exceed those levels, Whitecap shares offer an attractive alternative.

The company’s historical multiple of enterprise value to debt-adjusted cash flow (EV/DACF) is 3.9-times. I estimate the company generates approximately $3.6 billion of DACF flow at US$65 per barrel WTI. Whitecap’s net long-term debt is $3.45 billion, and its market cap is $11 billion, for an EV of $14.45 billion. This puts its EV/DACF around its historical average.

One of the chief attractions of Whitecap’s stock is its cash flow torque to commodity prices. The chart below captures the significant upside amid higher prices, assuming capex of $2.5 billion and that the shares trade at a 12% free cash flow yield.

The risks of permanent loss from the current stock price over a period of years is low. If commodity prices disappoint, Whitecap’s ample cash flow generation and conservative leverage profile ensure that it will survive any reasonable commodity price environment.

Risks

While Whitecap’s longer-term returns are clearly attractive from current levels, the shorter-term outlook presents a potential challenge.

For example, the current oil market consensus calls for large inventory builds beginning in late 2025 and persisting through 2026. If these builds approach the magnitude of current expectations, they’re likely to hold oil prices below US$70 per barrel. As long as significant inventory builds remain a clear risk, as they do today, long-term E&P investors should be prepared to endure a period of low prices and invest accordingly.

Despite the risk, I believe Whitecap’s dividend is sustainable below US$60 per barrel, so it remains an attractive investment candidate. Importantly, I believe a period of sub-US$70 per barrel WTI will give way to significantly higher prices over the subsequent years.

No one knows the extent of inventory builds or whether sub-US$70 per barrel prices will be sustained through 2026. I’m confident, however, that such low prices would stimulate demand and bring about lower U.S. production. If the downward trend in the international oil rig count amid recent oil prices is any indication, production outside the U.S. would also be at risk of declining. This then begs the question of whether OPEC+ would intervene with price cuts to forestall longer-term supply constraints and impairments. All these factors make sustained sub-US$70 per barrel WTI unlikely, barring a global recession, in my view.

In Whitecap’s case, the consensus natural gas outlook provides a counterpoint to the bearish oil consensus. If Henry Hub gas prices are sustained above US$4.00 per mcf, AECO natural gas prices will be more supportive of Whitecap’s cash flow and dividend sustainability than my modeling indicates.

Conclusion

Whitecap shares are one of the most attractive Canadian E&Ps at their current price. Their low risk of permanent loss, substantial upside potential, and large dividend yield provide an attractive risk/reward profile for any long-term investor.

Investors can take solace in the fact that management remains a large buyer of shares. CEO Grant Fagerheim owns 3.17 million shares and regularly buys in the open market. Management’s alignment with shareholders is a refreshing departure from legacy Veren’s management.

Like any E&P, its stock price will be sensitive to commodity prices. I believe it’s likely to make a large move higher once WTI rises out of the mid-US$60s per barrel range, where concerns about a dividend cut—whether valid or not—become less of an issue. At higher prices, dividend increases will deliver still greater value to shareholders.

Whitecap’s stock will become a favored destination for investors as shale production continues to mature and eventually decline. Investors should buy now before the investing herd heads north of the border.

Analyst’s Disclosure: Jon Costello has a beneficial long position in the shares of WCP:CA either through stock ownership, options, or other derivatives.

By: Jon Costello

Please read our more detailed write-up on VAL here.

The recent strength in Valaris (VAL) stock begs the question as to whether the stock price has overshot the company’s fundamentals, at least from a near-term perspective. The company's latest announcement alleviates those concerns.

Yesterday evening, Valaris announced two contract wins: one contract extension for the drillship Valaris DS-16 and one new contract for the drillship Valaris DS-18.

The DS-16 will remain in service with Occidental Petroleum (OXY). The extension pushes the end date of its service from May 2026 to December 2028. The new contract involves DS-18 moving from Chevron (CVX) to OXY in the Gulf of America beginning in the fourth quarter of 2026 to the second quarter of 2029.

Larger Backlog Provides Greater Valuation Certainty

The good news for VAL bulls is that the new contracts increase VAL’s backlog by $760 million, bringing its 2025 additions to $1.9 billion. At the company's most recent fleet status report on April 30, its backlog stood at $4.2 billion. These contract wins push the backlog close to $5 billion.

An investor in VAL shares must keep a close eye on the company’s backlog. Recall that the VAL bull thesis revolves around increasing dayrates, with higher contracted dayrates resulting in a larger backlog, all else equal. An increasing backlog provides greater visibility into VAL’s revenue, EBITDA, and cash flow. Offshore drillers tend to trade based on an EV/EBITDA multiple, so a larger backlog helps mitigate oil market and rig market volatility by locking in dayrates and increasing rig utilization for multiple years.

The contracts represent day rates of approximately $410,000. They stand to add approximately $80 million of EBITDA in 2027 and 2028. The dayrate and their EBITDA contribution in 2026 and 2027 are around what I expect for a mid-tier seventh-generation drillship. The news therefore doesn’t change my valuation.

The contracts are also positive from an offshore drilling macro perspective. The fact that day rates are holding firm in a relatively weak oil price environment is a positive sign, while the multi-year contract terms point to strong long-term demand. Furthermore, two drillships are taken off the market for future work, thereby reducing the rig capacity overhang and potentially creating positive momentum for future dayrates. If/when future supply is constrained, dayrates will take off to the upside. Each contract win brings the market closer to that point.

The negative is that the dayrates associated with these contracts are roughly in line with those for similar drillships. They don’t indicate a material uptick that is likely to send VAL’s shares or those of its peers sustainably higher. Offshore drillers will need a trend of higher dayrates to justify their bull cases, and these contracts show that the market isn’t there yet. Until it is, the bulls are engaged in a waiting game until more rigs are retired, active rig contracts are extended, re-contracted, and future capacity decreases.

Investment Implications

When I bought VAL at around $31 earlier this year, its market cap was low enough to make the stock attractive even if dayrates declined slightly. I plan to hold the stock for several years in expectation of the sector’s recovery.

With the shares now at $46, a holder should have an investment horizon of at least two years to increase the odds of generating an attractive return. Evidence of higher dayrates will probably be necessary to move the shares higher. Investors with a time horizon of less than two years might consider selling and buying back in a selloff.

My VAL investment thesis remains unchanged in light of this news. I still believe that higher dayrates are imminent and will translate into increased EBITDA and cash flow. Growing free cash flow will be distributed to shareholders through dividends and repurchases. I believe the shares still have the potential to be a multi-bagger over the next few years.

In fact, I had been looking to add to my VAL position in the $30s for the past month, but was surprised at how strong the stock has traded above $40. Perhaps in retrospect, that was a buying signal.

I like VAL over the near term because contract wins like these provide confidence that, even though oil prices may weaken, offshore drilling rig dayrates can remain firm. I want to maintain exposure to oil prices over the long term, and offshore drillers appear to be a better bet to me than E&Ps over the next few quarters. While I like E&Ps for direct oil exposure, the large oil inventory builds that the market expects to begin in the fourth quarter and persist through most of 2026 may feed through to lower oil prices and lower E&P stock prices. I don’t expect offshore driller stocks to be as negatively impacted as long as dayrates remain flat or higher.

But all offshore driller investors should be aware of the risks. Anything more than one or two floater contracts signed at weak dayrates could tank offshore driller stocks, as investors grow concerned about the possibility that those data points mark the beginning of an ominous trend of lower dayrates, lower EBITDA, and lower cash flow. By contrast, E&Ps are already reasonably priced for the current oil price environment. They’ll decline if oil prices fall, but they don’t have as much downside as offshore drillers if oil market fundamentals deteriorate significantly and take dayrates with them. They could also be quicker to respond to higher oil prices if investors remain wary of falling dayrates.

From a long-term perspective, the longer it takes for dayrates to reach the high-$500,000s level or above, the greater the cost of reactivating VAL's cold-stacked rigs, and the more likely it is that these rigs will be scrapped. A slow dayrate recovery can therefore reduce the value of VAL's cold-stacked rig fleet.

To mitigate the potential downside from holding offshore drillers over the shorter and longer terms, I’ve branched out into other energy sub-sectors with significantly more bullish fundamentals, as detailed in recent articles.

Conclusion

VAL’s contract wins are a net positive, as implied by today’s slightly higher stock price. Investors should feel confident holding VAL shares for a multi-year period, during which I expect dayrates to rise as the market becomes increasingly supply-constrained. As U.S. shale growth flattens out, major oil companies will turn to offshore for new finds. Offshore rig dayrates will be bid higher, providing a tailwind for offshore driller stocks. VAL offers the best combination of a conservative balance sheet, a fleet concentrated in floaters, floater specifications that allow for new contract wins, and stacked rigs capable of re-entering the fleet. I still believe waiting for a pullback is the right move before adding, but investors who are bullish for 2026 offshore activity should consider adding in the mid-$40s.

Analyst’s Disclosure: Jon Costello has a beneficial long position in the shares of VAL either through stock ownership, options, or other derivatives.

• An update on Strathcona Resources.

• Our take on the SCR/MEG offer.

By: Jon Costello with input from Wilson

Note: Dollar values in this article refer to Canadian dollars unless otherwise specified.

Strathcona Resources (SCR:CA) (OTCPK:STHRF), a core holding of our HFIR Energy Income Portfolio, dominated the E&P headlines this week. The company’s numerous bold moves underscore its ambitions to become a premier Canadian heavy oil E&P.

A quick summary of events is as follows: Wednesday evening, SCR announced the sale of its Montney conventional oil and natural gas assets for $2.84 billion and the Hardisty Rail Terminal for $45 million. Then on Friday, SCR announced its “intention to commence” a bid to acquire MEG Energy (MEG:CA)(OTCPK:MEGEF) for $23.27 per share, which represents a 9.3% premium to MEG’s previous-day closing price of $21.30. SCR also disclosed that it had acquired 23.4 million MEG common shares, equivalent to 9.2% of the company’s outstanding shares year-to-date through open-market purchases as of May 5.

Today, SCR shares traded 2.1% lower, to $30.26, while MEG shares have gained 18.7% to close at $25.29, 8.7% above SCR’s proposed offer price. The market’s reaction indicates that the deal won’t get done at the offer price and that higher offers for MEG could be forthcoming.

I own SCR shares through the HFIR Energy Income Portfolio and MEG shares through other funds I manage. For SCR, the sale of Montney assets was brilliant. I’m significantly more bullish about the long-term outlook for oil prices than natural gas prices, and as an investor who plans to hold SCR for years, I believe I’ll do better with a pure-play heavy oil producer than a more diversified oil and natural gas producer.

As a MEG shareholder, I’m less enthused. SCR’s proposed MEG offer is far too low to be taken seriously. No MEG shareholder in their right mind will support this deal. Eric Nuttall, a major MEG shareholder, has already registered his opposition to the deal, and other large shareholders are likely to follow.

In the end, I expect SCR’s bid to be successfully opposed.

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SCR's Montney Asset Sale

SCR’s sale of its Montney assets was a masterstroke. The $2.84 billion in proceeds represent half of SCR’s market cap but account for only 12% of its earnings. The proceeds will cause SCR’s net debt to fall from $2.9 billion to approximately $50 million.

The assets were sold to ARC Resources (ARX:CA), Tourmaline Oil (TOU:CA), and Canadian Natural Resources (CNQ). The deals are expected to close by July. They are shown within the red-dotted line on the map below.

Source: Strathcona Resources March 2024 Investor Presentation. Red-dotted line added by author.

SCR emerges from the sale as a pure-play oil sands producer. Its natural gas weighting falls from 29% to zero. Furthermore, the deal will lower SCR’s breakeven cost per barrel, which had been higher than its oil sand peers. A lower breakeven cost will be advantageous if oil prices remain depressed over the coming quarters.

Arguably the biggest coup SCR scored in the deal was the attractive prices for which it sold its Montney assets.

SCR sold its Pipestone asset to CNQ for $850 million, approximating PDP value. The deal represents a reasonable price but provides CNQ with development upside. SCR isn’t interested in developing natural gas-weighted resources, so its sale to a company that places a higher priority on developing the assets was a smart move.

SCR sold its Kakwa assets to ARC Resources—another large holding in our HFIR Energy Income Portfolio—for $1.695 billion. The assets produce approximately 150,000 boe/d and include two natural gas processing plants. Like the Pipestone assets sold to CNQ, the remaining drilling inventory of the Kakwa acreage is heavily weighted toward natural gas and NGLs.

SCR also sold its Groundbirch asset in the Montney to Tourmaline for a relatively pricey $292 million in Tourmaline common shares.

The divested Montney assets were contiguous with the existing assets of each respective buyer. For example, ARC Resources’ purchase of SCR’s Kakwa asset completes its consolidation of the core of the play, as shown below.

Source: ARC Resources Press Release, May 15, 2025.

Since acquiring contiguous acreage allows the buyers to quickly realize cost synergies, they can justify higher bidding prices.

Moreover, the buyers are also among the most sophisticated E&P operators. They will wring far more value from the assets than less sophisticated peers, which is another factor that allows them to bid richly.

SCR’s $2.84 billion asset sale represented 145% of the assets’ $1.159 billion PDP PV-10 value and a 22% premium to the assets’ $2.322 billion proved reserve value. The sales price was boosted by the presence of infrastructure and natural gas processing plants that accompanied the acreage.

By disposing of its Montney asset, SCR extended its proved reserve life by six years, from 23 years to 29 years. It extended its 2P reserve life index by ten years, from 40 to 50 years. SCR will emerge from these transactions with one of the longest reserve lives of North American oil and gas producers. The transaction also lowers the company’s corporate decline rate and improves its capital efficiency.

In light of SCR’s strategic priority to focus on oil over gas, it’s tough to find any negatives about its Montney asset sale. The only notable negative is that its sale of its condensate assets used to dilute its heavy oil represents the loss of valuable vertical integration.

Don’t Overlook the Rail Terminal Purchase

In a separate deal, SCR acquired the Hardisty Rail Terminal, the largest crude-by-rail terminal in Western Canada.

The terminal was formerly owned by USD Group (OTCPK:USDP) in its diluent recovery joint venture with Gibson Energy (GEI:CA) and ConocoPhillips (COP). The terminal has throughput capacity of 262,000 bbl/d, though year-to-date it’s only shipped 50,000 bbl/d.

This was an outstanding bargain purchase by SCR. SCR claims the terminal has a replacement value of $200 million, but when the prospects for its Diluent Recovery Unit improve, I suspect the returns from the asset will boost its value far above $200 million.

SCR’s ownership of the terminal is a brilliant strategic move. The Western Canadian Sedimentary Basin (WCSB)—where most Canadian oil is produced—currently has sufficient egress capacity to transport all its production. However, once the TMX pipeline reaches full capacity over the next two years, the basin will once again face egress constraints that cause WCS prices to trade at a greater discount to WTI. The difference between the two benchmarks has to widen to a point at which it incentivizes rail transport.

SCR’s ownership of a crude-by-rail terminal with greater capacity than its total corporate production improves its cost structure relative to its large Canadian oilsands peers who rely on third parties for long-haul transportation. It also insulates SCR from major blowouts in the WTI-WCS differential that occur from time to time in the WCSB. Memories of the painful 2018 episode are still fresh. When SCR’s peers are suffering financially from the next WTI-WCS blowout, its relative outperformance will allow it to execute acquisitions for assets or companies on the cheap.

Next Up: SCR’s Bid for MEG Energy

Another positive from SCR’s asset sale is its emergence with a cash war chest with which it can pursue new deals.

Witness today’s news.

SCR’s $6.9 billion proposed offer for MEG came as a complete surprise in the Canadian oilpatch. SCR provides a summary of its offer in the graphic below.

Source: Strathcona Resources MEG Combination Presentation, May 15, 2025.

SCR is proposing an offer of 0.62 SCR shares and $4.10 in cash for each MEG share. The consideration is equivalent to $23.27 per MEG share, a 9.3% premium to its closing price of $21.30 on Thursday, May 14.

This offer won’t be taken seriously by any MEG shareholder, director, or executive. MEG has already spurned the deal. In fact, it has turned down at least one offer from large-cap peers in recent years that was far superior to what SCR offered today.

Nevertheless, today’s events are clearly a positive for MEG’s shareholders. SCR’s offer will cause investors to take a closer look at the tremendous value that exists in Canadian heavy oil assets. As that value is more widely appreciated, the stocks of MEG and its large-cap oil sand peers are likely to trade at higher multiples. I’ve often been bewildered at the significant discount to which Canadian oil-weighted E&Ps have traded relative to U.S. shale E&Ps. Perhaps that discount will shrink, or even shift to a premium, as more investors appreciate value and bid the Canadian names higher.

As for SCR, the company stands to win in any outcome. Its purchase of 9.2% of MEG shares throughout 2025 at discounted prices will allow it to profit even if it loses its bid for MEG. Consider, for instance, that year-to-date, MEG shares have traded at an average price of $22.65. Today, they hovered around $25.00, representing an attractive annualized gain over the few months that SCR has held its MEG shares.

Since April 1, however, MEG shares have averaged $20.64. Given SCR’s impeccable nose for value and aggressive approach to acquiring underpriced assets, I suspect the company’s cost for its MEG shares is closer to $20 than the 2025 average of $22.65. It therefore stands to reap a very healthy annualized return at a price above its initial offer price.

If, by chance, a competing bid emerges and pushes MEG's share price higher, SCR would make a sizeable gain irrespective of its success or failure in acquiring MEG.

MEG’s Assets Would Upgrade SCR's Asset Quality

If SCR were to succeed in acquiring MEG, it would emerge with a higher-quality asset portfolio. MEG’s Christina Lake SAGD asset features greater well productivity than SCR’s assets. The asset’s advantageous geology and contiguous footprint have lower operating and capital costs, so it breaks even at a lower price and requires less capital per barrel of oil produced to maintain production.

I estimate that MEG’s breakeven cost per barrel necessary for sustaining flat production is approximately US$45 per barrel WTI. By contrast, SCR's heavy oil assets break even in the low-US$50s per barrel WTI.

MEG’s superior geological and operating characteristics allow it to produce significantly more oil for every dollar of capital invested in production. Consider, for instance, that MEG spent $14.99 of capex per barrel to generate its 100,139 bbl/d in 2024, while SCR spent $21.22 per barrel to produce its 106,623 bbl/d.

Even at MEG’s lower rate of capex per barrel, its production declined less on an annual basis in 2024 than SCR’s. Despite the year-over-year declines, both companies intend to grow their heavy oil production over the coming years.

During SCR’s conference call announcing the deal this morning, Adam Waterous referred to MEG as SCR’s “doppelganger” and its “identical twin.” With all due respect to Waterous’s expertise, I take issue with his statement. The facts make it clear that MEG’s Christina Lake SAGD asset is higher-quality than SCR’s oil sands assets.

Throughout 2025, SCR and MEG shares have traded at roughly similar multiples of 2P net asset value and EV/DACF. After SCR’s recent asset sale, it trades at a discount to MEG because the smaller net debt component of SCR’s enterprise value after its asset sale reduces its EV-based trading multiples, such as EV/DACF and EV/Boepd.

However, I’d argue that MEG deserves to trade at a premium multiple relative to SCR due to its:

• Longer track record of consistently successful operating results.

• Simpler operations.

• Higher overall asset quality and superior capital efficiency.

• Certainty of production growth prospects.

• Higher return on capital employed

• More liquid stock.

• Less risk of making strategic mistakes.

• More conservative balance sheet.

Consequently, attempts to justify SCR’s acquisition proposal by claiming it’s paying up for MEG should fall on deaf ears.

Other Potential Suitors for MEG

Of the other suitors likely to emerge, I suspect Canadian Natural Resources (CNQ) and Suncor Energy (SU)—also a holding of our HFIR Energy Income Portfolio—would be the most likely to make a bid.

The first thing that CNQ has going for it is its massive scale. Its enterprise value stands at $108 billion, so it will have no problem making a bid for MEG, with its $7 billion enterprise value. And since CNQ’s shares trade at a significant premium to MEG’s, it can afford to offer stock as consideration in a deal. CNQ's premium makes a MEG acquisition more accretive to it than it would be to other suitors with shares trading at lower multiples.

MEG could also be an attractive addition to CNQ’s extremely high-quality asset base.

Offsetting the possibility of CNQ making an offer for MEG are two considerations. First, CNQ’s assets are generally of higher quality than MEG’s. CNQ’s oil sands assets have lower operating costs and cash flow breakeven costs per barrel. As a result, an acquisition of MEG could negatively impact CNQ's heavy oil operating and financial metrics.

But perhaps even more importantly, throughout CNQ's long history, it has avoided engaging in bidding wars. I don’t expect it to start now. Rather, CNQ is more likely to remain culturally and strategically averse to making a competing bid in a hostile takeover of MEG.

SU may be interested in MEG due to its need to address the depletion of its Base Mine, which accounts for a considerable part of its upstream production. The Base Mine has a remaining life of approximately ten years, and MEG’s multi-decade reserve life would be an attractive fit for SU. The Base Mine produces roughly 250,000 bbl/d for SU. MEG’s 105,000 bbl/d of production can be increased significantly before the Base Mine reaches depletion.

At What Price is a MEG Acquisition No Longer Accretive?

I estimate free cash flow using metrics that are as close to comparable as possible. I use SCR's 2024 field operating income figures in its heavy oil segment disclosures of its annual report to determine free cash flow. MEG's free cash flow is calculated from its income and cash flow statements.

SCR’s oil sands assets generate approximately $577 million in free cash flow in 2024, as detailed below.

Based on SCR’s current stock price of $30.30, its 214.2 million diluted share count, and its $59 million of net debt, its enterprise value is $6.55 billion.

In 2024, WTI averaged US$75.72 per barrel. At that price, SCR generates an approximately 8.8% free cash flow yield on its current enterprise value.

In 2024, MEG generated $787 million in cash flow, as shown in the table below.

For MEG, based on SCR’s offer price of $23.27 per share, the company’s 263 million diluted shares outstanding, and its $769 million in net debt, its enterprise value stands at $6.89 billion.

Based on EV/FCF multiples, SCR can offer as much as $31.04 per MEG share before the deal is no longer accretive on a FCF basis. However, I don’t expect MEG’s shareholders and directors to agree to a bid even at that relatively elevated level, as it undervalues MEG relative to the company's long-term prospects.

Conclusion

In the end, SCR’s bid for MEG is likely to fail. MEG won’t willingly accept an offer that significantly undervalues its shares. Furthermore, hostile takeovers are rare in Canada. Other potential acquirers may be unwilling to participate in this one. All these factors stack the odds squarely against SCR’s bid—or even a sweetened bid—succeeding.

I’m holding onto my MEG shares. Investors with a purchase price below SCR’s offer price should consider doing the same, as they’re likely to do very well over the long term by simply staying put.

Analyst's Disclosure: I/we have a beneficial long position in the shares of MEG:CA, SCR:CA, SU:CA, ARX:CA either through stock ownership, options, or other derivatives.

By: Jon Costello

Energy stocks are seeing some of the greatest selling pressure since 2020. Even the highest quality names are plunging in sync with the dregs of the industry when fear spikes and “correlations go to one.”

Due to all the unknowns facing investors over the next few quarters—which include the prospects for a continued stock market meltdown and a global recession—investors should favor quality names that are certain to survive. Once macro conditions stabilize and the market once again distinguishes between high and low quality, these names will rally hard.

And in the event that adverse scenarios don't come to pass, high-quality names will do very well in a more mundane macro environment.

Among high quality, investors should also stick with larger cap stocks, as they’re less at risk of a “take-under” if macro conditions deteriorate further. A take-under is the situation when an investor buys a stock that ends up being acquired at a lower price, forcing a permanent capital loss.

One of The Highest Quality E&Ps

Among global E&Ps, we’re hard-pressed to find a higher quality large name than Canadian Natural Resources (CNQ) (CNQ:CA).

Even before this recent selloff, Canadian Natural Resources CNQ’s stock was under pressure relative to its peer group. Its shares began to underperform late last year. The underperformance grew larger throughout 2025, as shown below.

Source: Yahoo! Finance, April 12, 2025.

CNQ benefits from having one of the lowest free cash flow breakeven costs per barrel in the North American oil patch. We estimate its free cash flow remains positive at maintenance capex levels down to US$40 per barrel WTI. It will therefore survive any conceivable downturn and possibly emerge in stronger shape.

CNQ’s Headwinds

Three factors have weighed on CNQ shares in recent months outside the broader energy sector negativity and general market panic.

First, some investors are concerned that CNQ has grown too large to sustain the outsized organic production growth it has achieved since its founding in 1989. Second, the company is vulnerable to U.S. tariffs. Third, free cash flow distributions to shareholders were recently adjusted lower, from 100% to 60%. These factors are the reason for the stock’s underperformance relative to its sector.

1. CNQ’s Large Size

There is merit in the first concern, namely, that CNQ has grown too big to sustain outsized growth. After all, the company’s market cap stands at $77 billion against a backdrop of the approximately $200 billion market cap of Canadian E&Ps. Nevertheless, important considerations make this concern overblown.

Firstly, CNQ’s long reserve life ensures it can grow organically over at least the next five-to-ten-year period. The company’s proved reserve life extends some 26 years, far longer than any of the oil majors’ E&P operations.

Moreover, CNQ’s long-term growth target is not particularly heroic. The company intends to grow production in the low-single-digits percentage range, which should be manageable over at least the next few years. Its targeted growth rate is only slightly lower than those of its smaller Canadian E&P peers, such as Whitecap/Veren (WCP:CA), Strathcona Resources (SCR:CA), Cenovus Energy (CVE:CA), and MEG Energy (MEG:CA).

Secondly, shareholders should consider growth from a per-share perspective. CNQ’s low free cash flow breakeven and high return on capital ensures accretive share repurchases as the cycle turns down and its share price falls. Repurchases will continue the company’s longstanding trend of increasing production, reserves, and cash flow over time on a per-share basis. The chart below illustrates the steady upward trajectory of production per share.

Source: CNQ April 2025 Investor Presentation.

Thirdly, acquisitions still provide a potential avenue for growth. Whether growth comes from existing resources or an accretive acquisition shouldn’t matter under a top-notch management team like CNQ’s.

CNQ’s management and its top-tier assets lock in a higher-than-average return on capital, potentially for decades. Consequently, its shares trade at a higher multiple than peers. As a result, it can use its shares to acquire low-priced assets and companies on an accretive basis for shareholders.

Much of CNQ’s growth has come through acquisitions during downcycles. No doubt the company’s leadership will be on the hunt for high-quality assets that complement the company’s existing asset base if the current downturn persists.

The company’s most recent acquisitions illustrate how it creates value through acquisitions, even in the good times.

CNQ closed its US$6.5 billion acquisition of Chevron’s (CVX) Athabasca Oil Sands Project (AOSP) in December 2024. The deal added zero-decline SCO mining reserves and operating optionality to CNQ’s high-quality and diverse oil reserve base. The assets are in close proximity to CNQ’s existing Athabasca assets.

Source: CNQ AOSP Acquisition Presentation, December 2024.

It also brought Chevron’s 70% interest in Duvernay acreage producing 60,000 boe/d.

Then in January, CNQ swapped its 10% interest in the Scotford synthetic oil upgrader and certain carbon capture facilities for Shell’s (SHEL) 10% interest in the AOSP.

The December and January AOSP deals increased CNQ’s working interest in the project from 70% to 100%, adding 31,000 bbl/d of synthetic crude oil production at a low cost. CNQ will still operate and own an 80% interest in the Scotford upgrader. We wouldn’t be surprised to see the company make additional deals to increase its stake in the upgrader.

These moves illustrate the long-term strategic brilliance of CNQ’s management when it comes to acquisitions. The company has proven its ability to build shareholder value by consistently buying assets from motivated sellers. Its acquisitions have increased the quality and volumes of its oil production and reserves on the cheap. We would expect other such deals to emerge if the current downturn remains in place for another few months.

2. Vulnerable to Tariffs

The second investor concern about CNQ is its vulnerability to U.S. tariffs. This is an inescapable reality, but we don’t expect U.S. tariffs on Canadian oil production to be in place for long. We therefore view the current concerns as a buying opportunity for investors with a time horizon of more than a year. Once the tariff threat is gone, CNQ shares are likely to bounce back to the mid-$40s in short order.

3. Reduction in Shareholder Capital Returns

CNQ used debt to fund its $6.5 billion AOSP acquisition. In order to reduce the debt taken on to fund the deal, it changed its free cash flow distribution policy from paying out 100% of free cash flow after dividends to paying out 60% of free cash flow after dividends. Investors were miffed about the sudden and unexpected change to the long-anticipated 100% payout.

We view this as another temporary situation that long-term investors can use to their advantage.

CNQ is allocating 40% of its free cash flow to pay down debt. Even at US$60 per barrel WTI, it will pay down this debt rapidly over the next few quarters. Of course, there is a risk that it will take on additional debt to fund another acquisition during this downturn, but we suspect that any acquisition will be highly accretive to intrinsic value. As such, it is likely to offset the negative impact of reduced variable dividends and/or share repurchases.

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Operating Performance Remains Stellar

CNQ continued its outstanding operational execution yet again in the fourth quarter.

Adjusted funds from operations were 3% higher year-over-year. Production hit a record, while capex came in 6% lower than analyst expectations.

The performance allowed the company to return $1.7 billion to shareholders in dividends and share repurchases. CNQ also raised its common dividend by 4% to an annualized rate of $2.35 per share. On the current share price of $36, the dividend yields 6.5%, two full percentage points higher than its average yield throughout 2025.

CNQ Shares are Cheap

CNQ shares are trading at a rarely seen discount. For years, large institutions owned CNQ stock as a conservative way to gain long-term exposure to oil. We suspect that many of these funds are being forced to raise cash for various reasons by selling their most liquid positions, such as CNQ. The indiscriminate selling is causing most high-quality stocks to trade down in sync with their smaller peers. High-quality E&Ps have sold off worse than most other large caps outside the energy sector.

This selloff has brought the CNQ share price down to juicy territory for conservative investors who seek income and long-term capital appreciation. The following table illustrates the company’s free cash flow potential at different oil prices and the upside potential in its shares.

We’re confident that WTI will see US$80 per barrel once again. At that level, the nearly 60% upside potential in CNQ shares is very attractive for a large-cap stock. And the return estimates exclude dividends. CNQ offers the additional benefit of being conservative enough to be held in size at current prices for investors with a multi-year time horizon.

Barring a global depression, we estimate that WTI under US$70 per barrel isn’t sustainable for more than a year. As this downturn runs its course and oil prices recover, the shares are all but certain to respond by trading higher in response to CNQ’s surging cash flow.

In the meantime, investors can benefit from CNQ’s 6.5% dividend, which will be sustained in any realistic scenario. In the brutal conditions of 2020, the company kept its dividend intact. We believe it will do the same in 2025.

Conclusion

Investors won’t find many better alternatives among large-cap E&Ps than CNQ. The shares are as close to a set-it-and-forget-it proposition as an investor will find in the sector. At the current price of $36 per share, investors interested in both capital appreciation and income should consider making a long-term investment in these shares.

Analyst's Disclosure: Jon Costello has a beneficial long position in the shares of CVE, SCR.TO, MEG.TO either through stock ownership, options, or other derivatives.

CNX Resources (CNX) shares have been on a wild ride. They’re up 36.5% over the past year, outperforming the broader market but underperforming natural gas E&P peers Antero Resources (AR) and EQT (EQT), which gained 50.8% and 55.8%, respectively, over the same period.

Source: Yahoo! Finance, March 25, 2025.

Unlike AR and EQT, CNX shares have pulled back from their highs late last year, begging the question of whether they’re set to outperform.

The culprit for the recent underperformance was management’s ill-fated decision to bet on the continued rollout of the hydrogen economy. Back in May 2024, the company struck a deal with KeyState Energy and Pittsburgh International Airport to create a sustainable aviation hub that would use CNX’s coal-mine methane (CMM) as a feedstock to produce up to 70 million gallons of sustainable aviation fuel annually. CNX signed a $1.5 billion letter of intent to advance the project.

In the months after the announcement, CNX shares surged by more than 60%, primarily due to the run-up in natural gas prices. During this run, they outperformed both AR and EQT.

Trump’s election marked the turning point.

CNX’s sustainable aviation hub project was dependent on how the U.S. Treasury Department implemented the provisions of the Inflation Reduction Act, specifically, the 45V clean hydrogen production tax credits, from which CNX intended to profit in its airport deal. In guidance announced on January 3, the Trump administration included new restrictions that removed certain economic incentives necessary for CNX to pursue the deal and forced it to back out. In response to the move, its shares fell off a cliff, erasing nearly one-third of CNX’s market cap at its November peak.

The shares have since rallied back in the weeks since their January plunge, but their performance remains far short of peers. While they aren’t overpriced—and are likely to rally further if natural gas prices rise from their current $3.87 per mcf—we believe it’s prudent to avoid them in favor of AR until conditions for CNX improve.

CNX Overview

CNX is a natural gas-weighted E&P operating in the Marcellus and Utica shale basins. The company’s production is 94% gas and 6% liquids, with the liquids comprised almost completely of NGLs. More than 90% of the company’s dry natural gas production is sourced from conventional sources. The remainder is sourced from CMM. Management is guiding to production in 2025 of approximately 1.61 Bcf/d, or 275,000 boe/d.

The company’s production volumes have been fairly steady over the past five years, but volumes are set for a jump after it acquired the natural gas upstream and midstream operations of Apex Energy for $505 million.

CNX’s proved reserve life spans fifteen years at its expected 2025 production rate. However, these reserve figures don’t include those acquired in the Apex acquisition, which closed in January. Apex brought a contiguous block of 36,000 acres that abutted CNX’s own acreage. It also included around 20,000 undeveloped acres in the Marcellus and Utica. The deal is expected to add approximately 185 MMcf/d to CNX’s production in 2025.

CNX realizes a discount on its natural gas sales that can be in excess of 10% of Henry Hub prices. The discount is attributable to the regional oversupply and steep transportation costs in Appalachia. It is partially offset by the relatively high energy content of CNX’s production.

Outside of its upstream activities, CNX earns revenue from operating midstream infrastructure and its “New Technologies” unit, where it receives environmental credits in return for the CMM captured from abandoned coal mines. The company monetizes its carbon capture activities primarily through the Pennsylvania Alternative Energy Portfolio Standard program, in which companies purchase carbon offsets to use toward their own emission goals. In 2025, CNX expects to generate $75 million in free cash flow from 17.5 Bcf of CMM sales volumes, above the $63 million it generated from 18.3 Bcf of CMM sales in 2024.

Natural Gas Hedges: A Tremendous Cash Flow Drag

The main issue with CNX from an investment perspective is the company’s hedging program. CNX hedges more than almost any E&P in North America. The hedges provided a financial benefit over the past two years, when Henry Hub prices traded for long stretches in the $1.80 to $2.50 per mcf range.

However, the hedges will be a severe drag on cash flow over at least the next two years if the natural gas bull market pans out as we expect.

For 2025, CNX hedged a full 85% of its dry natural gas production using fixed-price hedges at an average price of $2.85 per mcf.

And it gets worse for CNX shareholders who are natural gas bulls. For 2026, CNX hedged another 74% of its dry natural gas production at an average price of $3.27 per mcf, assuming production remains at expected 2025 levels. If prices remain elevated—as we expect they will—the company will realize hedging losses in the hundreds of millions of dollars annually over the next two years. Consider where its hedges stand vis-à-vis Henry Hub strip prices:

Source: CME website, March 25, 2025.

Given the magnitude of volumes involved, CNX itself forecasts a $414 million hedging loss in 2025 from its hedges, as shown in the table below.

Source: CNX Q4 2024 Earnings Supplement, Jan. 30, 2025. Red-dotted line added by author.

The hedging losses include the price discount CNX receives on its production relative to Henry Hub prices. After realized cash losses from hedge settlements, free cash flow is expected to be approximately $500 million.

The extent of CNX’s hedging is perplexing, as the company has no ostensible need for such an extensive hedging program. It’s not exiting or running off its natural gas business; the failure of its airport deal suggests it’ll be committed to its E&P operations for the long term. Its debt is rather high, with $2.1 billion of net debt that is equivalent to 1.8-times cash flow on unhedged production. But debt isn’t at a point that would necessitate hedging 85% of production. After all, higher realized natural gas prices would accelerate debt reduction.

Moreover, CNX has demonstrated that it intends to reduce debt, as it has paid down approximately $100 million annually over the past four years. Additional debt reduction is slated for 2025 and beyond.

The company’s liquidity is ample, and debt maturities are manageable, as shown below.

Source: CNX Q4 2024 Earnings Slide Presentation, Jan. 30, 2025.

CNX’s hedging program also makes little sense from an operating cost perspective. Like its Appalachian peers, CNX is a low-cost producer in the U.S. It therefore has less need to protect against a sustained bout of low prices than E&Ps with higher operating costs. Its costs are well below those of Haynesville producers. We estimate that on an unhedged basis, CNX’s free cash flow breaks even at a Henry Hub price of approximately $2.35 per mcf with WTI at $70 per barrel, inclusive of corporate costs.

The cash flow drag created by CNX’s hedges severely limits the upside potential in its shares for at least the next two years and likely thereafter unless management’s hedging approach undergoes a major change.

Valuation

Inclusive of hedges and 2025 guidance, we estimate CNX will generate $477 million of free cash flow in 2025, assuming Henry Hub averages $3.50 per mcf and WTI averages $70 per barrel. This level of free cash flow generates a 10.1% free cash flow yield at the current share price of $31.75.

In a bull scenario in which Henry Hub averaged $5.00, the company would generate approximately $600 million in free cash flow, equivalent to a 12.7% yield. Obviously, the hedges significantly reduce the upside potential in free cash flow.

On an unhedged basis, CNX’s return profile is attractive, assuming the shares were to trade at a 12% free cash flow yield. In a natural gas bull market in which Henry Hub is sustained at $5.00 per mcf, CNX would generate a free cash flow yield of 28.3% on its current share price. Its return profile would look as follows.

This is what the company could conceivably achieve in 2027 if natural gas prices cooperate and it refrains from hedging. However, investors banking on such an outcome would have to be confident that management won’t make dumb capital allocation decisions until then. It would be helpful if management clarified its long-term hedging strategy.

It’s tempting to approach this situation as a long-sighted investor, initiating a long around current levels with the intention of holding for a three-to-five-year period. However, CNX’s management introduces enough unknowns into a multi-year holding period to prevent us from considering this strategy. We don’t consider it desirable to partner with a management team that is so risk averse that it feels the need to all but eliminate upside to shareholders if natural gas prices rise. Instead, we’d prefer to hold AR for a three-to-five-year holding period. Range’s management is superior. It is far more directly incentivized to perform for shareholders in all commodity markets. AR has distinguished itself as lower-cost than even CNX and has avoided hedges to capture the upside in a bull market.

If the economy entered a recession and all E&P names were pushed lower, CNX could be an attractive holding if its shares were bought at the low-$20s level. At, say, $25 per share, CNX| would offer a margin of safety and the prospect of multi-bagger returns if its management and board became convinced that the setup for natural gas is attractive enough to remain unhedged. However, the company would have to pay down debt by another $500 million or so to get away with not having to hedge at all.

Additional upside for CNX shares can come from continued share repurchases. In recent years, CNX has spent considerable sums repurchasing its shares. Since 2020, it has reduced its share count by a whopping 36%, from 225 million to 149 million shares. Unlike many other E&Ps, the company’s share repurchases have been concentrated in periods where its shares traded at a wide discount from intrinsic value.

Cash flow upside could also come from favorable rulings or legislation with regard to the various environmental credits it uses in its New Technologies segment.

Conclusion

We’d avoid CNX shares at the moment. AR shares are a superior alternative for natural gas bulls like us. That could change depending on the course of commodity and stock prices. But for the time being, we feel comfortable buying and holding AR while continuing to monitor CNX closely for positive developments.

Analyst's Disclosure: I/we have a beneficial long position in the shares of AR either through stock ownership, options, or other derivatives.

We also decided to make this article public. As always, thank you for reading.

By: Jon Costello

This morning, Whitecap Resources (WCP:CA) announced that it would acquire Veren (VRN) in an all-stock deal in which VRN shareholders will receive 1.05 shares of WCP. VRN shares ended the day 16.0% higher, while WCP shares sold off by 14.6%.

We’ve held VRN since October 31 of last year. I purchased the shares for the HFIR Energy Income Portfolio at an average price of $4.97, so the deal provides us with a return of ~14.69%.

But the timing of this deal is fortunate as it allows us to reinvest our VRN shares in other beaten-down stocks, with energy being our preferred alternative given the sector’s ridiculously underpriced equities vis-à-vis our longer-term oil and natural gas price outlooks.

Why I’m Not a Fan of This Deal

Despite the immediate benefits to our portfolio and investment returns, I’m not a big fan of this deal.

For one, it significantly undervalues VRN. This deal will reduce the long-term return prospects for VRN shareholders considerably, which is frustrating for investors who understand the economics resulting from VRN’s longer-term production growth.

The valuation discrepancy between the two is wide. As of Friday’s close, WCP traded at a multiple of 3.8-times EV to 2024 cash flow. As of today’s close, VRN trades at a far lower multiple of 2.6-times.

The deal’s timing is also frustrating for VRN shareholders. Management is no doubt aware that its reputation had been tarnished by the operating mishaps it committed last October. But its reputation was on the mend. Successful drilling results over the past few months demonstrated that the operational failure was attributable to management’s choice of completion methods and not to the company’s geology, as many had feared. Management was well on its way to proving that it was a strong operator.

But the job wasn’t done.

VRN’s stock price would have been the ultimate barometer of investor perceptions of the company’s management. I believe its continued successful execution over the next few quarters would have sent VRN shares comfortably above $6.00 at $70 per barrel WTI. VRN’s board and management should have held off in considering a sale until the shares traded at a higher price or management’s reputation was rehabilitated. After all, it doesn't appear that VRN’s board was under external pressure to sell. Nevertheless, they decided to sell the company while its shares were depressed by a reputational discount.

Various E&P commentators have suggested that the two companies tie up. I had been of the view that VRN’s management wouldn’t sell to WCP in an all-stock deal due to the valuation disparity between the two and the likelihood that WCP management would not want to pay up to acquire VRN. Clearly, I was wrong. WCP did manage to acquire VRN in an all-stock deal, though WCP’s management didn’t pay up for VRN’s assets.

Long-Term VRN Shareholders are Not Better Off

The deal will significantly reduce the long-term upside potential that VRN shareholders stood to realize if VRN remained a standalone entity. VRN’s operating and financial leverage, as well as its high percentage of crude oil production relative to WCP, provided it with superior cash flow torque to oil prices. Its increasing cash flow amid higher oil prices would have driven its shares significantly higher.

Moreover, VRN was slated to grow its production from today’s 192,000 boe/d to 250,000 boe/d in 2029. While VRN would spend significantly more than WCP on capex to accommodate this growth, its capex requirements were poised to decrease and level off after a few years.

These factors would have increased VRN’s cash flow torque to higher oil prices well above my estimates below of VRN as a standalone entity, which are based on the company’s current production rate. My return estimates from VRN's closing price today are shown below.

WCP has far lower upside. WCP has less cash flow torque and has less growth planned. WCP’s five-year plan called for 5% average annual growth from today's 177,000 boe/d to 215,000 boe/d.

The combined entity will have improved growth prospects relative to standalone WCP but reduced growth prospects relative to standalone VRN. The combined entity’s cash flow sensitivity to commodity prices will look like the following.

Not bad, but not as strong as VRN would have been as a standalone entity.

Investors seeking to maximize long-term upside amid sustained higher oil prices may want to consider switching out of WCP/VRN—which will be weighted 65%-to-35% liquids to natural gas—and into either Strathcona Resources (SCR:CA), MEG Energy (MEG:CA), or the beleaguered Cenovus Energy (CVE:CA). From today’s prices, these alternatives offer long-term return prospects that are as good or better than WCP/VRN in an oil bull market.

What VRN Brings to the Table

VRN and WCP share similar financial profiles when considering netbacks per Boe. VRN’s operating expenses were similar to WCP’s at around $13.75 per boe. VRN’s royalties were lower than WCP’s, and its income is shielded by a $900 million Canadian net operating loss carryforward. It also had lower marketing expenses. WCP, by contrast, had lower G&A and transportation expenses.

The combined entity will achieve significant operating and financial synergies. Operating synergies will be driven by the overlapping nature of the two companies’ Montney and Saskatchewan acreage. Financially, net debt to funds flow will be 0.9-times, lower than VRN’s pre-deal ratio of 1.1-time.

WCP will continue to pay its $0.73 per share dividend after the deal. At $70 per barrel WTI, the combined entity will cover its dividend 130%, less than VRN’s pre-deal dividend coverage of approximately 200%.

VRN Shares are Now a Hold

Aside from portfolio management-related pruning, I plan on holding VRN shares, at least for the time being. WCP will do well over the long term. The company will be a large dividend payer, with dividend hikes and special dividends likely amid sustained high commodity prices.

As a light oil producer, the combined entity will be a go-to name for U.S. investors as they begin to appreciate the ramifications of declining shale oil production. The combined entity’s larger scale will also enable it to secure attractive natural gas marketing opportunities that feature improved price realizations versus Montney and Duvernay in-basin pricing.

Over the longer term, WCP’s management is clearly the best choice for operating VRN’s assets. WCP’s management has one of the best operating track records in North America.

The operational fit between the two is a no-brainer, as this slide from WCP’s merger presentation demonstrates.

Source: Whitecap Resources, “Strategic Combination with Veren,” slide presentation, March 10, 2025.

WCP will emerge from the deal with improved oil-weighing in the Alberta Montney and a new attractive footprint in the Duvernay. VRN has been drilling some of the best wells in the Montney, and WCP’s shareholders will benefit from the company’s deep inventory of oily acreage.

A Competing Bid is Unlikely

Given how cheap VRN shares are—even after this deal announcement—VRN shareholders may hope for a competing bid. However, I expect this deal to go through. There are simply too few potential buyers with sufficient scale to consider a competing bid.

WCP management should get credit for the strategic timing of this purchase. It is pursuing the deal when its shares have held up better than its peers, giving it a better platform to go on offense during this downturn.

I’d speculate that Strathcona (SCR:CA) would prefer to remain focused on high-return condensate and heavy oil assets rather than expanding into Montney and Duvernay light oil. The other large oil sands players are also likely to confine their operational focus to bitumen and SAGD assets.

VRN’s assets don’t share strong synergies with those of Canadian Natural Resources (CNQ). ARC Resources (ARX:CA) is one of the only Canadian light oil producers with land and economics that are arguably superior to VRN's. ARX would probably consider a VRN acquisition to be dilutive of the quality of its business.

Outside of these names, Canadian E&Ps are too small to take a run at VRN. U.S. E&Ps are more likely to be acquirers as long as they trade at a premium to their Canadian peers and recognize that their days of doing so are numbered as their drilling inventory gets whittled down. Apparently, for the second point, we aren't quite there yet.

Conclusion

This wasn’t the result I was hoping for when I bought VRN shares. Fortunately, however, it occurred during a time when the Canadian oil patch trades at a massive discount to intrinsic value. I may ultimately decide to switch out of VRN if something else is more attractive, particularly if other high-quality E&Ps underperform WCP/VRN from here. As always, I’ll be sure to update subscribers if and when I do.

Analyst's Disclosure: Jon Costello has a beneficial long position in the shares of ARX:CA, CVE, SCR:CA, VRN either through stock ownership, options, or other derivatives.

By: Jon Costello

Incoming data continue to indicate that U.S. shale oil production is maturing. Fourth-quarter production results for U.S. independent E&Ps show shale production growing gassier. This phenomenon is becoming more pronounced over time and is occurring in most shale basins.

The large independent Permian operators—all of which prioritize crude oil over natural gas in their production mix—all saw their crude production decrease relative to their natural gas and NGL production on a year-over-year basis. These E&Ps may have expanded their production through acquisitions between the fourth quarters of 2023 and 2024, but despite their larger size, all saw their production grow gassier.

Diamondback Energy (FANG) is considered to be one of the best-managed U.S. independent E&Ps, with some of the best acreage in the Permian. Diamondback’s fourth-quarter oil production fell from 59.0% of the company’s total production to 53.9% on a year-over-year barrel of oil equivalent basis. The company’s natural gas production increased from 19.8% to 22.0% of total production, and its NGLs increased from 21.2% to 24.1% over the same timeframe. Fourth quarter results are shown below.

Diamondback’s notably gassier production was in large part attributable to its acquisition of Double Eagle last year. In early 2024, Double Eagle’s production was reported to be comprised of 69% liquids versus Diamondback’s 80% at the time. It remains to be seen if the legacy Double Eagle acreage—which was substantially undeveloped—can become more oily over time, but results to date aren’t encouraging.

Diamondback’s higher gas-to-oil ratio had a negative impact on its financial results, albeit a small one. In August of last year, the company decided to curtail some of its Permian oil production in order to limit its natural gas output amid a natural gas supply glut and local takeaway constraints. While the move made sense, it speaks to the risks to shareholders when basin-wide gasification occurs.

Permian Resources (PR) also experienced a higher gas-to-oil ratio in the fourth quarter. Year over year, its crude oil production fell from 47.9% to 46.5%.

Permian Resources’ acquisition of Delaware Basin acreage from Occidental Petroleum (OXY) didn’t prevent its oil weighting from falling.

Turning to the Bakken—historically the most oil-weighted of the U.S. basins—large producers in the basin also saw their oil weighting fall. Hess Corp.’s (HES) oil weighting fell from 45.9% to 44.8% year-over-year during the quarter. Its natural gas weighting increased, and its NGL weighting remained flat, as shown below.

The same is true for Chord Energy (CHRD), which experienced a steeper falloff in its oil weighting than Hess. Chord’s 2024 acquisition of Enerplus failed to bolster its oil weighting—another example where increasing size came at the expense of oil weighting.

Civitas Resources (CIVI), which has 356,800 net acres in the DJ Basin and 120,400 acres in the Permian, also saw its oil weighting decline. However, Civitas managed to buck the trend toward gassier production. It was the only large independent E&P to see its natural gas production remain flat instead of increasing. Its NGL weighting did increase, however.

Civitas’ results in the fourth quarter of 2023 include only a partial contribution from its Permian assets, which it acquired in an acquisition that closed in November of that year. Nevertheless, its oil weighting declined year-over-year in the fourth quarter despite the additional volumes.

Interestingly, Civitas’ DJ Basin production became more oily year-over-year during the fourth quarter. Its oil weighting increased from 46.2% to 47.7%. However, the company’s newly-added Permian production more than offset these gains to make its total oil weighting decrease. Civitas’ Permian oil production declined from 48.9% oil to 45.5% over the same timeframe. Its DJ Basin natural gas volumes held steady, while its NGL volumes in the basin decreased. Increasingly gassy Permian production could make Civitas’ $2.1 billion acquisition of Permian-based Vencer Energy from Vitol look foolish in hindsight.

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Consequences to Oil Macro and E&Ps

The consequences of the gasification of U.S. shale production are significant for the global oil market.

One important macro consequence is that U.S. crude oil production will be increasingly challenged to remain flat. Since 2010, U.S. shale production has accounted for nearly all production growth outside of OPEC+. An increasing gas cut in total U.S. production will put well productivity at risk of declining. Lower well productivity in the U.S. will ultimately cause the marginal cost of global supply to increase. Moreover, the marginal production required to satisfy growing global demand will have to come from somewhere else, but no other region is capable of producing the volumes necessary to meet the demand growth we expect over the next several years.

On an individual company level, the higher gas-to-oil ratio and lower well productivity will negatively impact E&P capital efficiency, free cash flow generation, and returns on capital. It also increases the risk that company reserves will be subject to write-downs if crude oil remains significantly more valuable on a barrel-of-oil equivalent basis than natural gas.

The impact on individual companies could be positive or negative depending on the course of commodity prices. If the ultra-bull natural gas scenario plays out and natural gas egress remains sufficient, the growing natural gas weighting would likely be a net benefit for E&Ps and their shareholders. Sustained higher natural gas prices in this scenario would be a boon to gassier E&Ps, in particular.

The gasification of U.S. shale and the risks it implies for E&Ps strengthens the case for investors who seek crude oil exposure to avoid U.S. E&Ps and favor Canadian producers. Many Canadian E&Ps have greater inventory depth and a lower gas-to-oil ratio than independent U.S. E&Ps. Investors looking to hold for several years are therefore less likely to encounter declining well productivity and more likely to benefit from oil-weighted production growth over their holding period.

An additional benefit is that Canadian E&Ps currently trade at lower multiples than U.S. E&Ps. The respective multiples can flip to penalize U.S. E&Ps and benefit Canadian E&Ps if investors grow more wary about declining oil weighting. Furthermore, Canadian E&Ps are on sale due to near-term concerns over the potential impact of U.S. tariffs on their cash flows. We don’t expect the U.S. to make the irrational move of subjecting Canadian oil and gas to tariffs. If it does, we would expect the move to be short-lived as it pushes U.S. gasoline prices higher. We reiterate our view that investors with a time horizon of more than one year should consider buying Canadian E&Ps now.

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Conclusion

The data continue to show the maturation of U.S. shale oil production. An increasing gas-to-oil ratio will only hasten the resource’s maturity, strengthening the macro case for investing in oil-weighted E&P stocks. At the same time, investors must be attentive to the risks of holding U.S. E&Ps for the long term. Given the greater upside we see over the long term, buying Canadian E&Ps and holding them for two to five years strikes us as a no-brainer.

Analyst's Disclosure: Jon Costello has no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours.

MPLX (MPLX) units continue to fit the mold of a ballast portfolio position. When we first invested in them back in April 2021 ($27.27), we viewed them mostly as a yield generator with the kicker of a low growth rate. At the time, the $30 billion market cap company was guiding to $800 million of annual capex. Its return on equity in the low teens implied low-single-digit Adjusted EBITDA growth over the longer term.

Over the past few years, however, we've been pleasantly surprised. MPLX has actually invested closer to $2 billion per year of capex instead of its guidance of closer to $1 billion. The result has been greater than expected Adjusted EBITDA growth, which, in turn, has driven greater than expected distribution growth. In November, MPLX increased its quarterly distribution by 12.5%, its third distribution increase of at least 10% in as many years.

While the company's organic growth capex has indeed tracked around $1 billion, it spent additional capex sums on executing bolt-on acquisitions and increasing its ownership interests in pipelines. The additional capex spending has generated attractive returns on capital while also fortifying the company’s midstream franchise, which now touches 10% of U.S. natural gas production.

We credit MPLX’s former CEO, Mike Hennigan—now the company’s Executive Chairman—for the company’s outstanding performance in recent years. His execution, characterized by regularly under-promising and over-delivering, has caused the units to approach their highest price since the MLP bubble back in 2015. We expect MPLX’s performance to continue under its new CEO, Maryann Mannen.

We remain steadfast holders of MPLX units. Over at least the next three years, we expect mid-to-high single-digit cash flow and distribution growth. The units will remain a ballast in our HFIR Energy Income Portfolio.

Fourth-Quarter Results

MPLX reported Q4 2024 financial results this morning. Adjusted EBITDA came in at $1.76 billion versus consensus expectations of $1.69 billion, for a 4% beat. Year-over-year Adjusted EBITDA grew by 8.6%, in line with the company’s growth rate in recent years. The cash flow growth facilitated a 12.5% year-over-year increase in the common distribution, maintaining a healthy 1.5-times coverage of the distribution by Adjusted EBITDA, a proxy for operating cash flow.

MPLX’s financial results were excellent. The following table shows the company’s impressive fourth-quarter performance and long-term growth.

Operating results during the quarter were similarly impressive, particularly in the company's natural gas and NGLs operations. However, a recent change in its segment reporting prevents a long-term comparison.

For context on how well these midstream assets can perform relative to refining assets, MPLX’s parent, Marathon Petroleum Corp. (MPC), reported $94 million of Adjusted EBITDA during the fourth quarter, a full 95% below that of MPLX. The MPLX distributions that MPC received during the quarter prevented MPC from reporting a large EBITDA loss.

Just as important as MPLX's beat was its plan for 2025. The company will continue to grow its Adjusted EBITDA as new projects come online. Higher cash flow guidance allowed management to increase its annual capex guidance from the $1 billion seen in recent years to around $2 billion, as shown below.

Source: MPLX Q4 2024 Earnings Conference Call Presentation, Feb 4, 2025.

The company’s natural gas and NGL asset footprint buildout is expected to consume 85% of its growth capex in 2025. It will occur in the Marcellus, Utica, and Permian shale basins and the Gulf Coast. These investments in growth will drive companywide Adjusted EBITDA higher over time.

MPLX announced major growth joint venture projects with Oneok (OKE). One of these is a 50%/50% joint venture in a 400,000 bbl/d LNG export terminal, and the other is an NGL pipeline that will service the export terminal. The pipeline is being built, operated, and is 80% owned by OKE and 20% owned by MPLX.

MPLX added several other new growth projects during the fourth quarter. These include its Matterhorn natural gas pipeline expansion, which will increase the pipeline’s capacity from 2.0 Bcf/d to 2.5 Bcf/d. This pipeline alleviated a severe Permian natural gas bottleneck. MPLX is also expanding into fractionation. These projects will enter service in 2025 and 2026, respectively.

Historically, the company has used third parties to fractionate its transported volumes. However, its natural gas infrastructure buildout over recent years has enabled sufficient integration for the company to source its own feedstock and then carry out the other services along the natural gas value chain, with fractionation being the latest addition. MPLX’s integration for natural gas and NGLs is shown in the graphic below.

Source: MPLX Q4 2024 Earnings Conference Call Presentation, Feb 4, 2025.

Other projects currently underway include MPLX’s expansion of its BANGL NGL pipeline from 125,000 bbl/d to 250,000 bbl/d and its expansion of the Utica shale gathering system.

These projects will keep growth momentum on track. We expect mid-single-digit percentage cash flow growth to drive a higher unit price. Due to inflation escalators in its contracts with MPC, cash flow will remain protected from inflation. We expect the yield on MPLX units to remain around today’s 7.4%.

Risks

Immediate risks include an acquisition by MPLX’s parent MPC, though MPC has stated that it prefers operating as two standalone entities. MPLX’s recent unit price run-up makes an acquisition by MPC less likely than it would have been before 2024 when the units traded at a steeper discount to value.

Another risk that MPLX faces is more long-term in nature. It relates to the midstream industry’s historical propensity to overbuild. More disciplined players like MPLX and Enterprise Products Partners (EPD) tend to sanction growth projects only when they’re justified by customer interest and financial returns; witness EPD’s announcement that it would not go forward with its Sea Port Oil Terminal. Unfortunately, the midstream industry has always included a bunch of aggressive growers who spoil the party for even the most disciplined industry participants. Today’s most aggressive grower would be Energy Transfer (ET). We’d lump Kinder Morgan (KMI) into the group, as well.

Midstream equities have had a spectacular run since 2020, but the risk is growing that the industry’s capital cycle is about to turn downward. Overexpansion can lead to lower returns on capital, which in turn lowers equity valuations in the sector. We’ll closely monitor developments in the industry and how they relate to its capital cycle.

Conclusion

We’re hard-pressed to find an income vehicle as attractive as MPLX units. Even though the units no longer trade at a steep discount—as they did when their yield exceeded 9%—we expect long-term Adjusted EBITDA growth to drive them higher. Investors can feel comfortable allocating funds to the units at their multi-year highs. With other sectors overvalued in today’s frothy markets, investors can still do well with a long-term holding in MPLX.

Analyst's Disclosure: Jon Costello has a beneficial long position in the shares of MPLX, EPD, ET either through stock ownership, options, or other derivatives.

Editor’s Note: To celebrate the resignation of Justin Trudeau, we have created a T-shirt that says, “Make Canadian Energy Great Again.” It’s been 9 years too long and finally, we can say good bye to that dreadful leader.

Let’s make Canadian Energy Great Again!

T-shirt Link

By: Jon Costello

Justin Trudeau’s resignation as Canadian Prime Minister earlier today marks a new era for the Canadian energy sector. This is the most bullish event for Canadian oil and gas stocks in more than a decade.

We’ve long favored Canadian E&Ps over their U.S. peers. However, we’ve found that many investors refuse to invest in Canadian oil and gas due to the adversarial relationship that has existed between the government and industry. We’ve lost count of how many times we heard a prospective investor question why they would invest in a country with a government that was trying to kill its own energy industry.

The change in leadership will usher in an improved Canadian oil and gas industry over the coming years. The changes range from the immediate to the longer-term. Virtually all are positive for investors in Canadian energy stocks.

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Big Changes Lie Ahead

Major change in the makeup of the Canadian government will not be likely until federal elections are held on or before October 20, when Conservative party leader Pierre Poilievre is expected to win. Nevertheless, the outlook for the Canadian energy sector and investor attitudes toward it will change immediately.

In the near term, Trudeau’s resignation makes it less likely that President Trump will impose tariffs on Canadian energy products. With left-leaning politicians like Trudeau rapidly losing support, the new prime minister will be keen on maintaining whatever popularity they can muster. They’re more likely to grant Trump his wishes regarding the border and drug trafficking than enter into a trade war with the U.S. that damages Canada’s already weak economy.

Longer-term, the changes will be more profound.

Since Trudeau was first elected prime minister in November 2015, his administration has sought to rein in Canadian oil and gas activity under the banner of reducing emissions as set forth in the United Nations Paris Agreement, which Trudeau signed in December 2015.

During Trudeau's entire tenure as prime minister, his administration increased regulations on oil and gas production, extracted tens of billions in taxes, and broadened federal regulatory power—all in the name of emissions reduction.

As these initiatives are rolled back over the coming years, the oil and gas operating environment will improve dramatically. Long-term projects will be planned and funded. Oil and gas E&Ps will see their operating, capital, and G&A costs decline and their return on capital increase. A multitude of risks faced by all E&Ps—from operational to legal to political—will recede.

In the end, these changes will create a more supportive environment for oil and gas investment. International capital will flow back to the sector, and equity valuations will increase.

Stifling Regulations

Since 2015, Canadian oil and gas investors have faced a continuous barrage of regulations and taxes imposed by Ottawa. Among those that have kept investors away from the energy sector are the following.

The Canadian government imposed a national carbon tax to reduce oil and gas sector emissions by 40% by 2030 from 2005 levels, consistent with the Paris Agreement. The tax was passed in 2018 through the Greenhouse Gas Pollution Pricing Act. The Act established a tax of $20 per ton of carbon emitted by the oil and gas industry. The tax increased by $10 per year until it reached $50 per ton in 2022. The legislation initially capped the tax at the 2022 level. However, in 2022, the government increased the annual per-ton increase by $15. It is scheduled to reach $170 per ton in 2030.

Canada is the only major oil producer that requires its industry to pay a carbon tax. This disadvantages the Canadian industry compared to competitors in countries that lack carbon taxes. Investors are understandably concerned that the tax will continue to increase if Canada fails to achieve its emissions targets, as many believe it will.

In July 2023, Clean Fuel Regulations came into effect that set stringent requirements for fuel producers and importers to reduce the carbon intensity of the fuels they produce and use to specified thresholds. Fuel suppliers that fail to meet the threshold are required to buy compliance credits.

The Canadian Impact Assessment Act granted broad powers to the federal government over assessing regulatory compliance.

Lest any oil and gas industry participant be so bold as to oppose these or other punitive measures publicly, the Competition Act threatened companies with fines of up to $15 million for making unsubstantiated climate claims. It went so far as to permit private litigants to sue purported perpetrators. The Act put the burden on oil and gas companies to prove that their representations were based on “adequate and proper substantiation,” which, of course, is subjective. It effectively muzzled industry critics of the government’s green agenda.

More regulations were set to arrive. In December 2023, Canada proposed a federal cap-and-trade system for the oil and gas sector to bring its emissions to “net zero” by 2050 as stipulated by the Paris Agreement. This cap would curtail significant volumes of Canadian oil and gas production. The uncertainty created by the cap’s mandates beyond 2030 remained a source of policy instability that deterred firms from sanctioning multi-billion-dollar oil and gas investments.

Other industry-stifling measures included the government not allowing transition periods for industry participants to implement onerous regulations, making upfront compliance essentially impossible.

The Trudeau government would fund green charities, like the Canadian Institute for Climate Choice and others, and then use the data they produce to justify more stringent regulations on the oil and gas industry. The government would also fund domestic media to incentivize hyper-critical coverage of industry while squelching the voices of government critics.

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The Outlook Brightens

New leadership will improve the Canadian energy landscape in many ways. Polls and betting markets show Pierre Poilievre as a shoo-in for the October national election. In a recent interview with Jordan Peterson, Poilievre outlined his energy priorities. As prime minister, he intends to eliminate carbon taxes, build more refineries, clear the hurdles to additional LNG export facilities, and add hydroelectric power.

Under Poilievre, Alberta—which has its own pro-energy government and vast natural gas reserves—will become a haven for data centers. Many will go off-grid, adding to regional Canadian natural gas demand and improving the prospects for the more westerly natural gas-producing regions in the WCSB.

Importantly for Canadian oil and gas investors, E&P financial returns will improve. Canadian energy producers already possess equity return profiles on par with U.S. shale producers, but Canadian E&P returns have been on the upswing relative to their U.S. peers. The narrowing WTI-WCS differential attributable to the Trans Mountain Expansion has boosted oil producers’ top line while costs have increased less. We expect the supportive operating environment that will emerge over the next few years to foster lower operating and capital costs. These will increase the return on capital earned by E&Ps even further.

Over the next few years, we expect the returns on capital generated by Canadian E&Ps to increase while the returns generated by independent U.S. E&Ps will decrease. Higher returns on capital translate to higher equity multiples, and we expect Canadian E&Ps to garner multiples in line with today’s U.S. E&Ps, as shown in the chart below.

Source: National Bank Financial, Dec. 20, 2024. Highlighted sections circled in red added by author.

Furthermore, Canadian E&Ps will increasingly be seen as having superior prospects versus their U.S. peers. U.S. E&Ps are seeing their production grow gassier at a rapid clip. At the same time, they’re facing the exhaustion of their most economic drilling locations. Canadian oil producers, by contrast, can hold their crude oil production steady and grow while retaining a multi-decade inventory of premium drilling locations. This will increase captial flows to Canadian names.

A multiple re-rate would result in a 25% bump in Canadian E&P stock prices, first, as investors begin to appreciate the consequences of the new regulatory regime and second, as they see evidence that sustainably higher returns are being achieved. Canada will become the obvious destination for U.S. and global equity capital seeking long-term exposure to oil prices.

While this may not sound particularly appetizing for today's investors, with most preoccupied with the latest tech craze, we expect the situation to grow more meaningful in the years ahead. Higher oil prices will be necessary as global oil demand continues to rise while non-OPEC+ conventional and unconventional sources become increasingly challenged to satisfy demand. Canadian E&Ps will fare particularly well in such an environment.

Conclusion

Investors should position for these changes now, before they’re more widely appreciated by the investing public. Investors in U.S. E&Ps should transition over to Canadian names.

We look forward to circling back in a year to see how the oil and gas operating environment has changed and how E&Ps have performed. If we’re right, high-quality Canadian E&Ps will have handily outperformed their U.S. peers from today’s levels. Given the changes on the horizon, investors should buy now and hold tight.

Analyst's Disclosure: Jon Costello has a beneficial long position in the shares of The HFIR Energy Income Portfolio either through stock ownership, options, or other derivatives.

By: Jon Costello

The chaotic trading in the energy sector has been a sight to behold. The investing public has left the sector for dead, and even the most attractive names are now selling at extremely attractive levels.

But babies are being thrown out with the bathwater in all parts of the sector. For investors brave enough to take the plunge and buy, a few names stand out at current prices.

Exxon Mobil (XOM)

XOM has sold off in response to its guidance last week for higher-than-expected capex over the next few years. The selloff has caused XOM to enter an attractive buy zone. At current prices, XOM is our favorite stock among the global oil and gas majors.

Investors were miffed after the company announced plans to spend between $28 and $33 billion annually on capex through 2030, above consensus expectations of $26 billion. Next year’s capex also came in high, at $27 billion versus expectations of $26 billion. The $25 billion in base capex was in line with expectations. Market concerns centered on the growth component, a large portion of which will fund production growth in the Permian.

The company has big plans to boost oil recoveries in the Permian. Most revolve around new technologies in a wide variety of areas. We don’t have enough engineering expertise to opine on the prospects for XOM’s new technology to increase oil recoveries. That said, some of its recently-developed technology looks promising, like its new coke-based proppant.

But if history is any guide, XOM will set high growth targets and then fail to meet them by a mile. The chart below, made by Paul Sankey back in 2020, illustrates the historical pattern.

Source: Paul Sankey, X, Dec. 1, 2020.

To be sure, history could repeat, and XOM could disappoint. But we’re not so pessimistic this time around. Management has navigated this aircraft carrier of a company superbly, focusing its upstream oil operations on highly prospective projects in Guyana and the Permian. We don’t believe their guidance is mere bluster. More than a little production growth is likely; the only question is how much Permian production consists of crude versus lower-value NGLs and natural gas.

If the company succeeds at increasing its Permian recoveries, it will wring significant additional crude oil volumes out of future production. With more than 15 years of high-quality drilling inventory, shareholders will benefit from sustained higher cash flow.

Permian growth won’t begin until 2026. For 2025, XOM is guiding for 1.5 million boe/d of Permian production, down from this year’s 1.6 million boe/d.

Beginning in late 2025 and picking up stream in 2026, XOM’s higher capex will drive production increases in the Permian, Guyana, and its LNG operation. Altogether, its upstream assets are expected to drive 1.2 million boe/d of incremental production by 2030, nearly 30% above today’s 4.2 million boe/d. The company is also guiding to more than $9 billion in upstream earnings potential at $65 per barrel Brent, equivalent to more than $2.00 per share at the current share count. At today's 13x P/E, that's an additional $26 on the share price, which today stands at $106. Of course, the numbers grow much larger if oil prices are sustained at higher levels, as we expect.

In most cases, investors are right to pan higher capex guidance. After years of poor investment returns, most prefer that energy companies keep capex flat and return excess capital to shareholders. We believe that view is misguided in XOM's case. By the 2027-2030 timeframe, we expect the world to need additional oil. We’re pleased that some will be sourced in the U.S. As global supply grows increasingly constrained over this period while XOM’s production ramps higher, we expect the company to benefit from both increasing production and higher oil prices. By then, natural gas prices may also be sustained at higher levels, delivering an additional boost to XOM’s bottom line. The company has been outstanding at capital allocation—the best among its major peers—so shareholders can be confident that higher earnings will be distributed as dividends and share repurchases.

XOM shares aren’t the cheapest in the energy space. But the company’s operational scale and diversification make its shares extremely safe. Moreover, XOM’s future is clear compared to its peers, making its stock attractive on a relative basis. The shares’ safe 3.6% yield is appetizing, with embedded inflation protection from its commodity exposure.

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Veren (VRN)

I’ve been harping on this name since early November. The shares can’t get a break, trading down day after day after day. Check out the chart of this falling knife since May:

Count me among the bloodied knife catchers. I bought shares for our HFI Research Energy Income portfolio at $5.08 and again at $4.66.

Despite the horrible price action, I’m optimistic about this name. Here is a recap of some of the salient facts.

• Management screwed up by completing a large batch of 12 wells with plug ’n perf instead of single-point entry. Bad on them.

• Nearby wells, even offsetting wells, show results on par with previously drilled wells, indicating the problem is not one of geology but completion technique and risk management.

• A chastened management team—which this one clearly is—is far less likely to repeat the same screw-up. The pressure is on to improve well results, and we believe management can execute.

• VRN is one of the largest acreage holders in the Montney. Its acreage is more liquids-rich than its Montney peers. Despite the recent poor well results, VRN has drilled some of the best wells in the play.

• Duvernay production will drive most of VRN’s growth.

• VRN’s five-year plan has been delayed, but still holds the prospect for growth to levels of more than 245,000 boe/d over the next five years from the 191,000 boe/d guided for 2025.

• The shares are trading at an EV/DACF of less than three times at $70 per barrel WTI. At $80 per barrel, they’re closer to 2.5 times, reflecting the shares’ bargain pricing.

• Continued debt reduction will increase value for shareholders. Share buybacks made at current price levels will be highly accretive.

• Assuming well results improve, VRN’s attractive return on capital amid anything but unsustainably low oil prices will drive investor sentiment toward the name higher.

• The stock price will rebound with investor sentiment.

Abysmal sentiment has caused investors to overlook these realities. As a result, VRN shares have closely tracked Baytex Energy (BTE), but VRN is very different than BTE. So much so, in fact, that a comparison is silly.

The high correlation between the two underscores investors' misunderstanding of VRN and its long-term prospects.

The heavy trading volume in VRN's shares suggests significant tax loss selling. This selling pressure will abate at year-end. Over time, I expect investors to become more interested in the name and to bid its shares back to levels above $6 per share.

VRN shares offer the combination of a safe and attractive dividend yield of 7% and more than 100% appreciation potential over the next three years. Appreciation potential increases thereafter as the company’s scheduled 2027 production ramp bears fruit in the form of increased cash flow, dividends, and share repurchases.

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Pembina Pipeline (PBA)

For the income crowd, Pembina has sold off to attractive levels. This company offers a simple story. Its expertise in building and operating gathering and processing infrastructure for oil and gas exposes it to Canadian oil and natural production growth without commodity price risk.

The shares now yield 5.4%, which is attractive in light of the company’s long-term dividend growth and capital appreciation prospects.

Longtime readers know we seek protection through growth in our income equity investments. PBA offers a case in point.

Whereas many of PBA’s U.S. peers face growth constraints due to a significant infrastructure buildout over recent years and soon-to-plateau U.S. oil production, Canada will continue to grow, and PBA will continue to expand in the Western Canadian Sedimentary Basin.

Its continued growth will drive its cash flow and dividend payout higher. Its excellent capital allocation is likely to ensure that investments are well made and excess cash flow is returned to shareholders.

PBA offers investors the kind of package that has driven midstream stocks relentlessly higher since 2020: volume growth that translates into cash flow growth, lower debt, and higher capital distributions to shareholders. PBA shares still have a long runway to benefit.

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Conclusion

For investors with strong stomachs, this is an outstanding time to add to well-positioned energy stocks like XOM, VRN, and PBA. I have no special insight into how their stocks will perform over the coming months, but I’m highly confident that investors will be pleased with their returns over the next two years and beyond. This is the time to get long.

Analyst's Disclosure: Jon Costello has a beneficial long position in the shares of VRN either through stock ownership, options, or other derivatives.

Note: Dollar values are in Canadian dollars unless otherwise specified.

Surprise, surprise—it’s another frustrating day for energy investors! Today, it's not that oil prices are falling for no apparent reason. Rather, it's that oil prices are trading higher and E&P stocks are trading lower. No wonder why so many have abandoned the sector.

The culprit for today's price action is Trump’s recent comments in his Time Magazine "Person of the Year" interview, in which he repeated his intention to lower energy prices, as shown in the excerpt below.

Source: Time, Dec. 12, 2024.

The "Trump Trade" has been spectacularly successful over the past few weeks, so why shouldn't investors jump on the bandwagon and sell E&Ps?

However, the selling is widening the chasm between E&P stock prices and the fundamental outlook. Put aside the fact that oil prices have risen to levels where E&Ps generate free cash flow. Recent news at the company level has been surprisingly bullish. For instance, the oil majors, including Chevron (CVX) and Exxon Mobil (XOM), have announced 2025 guidance that includes slight production growth and capital restraint—exactly what their shareholders want to see. Given the outlook for large E&Ps and our constructive outlook for macro fundamentals, we expect E&P stocks to outperform once sentiment inflects positively.

Two of our favorite large-cap E&Ps, Cenovus Energy (CVE) and Suncor Energy (SU), also announced 2025 production and capex guidance that shows both companies building on their strengths. Their fundamental performance is set to improve throughout the year, growing free cash flow generation capacity and building value for shareholders. Their strong outlook bodes well for their stocks once sentiment improves.

Cenovus Focuses on Upstream

CVE’s 2025 capital budget and production guidance were in line with our expectations, with no surprises. The company will focus primarily on boosting upstream production. Of the $1.6 billion budgeted for total growth capex, approximately $1 billion will be directed toward completing the offshore West White Rose project. The project is expected to begin production in the first quarter and ramp higher over subsequent quarters. At full capacity, West White Rose’s contribution to CVE’s production will increase until it reaches 45,000 boe/d.

The remaining $600 million of CVE's 2025 growth capex will be directed toward its oil sands operations. Its Foster Creek optimization project should be completed during the year. Its Narrows Lake tie-back is nearly complete and will commence production around mid-year.

Importantly, 2025 is expected to be the final year in CVE’s three-year investment cycle. The investments made during the 2023-2025 timeframe will drive production 150,000 boe/d higher. Free cash flow will increase significantly as production increases while capex declines.

CVE’s growth projects are expected to increase 2025 production to 825,000 boe/d, up 4% from 2024 levels. The growth will bring a sustained boost in the company’s cash flow generation potential.

CVE plans to spend $3.2 billion on maintenance capex. It is guiding for downstream throughput in the range of 650,000 to 685,000 bbl/d at 92.5% utilization, which is in line with consensus estimates. U.S. downstream volumes are expected to be up 2% year-over-year. Turnarounds are expected to reduce throughput by 15,000 bbl/d, around half the volumetric impact they had in 2024. As a result, downstream volumes in 2025 should increase by a few percentage points over 2024.

It’s unclear what portion of capex will be aimed at improving refinery reliability, but we expect the significant sums spent over the past few years to bear fruit in 2025. In light of CVE’s horrible share price performance—a great deal of which is related to its downstream underperformance—next year is shaping up to be make-or-break for management. In my view, either management improves CVE’s downstream operation to its long-term potential or the company divests its refineries. The latter scenario could also involve a change in management.

CVE intends to reduce downstream operating expenses by 7% versus 2024. When coupled with higher production, the improved cost base will increase cash flow and cash flow torque to higher oil prices.

For our part, we want to see downstream demonstrate that it can effectively capture refining margins on a consistent basis. Doing so will take the downstream segment from being a drag on EBITDA to a contributor.

CVE stock price fails to discount any of these improvements. We expect CVE to generate approximately $10.5 billion in cash flow with WTI in the mid-US$70s per barrel. Assuming management meets its capex guidance, the company should generate approximately $5.7 billion in free cash flow, all of which will be returned to shareholders. This is equivalent to a 14% free cash flow yield on CVE’s current market cap of $40.0 billion. Of course, the free cash flow yield increases significantly as WTI rises.

We put CVE shares in bargain territory and believe the shares are among the most attractively priced among North American large-cap E&Ps.

Suncor Continues to Bring Down Costs

Like CVE, Suncor Energy’s 2024 budget contained no surprises. It shows the company building on its spectacular performance under CEO Rich Kruger.

Suncor plans to spend $6.2 billion in total capex, 3% less than 2024. The company is guiding to 825,000 bbl/d of production, which is actually 6% below consensus expectations of 830,000 bbl/d. I suspect management is setting a low bar to maintain its ongoing stretch of five consecutive quarters of outperformance.

Suncor is also guiding to 95% refinery utilization in 2025. It expects downstream throughput to increase to 442,500, 1% above 2024.

The highlight of Suncor’s budget was its guidance for a continued decline in operating expenses, which are expected to decline by 7% from 2024. Management remains steadfast in its commitment to reduce Suncor’s operating expenses by $10 per barrel from 2023 levels. Due to its progress, lower operating expenses will be the most significant driver of free cash flow growth next year.

We expect Suncor to generate approximately $7.0 billion of free cash flow with WTI in the mid-US$70s per barrel, equivalent to a 10.4% yield on its $67.3 billion market cap. Like CVE, Suncor has already hit its net debt target, so 100% of free cash flow will be returned to shareholders.

Suncor shares trade at a discount to value—particularly if oil prices rise to reflect the fundamental outlook, as we expect—but CVE trades at a significantly greater discount. To be sure, CVE has its downstream operating headwinds, but as these get resolved one way or another, we expect its shares to outperform its large-cap E&P peers from current levels.

Conclusion

You’d never know it from E&P stock price performance, but the fundamental outlook is bright. Both CVE's and Suncor's business results stand to improve, which bodes well for free cash flow growth, dividends, and share repurchases in 2025 and beyond. Investors willing to capitalize on today's dour sentiment should consider buying shares of both before their improving results push their share prices higher.

Analyst's Disclosure: Jon Costello has a beneficial long position in the shares of CVE, SU either through stock ownership, options, or other derivatives.

By: Jon Costello

Energy investors can’t catch a break. After spending months navigating geopolitical volatility and dour investor sentiment toward next year’s oil supply/demand balances, they’ve been handed a few new bearish macro variables to deal with. These include:

• Fears that Trump’s “Drill Baby, Drill” mantra will lead to a torrent of U.S. oil supply.

• Scott Bessent’s nomination as Treasury Secretary and his promise to boost U.S. energy production by three million boe/d.

• Trump’s threat to impose 25% tariffs on all Canadian imports, including energy.

• A ceasefire between Israel and Lebanon, which eliminated any remaining geopolitical premium.

Together, these variables have caused oil and E&P investors to sell now and ask questions later. But important counterpoints for each variable have gone largely unnoticed, such as:

• The inability of U.S. producers to increase production anywhere close to the volumes hoped for by politicians.

• Bessent cited barrels of oil equivalent in his U.S. production growth figures instead of barrels of oil. Growth comprised only of natural gas and NGLs would be consistent with his claim.

• Tariffs on Canadian energy imports are highly improbable. They would increase the cost of feedstock for 20% of U.S. refined product production, thereby increasing domestic energy prices and lowering economic growth. This would represent a 180-degree reversal from Trump’s campaign pledges to grow the economy while reducing domestic food and energy prices. The tariffs would also put added pressure on the energy industry, a significant supporter of Trump’s presidential campaign.

• OPEC is likely to extend its production cuts scheduled to begin in January. If agreed during its meeting this weekend, it would tighten the 2025 oil supply and demand balance.

• Israel may be turning its focus away from Lebanon so I can focus directly on Iran.

• The physical oil market shows no signs of impending distress. It isn’t anticipating the massive inventory builds implied in consensus paper supply/demand balances.

While investors always have to be attentive to risks stemming from domestic politics, geopolitics, and the oil market's fundamental outlook—and some of these variables are sources of meaningful risk even today—the current concerns are dramatically overstated. The collapse in energy market sentiment they have created has provided a rare opportunity to buy beaten-down energy stocks.

Cenovus is An Obvious Choice

Cenovus Energy (CVE) shares have been tossed in the bargain bin courtesy of all the factors listed above, and then some. Depressed macro sentiment, depressed E&P sector sentiment, and company-specific headwinds are all hitting the shares at once. I believe all these are temporary factors that make for a fantastic long-term buying opportunity.

For starters, CVE is a low-risk operation. Its upstream segment has outperformed expectations and is poised to grow over the next few years. The company has reduced net debt to minimal levels, nearly eliminating financial risks to shareholders during periods of low commodity prices. CVE investors can rest assured the company’s equity value will be safe under any realistic economic or oil market scenario. At the same time, they will benefit from the massive free cash flow generated at higher oil prices.

To top it off, I expect CVE shares to undergo a multiple rerating—along with the other large Canadian E&Ps—as investor focus turns to the implications of plateauing U.S. shale production over the coming years. Canadian E&Ps will be the logical alternative to U.S. E&Ps for both institutional and individual investors who seek long-term exposure to oil prices. The increased capital flows that result are likely to boost valuation multiples of well-positioned Canadian E&Ps like CVE and its peers.

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CVE's Company-Specific Issues are Temporary

CVE shares have been penalized in recent months because management has yet to work out the kinks in the company's downstream operations, particularly those pertaining to its U.S. refineries.

The shares now trade at severely discounted levels. I estimate their 2025 strip free cash flow yield is 12.3%, far above Canadian Natural Resources’ (CNQ) 8.1% yield and Suncor Energy’s (SU) 9.2% yield.

If CVE shares were valued in line with Suncor, they’d trade 34% above today’s level. This is the kind of price appreciation I expect if management can resolve the outstanding downstream issues.

Despite the persistence of CVE's downstream headwinds, I haven’t lost faith in management's strategy and ability to integrate the company's upstream and downstream. This year alone, CVE has spent hundreds of millions of dollars to improve its U.S. refinery operations, and I expect the turnaround to bear fruit over the next few quarters.

Longer term, the benefits of CVE's integrated operating strategy will become apparent once Canadian production exceeds available pipeline takeaway capacity, which appears likely to occur in the 2026-2027 timeframe.

The fact of the matter is that Canadian oil producers are poised to grow over the next few years. Witness MEG Energy’s (MEG:CA) approval of a plan to grow its production by 25% by 2027. MEG’s growth plan comes on top of those of CVE, Canadian Natural Resources (CNQ), Strathcona Resources (SCR:CA), Veren (VRN), Obsidian Energy (OBE:CA), International Petroleum (IPCO:CA), and many other smaller E&Ps. Once this new production exceeds regional takeaway capacity, the differential between WTI and the Canadian oil benchmark, WCS, is likely to blow out until additional pipeline capacity can once again provide egress for all regional production. Unfortunately for Canadian E&Ps, new pipeline capacity won’t be available for many years.

CVE’s ownership of refineries allows it to evade the WCS discount applied to its upstream production. By sending its crude to its own refineries, it can capture the WTI-WCS differential as well as the refining margin between crude oil inputs and refined product output.

However, CVE doesn't have to send its crude to its refineries if market conditions favor third-party oil sales. Its marketing flexibility allows it to maximize free cash flow and return on capital.

When the WTI-WCS differential blows out, CVE’s operating model will be viewed far more favorably than it is today. The robust cash flow profile that results from its integrated model will boost its valuation multiple to higher levels. If the company can improve its return on capital, as I expect, its valuation multiple is likely to be on par with that of Suncor.

And what if CVE fails to turn around its refineries? Most likely, it will separate them from the rest of its business.

The company-specific issue holding back CVE's stock is therefore likely to be resolved in one of two ways: either the downstream performance improves, or the downstream segment gets separated from upstream operations. CVE investors win either way.

If CVE's refineries continue to underperform and end up getting sold at a loss, I expect its shares to respond with a rally, as the upstream segment will emerge unburdened by the downstream drain on its cash flow.

Alternatively, perhaps the refineries get spun off as a standalone entity that maintains a favorable business relationship with CVE. This outcome would also be positive for its shares.

Whether refineries improve or get separated, either would represent a positive catalyst for its shares. The fact of the matter is that CVE's management and board members have millions of dollars of options tied to the company's share price. Insiders have also purchased shares amounting to several million dollars in the open market over the past few years. The large shareholdings among insiders create an incentive to increase shareholder value and the share price. And if existing management isn’t up to the job at hand, I expect it to be replaced by a team that can resolve the ongoing issues.

Despite CVE's Challenges, My Thesis Remains on Track

CVE investors will have to persevere through times like these, when the stock languishes due to macro bearishness and company-specific issues. In a cyclical and volatile sector like energy, they're the price the investor pays for long-term outperformance. No investor can anticipate precisely how or when these negatives will surface. An investor can only be confident that they'll occur at least once or twice over a multi-year holding period.

We’ve held CVE shares in our Energy Income Portfolio since May 2023, when I bought them for the portfolio at $15.85. Since then, the shares have traded as high as $21.90 and now trade near their lows.

Despite the volatility, my CVE thesis hasn’t changed. The next leg of the thesis involves the successful resolution of the refining issues over the next few quarters. If the refineries continue to underperform, I expect that they'll be separated from upstream at some point over the next two years. In either scenario, the shares are likely to trade significantly higher than today’s depressed level.

CVE investors who hold for three to five years are likely to earn attractive total returns once the shares trade into the mid-$20s and higher over the coming years, as I expect.

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Shareholder-Friendly Capital Allocation

CVE is now distributing 100% of its free cash flow to shareholders. If—or, more properly, when—WTI increases above the $80 per barrel level, and assuming CVE improves its downstream operations, the company will become a free cash flow machine. Its free cash flow yield on today’s share price will comfortably exceed 20%, and all its free cash flow is likely to be distributed to shareholders. Over time, large dividends and share repurchases will increase the investment returns earned by CVE shareholders throughout the oil market cycle.

The company’s latest capital allocation move—announced last Monday—was the redemption of its Series 3 Preferred, which is likely the beginning of several preferred share redemptions. While the move will reduce cash flow available for common share repurchases, it will eliminate needless financing that was a holdover from CVE's 2020 Husky Energy acquisition.

CVE’s next capital allocation move will likely be an increase in its quarterly base common dividend, which I expect to occur in the first half of 2025.

Operationally, growth will build additional shareholder value. CVE’s 30,000 bbl/d Narrows Lake is expected to start up next year. Investors will then look forward to the 45,000 boe/d West White Rose project startup in 2026. These downstream growth initiatives mean that in the event the company has to shed its refineries, prospects for its shares will improve from steady production growth and the resulting growth in free cash flow per share.

Conclusion

John Templeton famously counseled investors to buy during the period of “maximum pessimism.” In that vein, the best time to buy E&Ps is when they’re most beaten down. As an investor who's been in the E&P game for many years, I can confirm that today's conditions qualify. Sentiment is in the dumps. The oil market's near-term outlook appears challenged. Temporary operational issues cast a pall over a company’s prospects. All these situations reverse in due course. As they do, E&P stock prices recover.

CVE offers a case in point. Investors should buy during today’s doldrums to benefit from a much brighter future over the coming years.

Analyst's Disclosure: Jon Costello has a beneficial long position in the shares of CVE, VRN, MEG:CA, SCR:CA either through stock ownership, options, or other derivatives.

Last week, we updated our E&P spreadsheet (the link is only available for paying subscribers) to reflect cash flow generation at $70 and $75 per barrel WTI. We found that E&Ps currently discount WTI in the mid-$70s per barrel. Prices above that level would cause E&P free cash flow to surge higher. Free cash flow would be returned to shareholders, and E&P stocks would trade well above current levels.

Recent news flow in the oil market suggests that higher oil prices are imminent, as data consistently points to a more constructive supply/demand balance than what is implied in consensus expectations.

We expect the positive news to continue. Investors should consider buying E&P stocks now before a shift in the fundamental outlook and investor sentiment sends their prices significantly higher.

The IEA’s Bearish Bias Strikes Again

For months, oil prices have been held down by the consensus narrative that 2025 oil market balances will be too loose for comfort. The narrative is captured in the IEA’s November 2024 Oil Market Report, published last Thursday, which forecasts an ugly 1.1 million barrel per day oversupply for 2025.

The oversupply is depicted in the following chart. This is what currently spooks the market.

Source: IEA

The IEA is the oil market’s de facto benchmark for the consensus outlook, particularly with regard to supply, so we understand investors’ reluctance to buy E&Ps in the face of such massive projected inventory builds.

Oil prices have moved lower in anticipation of these builds. In fact, prices have undershot levels implied by inventories to a degree rarely seen over recent years, as shown below.

Source: Lefert Clement, X, Nov. 15, 2024. Red-dotted square added by author.

The WTI price is discounting more than 100 million barrels of inventory builds, equivalent to an annual build of 274,000 bbl/d.

The mega-builds forecasted by the IEA are set to begin in January and remain in effect throughout all of next year. By year-end, they imply that 300 to 400 million barrels of excess oil supply will have to be worked down before fundamentals justify a WTI price above $80 per barrel.

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Reality Will Play Out Differently

Barring a deep global recession and/or OPEC’s abdication from market management, the IEA's forecasts strike us as ridiculous. By our estimates, the IEA’s oversupply is inflated by more than half.

Wilson discussed the problems with the IEA’s 2025 forecast in an update published last Thursday. He concluded that the agency included at least 300,000 bbl/d of excess OPEC+ supply growth and an additional 250,000 bbl/d of overstated U.S. production. Adjusting the forecasted oversupply for these factors brings the projected oversupply down by half to 550,000 bbl/d.

In the days since Wilson’s update, additional data have come to light that cast further doubt on the IEA’s 2025 supply forecast.

"Missing Barrels" Point to Larger-than-Expected Inventory Draws

In the IEA’s November report, its paper supply/demand balance for the third quarter of this year implied a global oil inventory build of approximately 400,000 bbl/d.

However, data on observed physical oil inventories indicate that draws occurred at a far greater rate. This trend is evident in satellite inventory data from Kpler, but it’s also apparent in the IEA’s own published figures.

The agency reported a 1.2 million bbl/d draw in observable inventories in the third quarter, three times its 400,000 bbl/d modeled draw. The difference between the inventory changes implied by the paper balances and the changes observed in physical global inventories are referred to as “missing barrels.”

The current missing barrel tally for the third quarter of 2024 is depicted in the chart below.

Source: Bloomberg, Nov. 19, 2024.

This underestimation of demand and/or overestimation of supply that blew out the missing barrel tally in the third quarter repeats a pattern of overly bearish balances published by IEA throughout all of 2024.

Consider that in January, the agency projected builds on the order of 1 million bbl/d in each of the final three quarters of 2024. Its January 2024 forecast is shown in the following chart.

Source: IEA, January 2024 Oil Market Report, Jan. 18, 2024. Red-dotted square added by author.

As we now know, the inventory builds that were expected to begin in April never materialized. This is a huge miss for the agency that has gone essentially unnoticed.

A similar miss for the fourth quarter that brings forth more missing barrels is likely. If the IEA’s numbers are off as much as we expect, incoming fundamental data will continue to track more bullishly than consensus expectations based on IEA paper balances.

A key implication of these inventory dynamics is that the larger-than-expected supply deficit now underway will carry over into the 2025 supply/demand balance. It will therefore reduce the magnitude of any anticipated oversupply for that year.

This deficit carryover could reduce the inventory builds expected by consensus by as much as 500,000 bbl/d, eliminating the majority of the IEA's forecasted builds for 2025. It could shift the outlook for E&P stocks from ultra-bearish to outright bullish, particularly from today’s depressed price levels.

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Brazil Disappoints, Again

Brazil is a major swing factor in the IEA's 2025 supply outlook, accounting for a quarter of next year's anticipated oversupply.

The IEA currently expects Brazil’s production to grow from approximately 3.25 million boe/d as of September 2024 to nearly 4 million boe/d by the end of 2025, representing more than 700,000 boe/d of expected growth over that timeframe.

However, yesterday news circulated that poured cold water on the IEA’s Brazil production forecast. Petrobras (PBR), Brazil’s national oil company, pushed back the extent and timing of its planned production increase over the next few years. PBR accounts for approximately 86% of Brazil's production and nearly all its production growth. Lower growth out of PBR translates into lower growth from Brazil.

PBR’s new five-year capital plan calls for production to increase from 2.8 billion boe/d today to 3.2 million boe/d by 2029. The 300,000 boe/d represents nearly all of Brazil’s growth over that timeframe.

The news illustrates the stark difference between the IEA's forecast and reality. Whereas the IEA is expecting Brazil’s oil production to increase by 700,000 boe/d of growth over the next fifteen months, PBR is calling for just 300,000 boe/d of growth over the next five years.

PBR’s growth will come from its new deepwater “pre-salt” offshore projects. All the while, its other production from “post-salt” offshore and shallow water/onshore reservoirs will decline at a rate of 10% per year. Such a high decline rate on a large production base increases the risk that production growth misses expectations if PBR fails to execute.

Poor execution would be in keeping with PBR’s long-term track record. With the exception of 2023, PBR has routinely failed to meet the market’s—and its own—annual production growth expectations due to higher-than-expected decline rates on legacy post-salt production, delayed startup of pre-salt projects, and overly optimistic internal growth forecasts that get cut and pasted each year into the IEA’s projections.

These issues caused the IEA to lower its 2024 growth forecast for Brazi several times this year. It had initially pegged Brazil's growth at 300,000 boe/d after the country's surprise outperformance in 2023. Every few months, however, it revised its estimates lower. It now expects Brazil to post flat production in 2024.

The IEA's overestimation of Brazil's growth can be seen in the following charts. The yellow-dotted line in the first chart below shows the IEA's 2024 Brazil production forecast made in its January 2024 Oil Market Report. Production was expected to average approximately 3.7 million boe/d for the year.

Source: IEA, January 2024 Oil Market Report, Jan. 18, 2024.

The solid red line in the next chart shows what has actually occurred through September of 2024. Brazil's production was stuck in the 3.3 million boe/d range. Production for the year was flat, while the 2024 exit rate stands nearly 500,000 boe/d below the IEA’s original forecast.

Source: IEA, November 2024 Oil Market Report, Nov. 14, 2024.

I expect PBR's recent extension of its growth timeline to cause the IEA to revise its 2025 Brazil production growth assumption downward. If it does, the agency's forecasted 2025 oversupply will be whittled down further, creating another bullish tailwind for oil prices and E&P stocks.

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Iranian Production: Up in the Air

Iran’s production outlook depends on the course of U.S. sanctions and their enforcement under the incoming Trump administration. At this point, Iran’s near-term production outlook is anyone’s guess. However, its production one year from now is more likely to be lower than higher. I’ve already seen reports of large Chinese refiners balking at buying Iranian barrels for delivery in 2025.

Some reputable oil market authorities, such as Energy Aspects, expect big Iranian supply losses. The following chart plots Iran’s actual supply growth under the Biden administration and Energy Aspects’ expectations for what is likely to occur in 2025 under Trump.

Source: Energy Aspects, Nov. 18 2024.

Supply losses of this magnitude, when coupled with the other supply disappointments mentioned above, would tip the oil market into a supply deficit absent compensating supply increases by OPEC+.

Meanwhile, Demand is Improving

Bears often cite the weak demand outlook to explain the persistent oil price weakness. Like supply, however, demand may also be shifting in favor of the bulls. Refining margins, for one, indicate that demand has picked up to a material degree over recent weeks.

Source: Barchart.com

Higher margins give refiners the green light to increase crude oil throughput, thereby drawing crude inventories lower and bolstering crude prices.

Time spreads also imply a healthy demand outlook. The 1.2 million bbl/d inventory build forecasted by the IEA in the first quarter of 2025 is nowhere to be found.

Source: Barchart.com

Higher-than-expected demand may be just what the oil market needs to send WTI back to levels implied by inventories in the $80-to-$85 per barrel range. Needless to say, such conditions would bring about huge gains in E&P stocks from today’s prices.

Conclusion

As more data trickles in, the prevailing bearish narrative for 2025 is becoming less believable. If the supply disappointments come to pass, they could put the oil market into a supply deficit in 2025, similar to what happened in 2024. Oil market management would then rest firmly in the hands of OPEC+. We would expect WTI to trade in the $75 to $90 per barrel range throughout the year, buoyed up and down based on demand factors. Today’s E&P stock prices would represent the bottom of the trading range.

Aggressive investors should consider buying shares in their favorite oil-weighted E&Ps now. Those that do stand to reap the biggest gains as the bullish outlook becomes reflected in higher prices for oil and E&P stocks.

Risk-averse investors may prefer to wait for a discernible sentiment change before loading up on E&P stocks. They should be on the lookout for such a change over the coming weeks so they can buy before it becomes obvious in the broader market. Alternatively, they can simply buy the most conservative names, such as Canadian Natural Resources (CNQ), and eliminate the need to get the timing right.

The oil market's fundamental outlook is clearly brighter than the consensus expects. My next article will discuss some of my favorite E&P stocks to buy as sentiment toward the sector improves over the coming months.

Analyst's Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours.

I’ve been investing in the energy sector since 2009, and I’ve never witnessed the kind of divergence that exists in today’s market. In short, the historical relationship between oil prices and global inventory levels has broken down to an extent I’ve never seen.

Oil prices have always exhibited a strong inverse correlation with oil inventory levels. Steadily growing inventories indicate that supply outstrips demand. Higher inventories imply more slack in the market. The converse is also true. Inventory declines indicate that supply is lower than demand.

Charts that plot oil prices versus inventory levels over time show a price line and an inventory line that are essentially mirror images of one another. Today, the mirror image has disappeared as both inventories and prices head lower. We're now at the point where global inventories are far too low for current oil prices.

Global Inventory Levels are Low

In point of fact, inventories currently stand at their lowest levels going back to 2017, as shown in this chart:

Source: Eric Nuttall, X, Nov. 7, 2024.

Recall that under normal circumstances, lower inventories imply higher prices. Historical price behavior bears this out. The higher inventory levels shown one, two, and three years ago on November 8 of 2023, 2022, and 2021 coincided with oil prices of $77, $89, and $81, respectively. These figures aren’t adjusted for inflation.

In all three years, inventories were higher than today's. Given their inverse correlation with prices, their prices should be lower and today's prices should be higher.

The relationship isn’t perfect. For instance, on November 8, 2022, an oil price of $89 was higher than the level implied by inventories. However, prices corrected in short order, ending the year at $79, in line with the levels implied by inventories.

In the past, the relationship has tended to break down temporarily, but it reasserts itself, typically over the course of a few weeks. Before today’s divergence, the most recent instance was in April, when bullishness regarding Middle East tensions caused oil to trade above the price implied by inventories.

In hindsight, this was a selling signal. Wilson and I used the opportunity to sell down a portion of our E&P holdings in anticipation of a reversion. Over the subsequent weeks, prices corrected, dropping back down to more “normal” levels.

Today’s price/inventory divergence has been in effect since August. This is far longer than any other instance I can recall.

At least so far, it shows no signs of letting up.

What Is WTI’s “Fair Value” Today?

Today’s divergence is far greater, longer lasting, and more persistent than anything I’ve experienced.

To determine its magnitude, we can reference the work of various analysts who have developed regression models to estimate the current “fair value” of WTI or Brent. Michael Rothman at Cornerstone Analytics, for instance, has a particularly good one.

On X, the account handle @UndervaluedOnG publishes the results of a similar regression analysis after weekly U.S. inventory reports. The price-to-inventory data has an 87% fit. The theoretical maximum 100%, so this model does a good job correlating the two variables. Its output is typically in the ballpark with other models I’ve seen.

The chart below shows the data.

Source: @UndervaluedOnG, X, Nov. 6, 2024.

Now, there’s a lot going on in this chart, but suffice it to say that it estimates WTI’s “fair value” to be approximately $85 per barrel as of November 6.

WTI closed today’s trading session at $70.41 per barrel. Based on the modeled “fair value” estimate, WTI has nearly 21% upside from its current price.

Implications for the Oil Market

Trying to tease out the reasons why prices are so disconnected from inventories is so complicated as to be an exercise in futility. But we know enough to be highly confident that prices are seriously out of whack with fundamentals.

There are several implications of this fact.

First, we can state with confidence that there is no geopolitical premium in the oil price. In fact, one can argue that there exists a massive geopolitical discount.” Of course, this makes no sense given the hostilities underway in the Middle East and the non-zero chance that a mistake made by, say, the Houthis or some other aggressor group disrupts supply.

Another implication is that the current pricing is acting as a de facto price control. It’s an established principle of economics that when prices are kept too low, shortages emerge. Severe shortages create the potential for a price spike. With regard to today’s oil market, we can infer that if prices remain too low, inventories will be drawn down to the minimum levels at which refineries can operate. At that point, prices will surge higher.

If oil prices are held down for too long, a price spike is only a matter of time, though the comeuppance could be a long time coming. However, we’re seeing a key step in the process, namely, surging refinery margins, which occurred again today despite the ugly price action.

Another implication is that the lack of price response to supply and demand developments creates havoc for fundamental-based traders. Consequently, many—if not most—of significant size have exited the oil market.

In their absence, momentum-based algorithmic programs now dominate oil futures trading. A market increasingly dominated by momentum traders distorts the price discovery process. A distorted price discovery process forces even more fundamental-based traders out of the market, which causes more severe distortions, and so on. Prices are left to drift higher or lower with little fundamental justification.

This is not how markets are “supposed” to work. In the end, it’s bad for capital allocation and the long-term health of the market.

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Implications for E&P Stocks

There are several implications for energy investing. I’m currently conducting my own energy investing program under the following assumptions.

• Commodity economics dictate that, one way or another, oil prices will eventually reflect fundamentals.

• E&P stock prices are highly correlated with oil prices.

• When oil prices revert to their normal relationship with fundamentals, so will E&P stocks.

• I don’t know when that reversion will occur.

• The upside in E&Ps is enough to justify the wait.

My own interpretation of the price/inventory relationship is that it represents a margin of safety in the event that the demand reduction that so many investors fear does, in fact, arrive. In that scenario, supply can overshoot demand and cause inventories to build massively before fundamentals reflect today’s price.

This view of the situation gives me greater conviction to buy well-positioned E&Ps. Since I don’t know when the situation will resolve, I’m sticking with long-term investments that I estimate possess enough upside to justify waiting through stretches of volatility.

My favorite high-quality names are MEG Energy (MEG:CA), Cenovus Energy (CVE), and Suncor (SU). These stocks have all but eliminated debt as an existential risk. They’re safe in the face of the negative investor sentiment surrounding a potentially loose 2025 oil market supply/demand balances and lingering concerns about global oil demand.

Investors who are comfortable embracing more risk but also greater potential returns should favor E&Ps with more cash flow torque to commodity prices. Those with the biggest appreciation potential relative to their risk include Veren (VRN) and Strathcona Resources (SCR:CA). I hold both in the HFIR Energy Income Portfolio and in accounts I manage. Both names possess cash flow torque that I estimate could send their shares up more than 100% if oil prices rise above $85 per barrel, as I suspect they will over the next two to three years.

Prospective investors of Veren and Strathcona should keep in mind that cash flow torque works both ways. These stocks could underperform if commodity prices decline. Still, both will make it through nearly any realistic downturn scenario and prosper on the other side.

Risky micro-cap E&Ps will also outperform amid a reversion to historical norms, though these also entail a risk of permanent loss if oil prices are sustained at current commodity price levels or if prices fall lower. I’d avoid them for the time being.

Investor Sentiment is Playing a Role

Investor sentiment matters. Sentiment tends to follow price, so today’s low prices lead to dismal sentiment that deters investors from buying, thereby creating even lower prices. This dynamic has created bargain prices among many E&Ps. It’s what great energy stock buying opportunities are made of.

In the opposite fashion, an upswing in prices can beget even higher prices when fundamentals are supportive and sentiment begins to improve.

Even without a price rally, sentiment itself may be the spark that causes prices to rally. For instance, even the slightest improvement in the consensus view of 2025 supply/demand balances can dash many investors’ fears and send oil prices significantly higher.

Conclusion

Oil prices are too low. They currently discount a scenario in which severe demand weakness causes massive inventory builds. If these builds don’t occur, oil prices will increase significantly.

I’m actively buying E&Ps in this environment. I recommend that investors keep it simple and stay safe. MEG, CVE, and SU are no-brainers over a three-year holding period. Investors can buy with confidence that substantial gains are in store over that timeframe.

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Analyst's Disclosure: Jon Costello has a beneficial long position in the shares of CVE, SU, SCR:CA, VRN either through stock ownership, options, or other derivatives.