Energy Sector Underperformance: A Strategic Buying Opportunity in Undervalued Oil Equities

The U.S. energy sector is at a crossroads. After years of robust growth, a prolonged decline in drilling rig activity has sparked concerns about the trajectory of oil production. Yet, for investors with a long-term horizon, this period of underperformance may signal an inflection point. Sustained reductions in drilling activity—particularly in the Permian Basin, the heart of American oil production—have created a unique opportunity to identify undervalued energy equities poised to benefit from a potential production rebound and favorable cost structures in a consolidating industry.

The Rig Count Dilemma: A Signal of Structural Shifts

The U.S. drilling rig count has declined by 7% year-to-date as of July 2025, with oil rigs hitting their lowest levels since 2021. The Permian Basin, which accounts for nearly half of U.S. crude output, has seen its active rig count drop to 263 as of July 18, 2025, the lowest since December 2021. While this decline reflects operators' caution in the face of low oil prices and economic uncertainty, it also underscores a critical reality: the industry's reliance on efficiency and technological advancements has allowed production to remain resilient.

For example, the Permian's new-well oil production per rig increased by 14 barrels per day in June 2024 compared to May 2024, demonstrating that operators are squeezing more output from fewer rigs. However, the EIA forecasts that U.S. crude production will peak at 13.5 million barrels per day in Q2 2025 and decline thereafter as rig counts remain constrained. This creates a supply-side tightness that could drive prices higher in the medium term—a dynamic that investors should not overlook.

Undervalued Equities: Low-Cost Producers in a Consolidating Sector

The key to capitalizing on this environment lies in identifying companies with structural advantages: low breakeven costs, disciplined capital allocation, and exposure to high-productivity basins like the Permian. Three names stand out.

1. Permian Resources Corporation (PR): A Model of Efficiency

Permian Resources has emerged as a standout in the Permian, with a breakeven cost of $30 per barrel in its Northern Delaware Basin assets—among the lowest in the industry. Acquiring APA's assets in 2024 for $608 million added 13,320 net acres without diluting liquidity, and its drilling and completion costs have dropped to $750 per lateral foot in Q1 2025. This efficiency allows Permian to generate free cash flow at $60/WTI, providing a $35/barrel cushion at current prices.

At a price-to-EBITDAX of 4.5x—well below its five-year average—and a fortress balance sheet with $3.2 billion in liquidity, Permian is trading at a discount to its intrinsic value. Analysts project a 12,000 BOE/d contribution from its new assets by year-end 2025, further solidifying its growth potential.

2. Diamondback Energy (FANG): M&A-Driven Growth

Diamondback Energy, a $50 billion Permian giant, has leveraged strategic M&A to bolster its position. Its 2024 merger with Endeavor Energy Resources is expected to generate $3 billion in synergies, with oil production projected to rise to 335,000 barrels per day in 2025. Despite a 28% decline in Q3 2024 net income due to acquisition costs, the company exceeded revenue forecasts by 10%, showcasing operational resilience.

Diamondback's GAAP P/E of 10.40 is below the sector median, and its stock trades at a 20% discount to the average analyst target of $215. With a “buy” rating from 82% of analysts, the company is well-positioned to capitalize on the Permian's long-term growth trajectory.

3. Matador Resources (MTDR): A Consolidation Target

Matador Resources, with a $8 billion market cap, is another Permian standout. Its recent $1.8 billion acquisition of Ameredev II added 31,500 BOE/d in production and strengthened its Delaware Basin footprint. The company's GAAP P/E of 8.40 is significantly below the sector average, and its free cash flow is projected to exceed $7 per share in 2025. Analysts see Matador as an acquisition target itself, given its strategic acreage and undervalued stock.

The Bigger Picture: Consolidation and Policy Tailwinds

The energy sector is undergoing a wave of consolidation, driven by the need for scale in a low-margin environment. The $60 billion Exxon Mobil acquisition of Pioneer Natural Resources in 2023 and the APA-Callon Petroleum deal are emblematic of this trend. Smaller, high-efficiency producers like Permian and Matador are likely to attract acquisition interest as larger firms seek to secure low-cost assets.

Meanwhile, the Trump administration's pro-energy policies, including streamlined permitting and support for domestic fossil fuel development, could further accelerate production growth in the Permian. These factors, combined with the EIA's forecast of Permian output rising to 8 million barrels per day by 2030, suggest a favorable long-term outlook.

Investment Thesis: Buy the Dip, Not the Peak

The current underperformance in the energy sector is a function of near-term headwinds, not a fundamental shift in the industry's value. With oil prices near $65/barrel and production costs falling, the margin of safety for high-efficiency producers is widening. For investors, this is a rare opportunity to buy into companies with strong balance sheets, low breakeven costs, and exposure to the most productive basin in the U.S.

The key is to focus on companies that can outperform during the next production rebound. Permian Resources, Diamondback Energy, and Matador Resources meet this criterion, offering a mix of growth, capital efficiency, and strategic positioning. As drilling rig counts stabilize and production declines catch up with demand, these equities could deliver outsized returns for those who act now.

In the words of Warren Buffett, “Be fearful when others are greedy, and greedy when others are fearful.” The energy sector is at its most fearful moment in years—and that may be its most attractive entry point.