Three Energy Stocks: A Historical Lens on the Current Buy Case

The current energy rally is a stark reversal of a decade-long pattern of chronic underperformance. From 2012 to 2021, the sector was either the worst or second-worst performer in the S&P 500 in 7 of those 10 years. This wasn't a series of minor dips; it was a punishing stretch of losses, with the sector posting double-digit declines in 2015, 2018, and 2022. The only years it managed to outperform the broader market were 2016 and 2021, both of which coincided with sharp recoveries in oil prices after steep drops. The pattern is clear: energy stocks have been a feast or famine proposition, with meaningful gains almost exclusively tied to a sustained oil price recovery.

This long-term underperformance has created a profound valuation gap. The sector's shrinking index weightings tell the story. In the S&P 500, energy's weighting has fallen to just 3.7 percent, less than a quarter of what it was a decade ago. No single large-cap energy company commands even a 1% weighting, a dramatic decline from the 12.6 percent weighting the sector held in 2011. This isn't just a market share loss; it's a signal of investor neglect and a lack of confidence in the sector's ability to generate consistent returns.

The root cause is the commodity itself. The sector's fortunes are inextricably linked to the price of crude oil, which has been volatile and trendless for over a decade. When oil prices stagnate, energy companies cannot produce the sustained earnings growth needed to justify a higher market value. Their profits remain flat, but their stock prices are punished for failing to deliver. This creates a vicious cycle: low stock prices lead to low valuations, which in turn lead to low capital allocation for new investment, perpetuating the cycle of underperformance.

The bottom line is that the current rally is a direct response to breaking this long-standing pattern. The sector's recent outperformance is a bet that the commodity price trend has finally turned. For investors, this historical context is critical. It frames the current move not as a simple cyclical bounce, but as a potential structural shift in the sector's fortunes. The risk, however, is that this is merely a "famine" to "feast" transition, and the sector's future returns will remain as volatile and dependent on oil's whims as they have been for the past ten years.

The Current Setup: Supply Glut Meets Demand Resilience

The near-term investment case for energy is defined by a stark contradiction. On one side, a looming supply surplus threatens to cap prices. On the other, resilient demand growth and a long-term energy mix that remains heavily fossil-fuel dependent create a foundation for upside. This tension sets the stage for a market where volatility is likely, but the ceiling on downside is being drawn by fundamental needs.

The supply story is clear and bearish in the near term. The International Energy Agency forecasts a global oil surplus that will push the Brent crude oil price to an average of $55 per barrel in the first quarter of 2026. This projection is underpinned by a market where global oil inventories rose to four-year highs in October, with stock builds averaging 1.2 million barrels per day through the first ten months of the year. The surplus is real and growing, with the projected global oil surplus from the fourth quarter of 2025 through 2026 averaging 3.7 million barrels per day. This glut is a direct result of a supply response that has outpaced demand, creating a fundamental headwind for prices.

Yet this bearish supply backdrop is being met with surprisingly resilient demand. The IEA projects global oil demand will rise by 830 thousand barrels per day in 2025, a figure that includes a significant upgrade for 2026. This growth is not a relic of the past; it is being driven by modern, energy-intensive sectors. The forecast notes that electricity generation by the power sector grows by 2.4% in 2025, a trend powered by data centers and other large industrial loads. This demand resilience acts as a buffer, limiting how far prices can fall. It also suggests that even as the world transitions, the absolute volume of fossil fuel consumption will remain high for years.

This creates the core investment tension. The supply surplus provides a clear downside price floor, with the $55 Brent forecast acting as a near-term target. But the demand story, particularly from industrial and power generation, provides a powerful constraint on that downside. The market is already pricing in this dynamic, with prices having fallen nearly $20 per barrel since January despite the inventory build.

The long-term energy mix further validates this setup. The IEA's World Energy Outlook projects that fossil fuels will maintain a large share of the global energy mix beyond 2050. This isn't a short-term forecast; it's a structural projection that underscores the enduring role of oil, gas, and coal in the global economy. For investors, this means the demand resilience seen in 2025 is not an anomaly but a feature of the energy system for the foreseeable future.

The bottom line is a market caught between two forces. The immediate pressure is downward from a supply glut, setting a clear price target. The countervailing force is a demand that refuses to fade, supported by powerful new energy users and a long-term energy mix that remains fossil-fuel heavy. This creates a constrained trading range: prices are unlikely to collapse to the $55 level without a major demand shock, but they also lack a strong catalyst for a sustained breakout. The investment case, therefore, hinges on navigating this narrow band, where the primary risk is a faster-than-expected resolution of the supply surplus, and the primary opportunity is a demand shock that reinforces the IEA's long-term fossil fuel projections.

The Investment Case: High Yields and Cash Flow in a Volatile Cycle

For income-focused investors, the current energy cycle offers a compelling case built on tangible financial benefits. The sector's recent underperformance, with the average S&P 500 energy stock up only about 4% year-to-date, has created a gap between price and fundamental strength. This is where the investment thesis crystallizes: companies like ConocoPhillips and Oneok are generating substantial surplus cash flow at current oil prices, which they are returning to shareholders through high, growing yields.

The core of this case is the massive free cash flow being generated. ConocoPhillips, for example, needs an average oil price in the mid-$40s to fund its capital program but currently operates in the low $60s. This creates a significant buffer. The company produced $6.1 billion in free cash flow through the first nine months of this year and expects to capture an additional $6 billion in annual free cash flow by 2029 from major projects. This surplus fuels a powerful dividend story. With a current yield of 3.47%, the company recently hiked its payout by 8% and aims for top-tier dividend growth. The cash flow is the engine; the yield is the return.

Midstream companies like Oneok provide a different, yet equally attractive, cash flow profile. These businesses generate very stable cash flow backed by long-term contracts and government-regulated rate structures. This predictability supports a high, growing dividend. Oneok's current yield is 5.66%, and management expects to increase it by 3% to 4% annually. The company's recent acquisitions and organic projects are designed to capture hundreds of millions in synergies, directly funding this dividend expansion. For investors, this is a low-volatility play on energy infrastructure that delivers a double-digit total return potential.

The bottom line is a convergence of yield and growth. Energy stocks appeal to investors seeking diversification and inflation protection, but the current cycle adds a layer of financial discipline. Companies are not just paying dividends; they are funding them with surplus cash from operations, which is then used to drive further growth. This creates a virtuous cycle where rising energy demand, as projected in the Annual Energy Outlook 2025, translates directly into higher cash flows and, ultimately, higher shareholder returns. For the patient investor, the case is clear: buy the yield today, and let the cash flow growth compound it.

Risks & Guardrails: Where the Cycle Could Reverse

The bullish case for energy and metals is compelling, but it rests on a fragile convergence of macro and industrial forces. Stress-testing this thesis reveals three primary risks that could derail returns: a deeper oil price collapse, execution failures on major projects, and a shift in regulatory policy that alters the demand equation.

The most immediate threat to energy sector returns is a deeper oil price decline. The U.S. Energy Information Administration forecasts Brent crude will fall to an average of $55 per barrel in the first quarter of 2026 and remain near that level. This is a critical inflection point for dividend sustainability. For a company like ConocoPhillips, which needs an average oil price in the mid-$40s to sustain its capital spending program, a sustained $55 price is a floor, not a ceiling. While it generates surplus cash flow today, a prolonged period at $55 would pressure the company's ambitious capital return plans, including its target for dividend growth. For the broader sector, where the average stock is up only about 4% year-to-date against a nearly 18% rise by the broader market, a deeper oil downturn would likely reverse this underperformance, crushing investor sentiment and valuations.

Execution risk is the second major guardrail. Companies are pursuing massive, capital-intensive projects to capture future demand. Oneok, for instance, has spent the past few years strategically expanding its midstream platform by making a series of acquisitions, including a $5.9 billion purchase of Medallion Midstream. While the company expects to capture hundreds of millions of dollars in cost savings and other synergies, integrating these deals is complex and costly. Any misstep-cost overruns, regulatory delays, or failure to realize promised synergies-could erode the projected free cash flow and jeopardize its dividend growth targets. Similarly, NextEra Energy's plan to invest upwards of $100 billion by 2032 in Florida is a multi-year commitment. Execution risk here is operational and financial, not just regulatory.

The third, and potentially most disruptive, risk is policy uncertainty. The energy transition is not a static process; it is governed by shifting regulations. The AEO2025 explicitly models two alternative policy cases to examine the effects of recent regulations on power plants and vehicle fuel economy and emissions. A reversal or delay in these policies-such as easing emissions standards for power plants or slowing the phase-out of internal combustion engines-could fundamentally alter the long-term demand outlook for natural gas, renewables, and the metals that support them. For example, if coal plant emissions rules are relaxed, coal consumption could remain elevated, reducing the need for new gas pipelines and transmission lines, which are key growth drivers for companies like Oneok and NextEra. This regulatory whipsaw could abruptly reverse the structural demand thesis underpinning the sector's growth.

The bottom line is that the current investment case is not a straight line. It depends on sustained oil prices above critical breakeven levels, flawless execution of multi-billion-dollar deals, and the continued forward momentum of environmental regulations. Any one of these pillars cracking would test the resilience of the rally.