Dear Valued Clients and Friends,
I made the decision early in the week to devote this week’s Dividend Cafe to the Energy sector after I was asked a very thoughtful question near the end of this Fox Business interview on Monday. I believe there continues to be a generational investment opportunity here that deserves unpacking – and that is very different from what many understand. There also was so much talk this week about the reasonably insane idea of banning diesel exports that I was in a real “energy state of mind.” By the middle of the week I was wondering if I needed to ditch it and talk about the 10-year and 30-year bond yields hitting highs they have not seen in roughly twenty years. But then I remembered that I write this every week and I get to swing the bat again, so I stuck to my original plan.
So, yes, the bond yield issue will be covered soon. But today there are a few things that stick out as particularly important for investors, and outside conventional thinking. Being an unapologetic Energy bull (as I am) is not mainstream. But defining my energy bullishness outside a view on the price of oil or any kind of outlook about the Iran war is even less mainstream. Attaching energy bullishness to a specific investment strategy is risky, but that is what we are going to do today. Let’s jump into the Dividend Cafe …
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First, No Investor Cares
I write a lot that one of the reasons every investor has to care about the risk and basic situation with AI is that the concentration within the major market indexes has reached unprecedented levels. A “diversified” S&P 500 index investor has the highest exposure to a single sector (and even more so if you more rightly look at it as the “dual sector” exposure that is really a single sector) that they have ever had by a wide, wide margin (making the 1990’s tech concentration look absolutely conservative by comparison). A “diversified” S&P 500 index investor also has the highest exposure to a “single stock” and to “two stocks” and to “three stocks” and to “ten stocks” that they have ever had (again, by a wide, wide margin). In other words, the stakes are very high around these themes, exposures, and factors for almost all investors – even investors who think they are not that weighted or focused in the AI space.
But if that is true, then the inverse is certainly true about Energy for many, many investors. The entire Energy sector is 3.4% of the S&P 500 (and this is “up” from the 2.9% it was at the beginning of the year). Apple, on the other hand, is 7.4% of the S&P 500. Apple – one company. More than 2x the entire energy sector within the S&P. So while Energy has moved from 2.9% to 3.4% of the index, and done this by being up +38% YTD, why should an investor care? It isn’t moving the needle in their portfolio whatsoever.
And by the way, I am referring to Energy as the entire Energy sector within the S&P 500. Did you know that Midstream Energy is only 0.5% of the S&P 500?????? So back to my Apple analogy (using Apple because it is so massive in market cap), one company becomes 14x the entire energy infrastructure (pipeline/storage/transportation) sector in the U.S. stock market. The idea that our Energy needs are provided, that oil and gas gets to us, gets to refiners, gets to other countries we sell it to, gets extracted and processed, becomes the end products they become (more on how butane, propane, and ethane are so vital to American life below) is 0.5% of American economic life is positively comical.
But it certainly does explain why investors don’t have to care. And indeed, they don’t.
It also explains why when Energy is underperforming, it makes it very, very hard for a money manager with an outsized Energy exposure to outperform. And it also explains why when Energy is doing well, it provides a meaningful opportunity to exceed the market return. All of this (in both directions) is because of math.
What this Dividend Cafe is NOT about
An investment periodical making a case for Energy bullishness in September 2026 when WTI crude is $93, and when it has averaged roughly $90 since the Iran war started, is almost certainly making a case centered around the price of oil and the Iran war. WTI was $67/barrel on February 27, the day before the Iran war started. It averaged $91 in March, $100 in April, $102 in May, fell to $84 in June when the “ceasefire” and “MOU” was announced (you are forgiven if you forgot about that MOU), seemed to be normalizing when it averaged $80 in July, inched higher to $84 in August, and now has pushed higher again here in September. So a $90 average off a $67 starting price for what has now been six months is pretty substantial.
And truth be told, I can’t offer a reason why it will go down any time soon. I do believe it will. I just can’t tell you why. Or how. Or when. But other than that, you can take it to the bank. In all seriousness, I already wrote a piece earlier in the year about why my Energy thesis was not connected to the Iran war. And if you look at that date (April 2), I did not exactly know that six months later we would still have no more clarity than we did then about the Strait of Hormuz. I argued that “economic activity is energy transformed” and stand behind that. Transforming energy generates wealth and wealthy societies (a) have energy to transform, and (b) transform it very well. America should take a bow here. Some have A and not B. Some do not have A. But we have both. We ought to be grateful. But I suppose gratitude requires an understanding of what you are supposed to be grateful for. I digress …
So this Dividend Cafe is not a mere restatement of the fundamental realities that underpin economic activity, energy transformation, and harnessing it all into productivity. And it is not a case for the Iran war to end or not end, for the Strait to stay closed or re-open. It is a case for a sector that creates great value for investors when oil is at $90 in the midst of a supply shock, or when oil is at $65 in the midst of a demand boom. It is a case for energy divorced from the price of crude oil. And it is a case for energy without much thought of crude oil at all.
But Those Supply Particulars Matter?
It is obviously true that things like the closure of the Strait of Hormuz facilitate a supply shock in oil. The flow of about 20 million barrels of oil per day through the Strait of Hormuz dropped to 2.7 million barrels last spring – an 86% reduction, and something previously incomprehensible for its ramifications to global supply. Even if it is true that the number has since improved to 6.5 million barrels per day, that is still a 68% reduction from pre-war levels. Now, there was obviously a massive amount of inventories that buffered this impact – far more available inventory than anyone seems to have understood. And yet those inventories have now been well drawn down. The IEA estimates that 507 million barrels have been drawn down since the war began. Look at the global build-up we see in 2025, and the drawdowns we see in 2026:
More than 300 million barrels of emergency oil stock have been released (globally). We are talking about 2.8 million barrels per day for six months that have come out of pre-stocked oil inventory. Put differently, the world (ex-U.S.) has largely been living off yesterday’s oil to replace production that is not happening today.
Of course, the Strait of Hormuz is not everything. The U.S. has ample oil supply and production capacity. Several million barrels per day have been rerouted through different Gulf passageways (Saudi and the UAE were able to bypass some portion of Hormuz reliance). And let’s also not forget that when prices go up in response to a supply shock, demand erodes – which then solves for the lack of supply. This interaction between supply and demand is one of the first laws of economics, and its application in oil markets has been the gift that keeps on giving for economics teachers (provided they understand it themselves, which I would not always take for granted if I were you).
In short, oil prices moved higher because of supply constraints that were, themselves, buffered by an unprecedented build-up and then draw-down of inventories. Demand remains strong but has eroded to some degree (in the short term). These 2026 particulars explain the price action and profit action that has existed in the space.
The Next Step
If I were a betting man, I would expect supply to be limited relative to demand in the short and intermediate term, regardless of how this Hormuz mess plays out in the weeks and months to come. I do not believe China will underwhelm in its demand over the next 1-2 years. I believe that most U.S. producers, talking in generalities, have been quite disciplined in their capital spending throughout this boom and avoided the temptation to over-invest and overspend that has gotten them into trouble in various past incidents. At a high level, one could say that there is a short-term story (largely led by Iran/Hormuz issues) wherein supply is constrained, demand is strong, and capital allocation is intelligent – and that bodes well for the complex.
Then there is the fact that the relative relationship between the energy sector and oil prices is not remotely reflected in the current stock prices. In other words, those worried that a big drop in oil prices would lead to an equally big (and sustained) drop in energy stocks may not appreciate the relative disconnect already reflected in market prices …
But those points in the two paragraphs above are not the basis of our long-term ownership thesis for Energy. As it pertains to major integrated plays, we do believe supply/demand factors are favorable, and we do believe their capital allocation has become remarkably prudent. Given the reality of cyclicality and commodity price volatility, we do favor less-levered names and those with a history of prudence, dividend sustainability, and fortress balance sheets. All of that is true.
But we also believe that those who believe in the AI story and separate it from the Energy story have no idea how the AI story is supposed to work. If you believe there is going to be AI, you have to believe we are going to produce more power, and if you believe we are going to produce more power, the electricity production requires vastly more oil and gas behind it than is ever, ever discussed. A demand catalyst that is longer-term than the short-term possibility of the supply shock is quite compelling. And as long as we do not have grossly overpay for these fundamentals, it is a cogent investment thesis. So, speaking of valuation …
Value in a World of Valuation
Energy’s earnings are presently 4.9% of the S&P 500’s earnings, but the market cap is only 3.4% of the S&P’s market cap. Not even Financials (12.1% vs. 15.5%) have as much of a differential between earnings contribution and market cap within the index.
The Energy sector’s forward P/E is always lower than the S&P 500’s full P/E ratio. That historical relationship (lower P/E for a variety of reasons – higher capital intensity, lower earnings growth, etc.) is baked in. But the noteworthy piece is that the energy sector’s valuation relative to the S&P is currently only 70% of its own historical average. This is simply incomprehensible to me. And tantalizing.
In short, we think Energy has a short-, intermediate-, and long-term story that presents a solid investment case, without forcing us to grossly overpay or move out on the risk curve in a way that should make people shudder.
And then there is this …
The Midstream Case
If I could not find a case to be made for U.S. oil and gas producers, even those with decades of dividend growth behind them, with fortress balance sheets, and with a global footprint and catalysts for growth that are all exciting, I would still say that the Energy story represents one of the most compelling opportunities of our time when you “meet in the middle” – that is, outside of the embedded volatility of the downstream complex (refining) and the cyclicality of the upstream space (production). There is a “midstream” sector that remains compelling under a number of scenarios. And it is a by-product of “investment PTSD” that this is not talked about all the time.
First, I say “investment PTSD” to delineate it from real PTSD, which is serious and most often connected to things like military combat where people actually deserve to use the term. Having had a bad experience with an investment is not in the same category, so some delineation is in order.
Second, what I refer to is that for many midstream investors, especially those in sub-par names or vehicles, or those with less focus on quality discernment, the events of 2015 and 2020 left a bad taste in the mouth of many investors, institutional and retail alike, where a return to the investment thesis was just “too traumatic” for them. I am being tongue-in-cheek, sort of, and not especially flattering, since the annual returns for the sector since have been:
| Year | Annual Return |
|---|---|
| 2021 | +40.1% |
| 2022 | +30.9% |
| 2023 | +26.6% |
| 2024 | +24.4% |
| 2025 | +9.8% |
| 2026 | +23.8% |
| *Alerian MLP Index | |
But it is true, nonetheless, that outside recoveries notwithstanding, much of what took place between poor capital discipline, poor governance, saturated markets, Saudi/OPEC/Russia shenanigans, and so forth and so on, caused some to say, “never mind, I’ll look elsewhere.”
And I believe what gets missed there is that not only are we well into one of the great recoveries and reality checks in history, where it has been the skeptics who have been humbled, not the believers, but it ignores the “Midstream 2.0” reality that we are living in – one in which mistakes from the past represent lessons learned, and where capital discipline has replaced capital recklessness and Ponzi economics (though for those looking for such, I do have a data center to sell you).
The midstream story is one of natural gas demand, a cleaner fuel that has replaced coal as the primary driver of electricity production in our country. The business model continues to largely involve pay-to-play contracts that mitigate commodity risk, regardless of sentiment. This natural gas demand is domestic and global, as little things like “heat” and “power” and “food” require it here in the States, as do our cosmetics, plastics, petrochemicals, and more (from natural gas liquids); and then globa,l as our capacity to export liquefied natural gas (LNG) is set to double in the next five years. And if you believe we will soon not need heat and food because of AI (hey, I promise you there is someone on social media saying this!), I assure you that the AI which allegedly will take away our need for warmth in our homes requires power for data centers – and that power has to come from, you guessed it, natty gas.
It is not easy to build pipelines, and these legal rights and embedded scarcities are valuable – very valuable. The contracts generally have inflation protections and kickers that favor the pipeline companies.
Volume growth, pricing power, and enhanced distribution are enviable business dynamics. When combined with an improved capital discipline in “2.0,” the investment story is as exciting to me now as it was before this ferocious post-COVID rally. Leverage is way less. Dilutive equity issuance is minimal. Balance sheets are vastly improved. Self-funded capex is common. And distribution growth is robust (someone should write a book on that).
I can only say that high yields at purchase with high single-digit growth of distribution, with the secular tailwinds in natural gas liquids, LNG exports, Permian volumes, and AI buildout, all cause me to believe this is what investors should primarily be talking about when it comes to Energy – not when the Strait of Hormuz will or will not reopen.
About That Diesel Ban
I will wrap things up quickly, but I just want to say, since it is adjacent to the subject at hand: The idea that it would benefit diesel prices to ban exports is not rooted to any kind of economic common sense. Don’t just listen to me. I was live on air Wednesday with President Trump’s own former Energy Secretary, Dan Brouillette. He cogently made the point. And then there’s Art Laffer, a supporter of the President who has advised on countless tax, regulation, and energy proposals.
Sometimes these things create an opportunity for economic education. And here the education is simple: Disincentivizing production drives prices higher, and systematically eliminating customers disincentivizes production.
Conclusion
Okay. We covered a lot today. But the fundamental takeaway is this: Investors not looking for a weekly or monthly return timeline can look at the Energy sector at a time when no one else is, find attractive valuations and fundamentals, and especially in the Midstream space, find a structural argument with a half-dozen tailwinds to be excited about. And that is how you want to do it in a world gone mad.
Quote of the Week
“One of the criticisms you sometimes hear of communism, for example, is that it sounds good in theory, but it never works in practice. That’s actually not true. Communism does not sound good in theory. The world it envisions for all of us is small, flat, grey, leveled of all exception, drained of all that is good and noble in the human soul. The world it envisions is a world without courage, a world without creativity or ambition, a world without heroes or glory or great causes to strive towards, without – a world without miracles, without myths, without men who rise above the rest to do incredible and extraordinary things. And the world communism envisions is a world without God.”
~ Sec. Marco Rubio
More to Chew on
- I am not the one saying Georgia and North Carolina are off the table
- IEA on Hormuz impact and supply offsets
- Real Disposable Income has always been the thing
- Karl Rove and midterm surprises
* * *
I hope you all have a wonderful weekend, that USC will learn how to play defense in the next 24 hours, and that the “nor’easter” supposedly coming will not delay my flight this weekend to the conference in Vegas at which I am to speak Monday. I also hope you will read next week’s Dividend Cafe, which I am very, very excited to write. I’ll leave it there. Fight on… like Midstream after COVID.
With regards,
David L. Bahnsen
Chief Investment Officer, Managing Partner
The Bahnsen Group
thebahnsengroup.com
This week’s Dividend Cafe features research from S&P, Baird, Barclays, Goldman Sachs, and the IRN research platform of FactSet
