Hirs: Investing for 2025—Growth by Acquisition

Ed Hirs lectures on energy economics at the University of Houston, where he is an Energy Fellow in the College of Liberal Arts and Social Sciences.

U.S. oil and gas investing in 2025 will be a mixed bag. Fundamentals including the political winds argue against drilling more wells, while these same fundamentals argue for a buyers’ market for assets. 

The negative fundamentals start with the WTI forward strip in backwardation with futures trading below $70/bbl. Next, more than 50% of respondents in the latest Dallas Fed Energy Survey will not make investments at less than $70/bbl. Third, the new year has started with the U.S. oil rig count down year-over-year despite the historically strong oil price. And the data point to rising breakevens for oil, especially in the Permian Basin, which is gassier by the day. 

The last two years have not been kind to gas producers, with the Henry Hub averages and electricity price averages below $3/Mcf. Demand growth is expected but will not happen quickly. LNG export facilities under construction will help, but most are still years away from commissioning.

Data centers are driving new demand for onsite or behind-the-meter gas power plants, but in this instance, gas marketers will be more likely than producers to profit initially because the ability of U.S. gas producers to get to market is restricted by limited pipeline capacity exacerbated by very tight federal regulations.

U.S. oil and gas producers will face higher costs in 2025 from mass deportations, new tariffs and wastewater disposal even if recent Biden administration rules are reversed. Abandonment liabilities will continue to increase.

Political Headwinds

For the next four years, climate-driven federal political headwinds will lessen, but the energy transition is underway in electricity markets. It is hard to compete against suppliers that have virtually no operating costs. Solar farms will continue to expand while battery farms that use the simple model of buying low and selling high in the restructured electricity markets will continue to displace legacy generation assets.  

For 2025, the global oil market is biased to scenarios that will bring lower oil prices back to the U.S. On the supply side, a ceasefire in the Russia-Ukraine war will bring pressure on the allies to relax oil market sanctions against Russia. Within OPEC, Saudi Arabia’s shut-in capacity may be brought to market for one of two reasons: to punish OPEC members who have been cheating on quotas or as part of a geopolitical deal with the U.S.

On the demand side, China appears to have reached and passed the point of peak oil demand.   While the U.S. has enacted 100% tariffs on China’s electric vehicles, that tariff has zero impact on China’s transition to EVs or the impact on the global oil market. China’s slower economic growth is also a factor.  

Market Opportunities

While oil and gas stock prices have rallied recently, they have not exceeded that of many market indexes. The buyers of public stocks are not investors per se but technical portfolio managers who are focused on the risk-return characteristics of all stocks and financial instruments.

When one stock deviates from market averages for risk and return, the portfolio manager will buy or sell depending on the arbitrage that is available. Consequently, oil and gas stock prices have been lifted more by the broader stock market expansion than they have by the industry’s investment fundamentals. 

The prospect of lower oil prices, stable natural gas prices and continued lower interest rates argue in favor of lower valuations for oil and gas assets, both public and private, for 2025. Public markets will continue to see non-cash acquisitions, with some public companies exiting by going private. The year 2025 will be a year for buyers—growth by acquisition will dominate growth by the drill bit.