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Oil Drops on Diplomatic Progress with Iran, Tight Inventories Limits Downside, RBC Says

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Oil prices came under renewed pressure on Friday after the White House signaled that a nuclear agreement with Iran could be reached in the near term, raising expectations for additional crude supplies to return to the market, RBC Capital Markets analyst Scott Hanold said in a Friday note.

US benchmark West Texas Intermediate crude fell below $80 per barrel, although prices remain approximately 18% higher than levels seen before the outbreak of conflict in late February. Shares of US exploration and production companies also weakened, leaving the sector up just 6% since the start of the conflict.

Despite the prospect of an easing in geopolitical tensions, Hanold said the impact on global oil fundamentals has already been significant. Supply and inventory buffers have been substantially reduced, supporting expectations for higher medium-term oil prices. Analysts estimate that the industry's mid-cycle oil price could remain at or above $75 per barrel for the next several years.

US crude inventories currently stand about 5% below their five-year average. In its latest Short-Term Energy Outlook, the US Energy Information Administration projected total OECD oil inventories will fall below 2.3 billion barrels by December, the lowest level since the agency began tracking the data in 2003.

Energy equities broadly declined over the past week. Oil-focused E&P companies fell roughly 5%, while natural gas-focused producers declined about 6%. Large-cap energy stocks were down 4%, while small- and mid-cap names lost 5%. The SPDR S&P Oil & Gas Exploration & Production ETF (XOP) fell 4% during the period, as WTI crude declined 7% and Henry Hub natural gas prices dropped 8%.

Investor interest in the energy sector remains intact but highly selective, according to discussions with long-only funds, generalist investors, and hedge funds. Investors continue to cite attractive valuations, with free cash flow-to-enterprise value and free cash flow-to-market capitalization yields averaging in the low- to mid-teens.

Interest in natural gas producers remains more limited amid concerns that a strengthening El Nino weather pattern could weigh on demand. However, investors have shown growing interest in Expand Energy (EXE) due to its relative valuation. Other energy names drawing attention include Devon Energy (DVN), ConocoPhillips (COP), Diamondback Energy (FANG), and Permian Resources (PR).

Price: $167.10, Change: $+3.69, Percent Change: +2.26%

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