We believe investors should be open-minded about old-fashioned energy for two reasons.  First, we have a growing conviction in oil companies’ capital discipline.  Second, while commodity prices may rise due to severe underinvestment, they do not need to for the sector to become a massive profit engine for investors.


  • On March 29th, 2020, we published a study on sector responses in crashes. With oil at negative prices, energy stocks down 61%, and industry consolidation underway, we believed that survivors of the carnage were a “…call option on the eventual resumption of even partially normal human behavior.”
  • In April 2020, we published an update noting that with total stimulus exceeding 30% of GDP, despite elevated valuations, stock selection would be key to strong performance.
  • In March of 2021, we published a study of the Great Inflation of the 1970s which showed that not only had Energy & Staples been some of the biggest beneficiaries of inflation, but that the market’s valuation structure was such that many popular sectors were priced like long term inflation was impossible. Watch our follow-up presentation on equity duration here.
  • Since then we have written pieces that discussed the bubble in renewable energy companies, a piece explaining that ESG and brutal capital destruction were setting energy up for the virtuous cycle of capital discipline, rising free cash flow, deleveraging, multiple expansion, and healthy dividend yields.
  • A piece discussing soaring food prices due to drought and rising energy costs as well as a piece showing that magazine covers were giving their classic contrarian buy signal and showing energy has the lowest weight in the S&P 500’s history.

Fig. 1 below is at the heart of our first point of conviction – oil prices do not need to rise for energy stocks to see explosive growth in profits.  When oil peaked at $140/b, the sector generated $53bn in FCF.  The energy sector today has generated $35bn in FCF in the trailing 12-months, with oil at an average price of $52.  This means, energy stocks are generating ~70% of the FCF despite oil prices being 63% lower than the prior peak.

This is simple and powerful evidence of the importance of capital discipline to overall sector profits.

Energy Generates 70 of the Profits Seen at Peak Oil Despite Oil Being 63 Lower


This is why the KCR team has such deep roots in data-driven behavioral finance.  The below chart shows how narrative can trump facts and profits for only so long.  The navy blue line is still the energy sector’s FCF.  But the light blue line is now the aggregate market cap of energy companies.

[1] So obviously Twain was not talking about value investing, but we hope you catch our meaning ☺

[2] https://www.economist.com/briefing/2020/11/14/value-investing-is-struggling-to-remain-relevant Note: We think the world of “The Economist”

[3] https://www.economist.com/briefing/2020/11/14/value-investing-is-struggling-to-remain-relevant Note: We think the world of “The Economist”

[4] https://www.investopedia.com/terms/s/shitcoin.asp

[5] Hat tip our long-time friend AR

[6] Value is defined as the bottom decile of Long-Term Earnings Growth

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