Finding Opportunity in Energy's Moment of Truth

A look at the Dallas Fed's Q2 Energy Survey and What It Means

By Bryan Kaus

The energy sector stands at an inflection point. The Dallas Federal Reserve's Q2 2025 Energy Survey reveals a market gripped by uncertainty on outlook, despite robust rhetoric. Reality is that business activity has turned negative at -8.1, down from +3.8 the previous quarter, while uncertainty has spiked to 47.1, the highest level in recent memory. Yet for those with the patience and discipline to look beyond the headlines, this moment of anxiety presents precisely the kind of opportunity that separates leaders from the pack.

Warren Buffett's timeless wisdom rings especially true today: "Be fearful when others are greedy and greedy when others are fearful." While the market trembles, the fundamentals tell a more nuanced story—one that rewards careful analysis over emotional reaction.

Reading the Room: Caution, Not Capitulation

What we're witnessing isn't panic, rather it is prudence and discipline. Energy executives are rightfully acknowledging market headwinds, but this measured caution is far removed from the despair that characterizes true downturns that we’ve all seen. Smart operators are stress-testing their assumptions, questioning their strategies, and positioning for what comes next. This is exactly the kind of disciplined thinking that creates long-term value.

The survey data supports this view. While sentiment has softened, we're not seeing the wholesale retreat that accompanies genuine crisis. Instead, we're seeing the kind of rational risk assessment that often precedes the next cycle of opportunity. Now, whether that is a huge boom or a smaller boost, the data indicates a more moderated recovery - still worth pursuing.

The Cost Structure Revolution

The survey reveals a fascinating divergence that astute investors (and actors) should note carefully. Oilfield service companies are experiencing severe margin compression. Input costs have surged from 30.9 to 40.0 on the index, while margins have collapsed to -33.4. This pain creates opportunity. Service providers are vulnerable, and smart E&P companies should be locking in favorable agreements now. This is a sentiment recently validated in earnings reports from the likes of Haliburton etc.

Meanwhile, exploration and production companies are seeing their finding-and-development and lease-operating costs decline. This divergence creates a window for strategic operators to secure advantageous terms across their supply chain. Now is the moment to further optimize. The companies that act decisively today will enjoy structural cost advantages for years to come.

The Tariff Reality: Planning Around Policy

Steel tariffs at 50% represent a significant headwind that cannot be wished away. The survey shows these tariffs are adding 4-6% to overall drilling expenses, with one-third of operators expecting to reduce well counts as a result. This disproportionately impacts smaller independents who lack the scale and negotiating power of major players.

The strategic response is clear: companies should be entering into multi-year agreements for critical supplies like Oil Country Tubular Goods (OCTG) to stabilize their cost exposure. Those who act quickly will insulate themselves from further policy volatility while their competitors remain exposed. Of course, everything with a grain of salt as we’ve seen the direction on tariffs being a bit fluid - making it challenging to manage supply chains and investment effectively in this space.

Water: The Constraint Nobody Saw Coming

Perhaps the most significant long-term challenge emerging from this survey is produced-water management in the Permian Basin. Nearly three-quarters of respondents expect water handling to restrict drilling activities within five years, with almost a third anticipating significant constraints. This is a big deal and a systemic constraint.

This isn't just an operational challenge that can be easily remedied. Rather, it is a competitive differentiator in the making. Companies investing now in recycling infrastructure, deep disposal wells, and midstream water partnerships will enjoy structural advantages over those who wait. The winners of the next decade will be determined by who solves this problem most effectively today. To quote Ricky Bobby, “If you ain’t first, you’re last.”

Stress Testing for Reality

Disciplined energy investing requires rigorous scenario planning (one of my favorite activities), and the survey provides sobering clarity. At $60 WTI, 61% of operators would begin cutting production. At $50 WTI, 88% foresee declines, with nearly half expecting severe cutbacks.

These numbers should inform every investment decision. Companies that can only generate returns at today's prices are fundamentally speculative bets. Those building projects that work at $55 oil and $3 gas are building for durability. In energy, as in all cyclical businesses, it's not the high-return projects that create lasting value - it's the low-breakeven projects that generate cash through the cycle and make it to FID.

Price Expectations: Stability Over Speculation

The market's price outlook reflects reserved thinking. WTI is expected to reach approximately $68 by year-end 2025, with Henry Hub gas around $3.66. These aren't the euphoric projections that characterized previous cycles, rather they represent realistic, sustainable pricing that supports rational capital allocation. The sweet spot.

This stability-focused outlook should inform strategic planning. Companies positioning for modest, sustainable growth rather than boom-bust cycles will find themselves better positioned for long-term success - especially given the volatility of global geopolitics on market prices.

The Talent Arbitrage

In a subset of this, we need to consider the labor force. Employment indices turning negative creates an often-overlooked opportunity. Periods of market caution are historically the ideal moments for visionary companies to recruit top-tier engineering and operational talent. The best teams are built during downturns, not upturns.

Companies with strong balance sheets should view current market conditions as a chance to upgrade their human capital. This being especially true given the waves of layoffs and restructuring of the last few years from M&A and efficiency plays - good talent is likely to be available. The engineers and operators available today may not be available when the market turns.

A Strategic Framework for Uncertain Times

Drawing from my own experience across market cycles, successful energy strategy in this environment requires five non-negotiables:

Fortress Balance Sheets: Maintain net debt-to-EBITDA ratios below 1.0. Financial flexibility isn't just prudent - it is essential and it is strategic. Companies with strong balance sheets can act while others retreat. Especially as rates remain a bit elevated.

Variable Capital Allocation: Companies should structure dividends and buybacks based on sustainable free cash flow above reinvestment thresholds. Shareholders deserve returns, but not at the expense of long-term competitiveness. I cannot emphasize this enough - dividends for dividends sake without considering the longer-horizon is a tempting but lazy approach that undermines longer-term value creation. Have your cake and eat it too.

Strategic Supply Agreements: For integrateds or upstream companies: Treat produced-water handling and steel supply agreements as strategic assets. Lock in favorable terms now while you have negotiating leverage. This can also apply in the midstream space as well (a bit less true for downstream).

Opportunistic Acquisitions: With service companies experiencing severe margin compression, high-quality assets are becoming available at compelling valuations. Patient capital will be rewarded. I would also suggest there are opportunities for strategic JVs in the midstream and downstream spaces to create further complimentary / integrated systems to meet demand - this being especially true in the natural gas space with demand for power generation booming. Those that can deliver to the key markets on favorable terms are likely to create a bit of a value moat - especially within established infrastructure vs. those that require greenfield development.

Conservative Economics: Only approve projects that generate attractive returns at $55 oil. Everything else is speculation, not investment. Creating a rational floor mitigates risk and ensures stability should volatility swing around - which seems quite a real prospect based on what I see from global demand and market dynamics.

Turning Obstacles into Advantages

Marcus Aurelius observed that "the impediment to action advances action. What stands in the way becomes the way." Today's big challenges such as tariffs, water management constraints, market uncertainty - are tomorrow's competitive moats for companies positioned to address them strategically. I cannot emphasize this enough.

In energy, as in all cyclical industries, volatility is not the enemy of value creation, rather it is the source of it. Many people overlook that being too bullish or too risk-averse. The companies that emerge stronger from this period of uncertainty will be those that maintained discipline when others panicked, invested when others retreated, and planned for decades while others worried about quarters. Again, this is what will define leaders from laggards. Those that make money because of themselves, not simply in spite of their actions, which is stunningly common.

The energy sector has always rewarded patient capital and punished speculation. That fundamental truth hasn't changed. What has changed is that current market conditions are creating the kind of opportunities that define careers and companies.

The question isn't whether this uncertainty will pass - it will. The question is whether you'll be positioned to benefit when it does. Navigating headwinds well means that when the winds do shift, you are more apt to catch the tailwind and set apart from the pack.

TLDR: Energy Sector Strategy - Q2 2025

The Setup: Dallas Fed survey shows energy business activity turned negative (-8.1) with uncertainty at record highs (47.1), but this represents prudent caution, not panic—creating opportunities for disciplined players.

Key Market Dynamics:

• Cost divergence: Service companies getting crushed (margins at -33.4), E&P costs declining—lock in favorable service agreements now

• Tariff impact: 50% steel tariffs adding 4-6% to drilling costs, hurting smaller independents most

• Water crisis: 75% expect Permian water handling to constrain drilling within 5 years—invest in solutions now

• Price sensitivity: 61% of operators cut at $60 oil, 88% cut at $50 oil

Strategic Framework:

1. Fortress balance sheets (debt/EBITDA <1.0)

2. Variable returns tied to sustainable free cash flow

3. Lock in strategic supply agreements (steel, water management)

4. Buy distressed service assets at compelling valuations

5. Conservative economics ($55 oil breakeven minimum)

Bottom Line: Current volatility creates the opportunities that separate leaders from laggards. Companies maintaining discipline while others panic, investing while others retreat, and planning decades while others worry about quarters will capture the tailwinds when market sentiment shifts.

Investment Thesis: Patient capital in energy gets rewarded—this downturn is setting up the next cycle's winners.