Oil’s Balancing Act Can’t Last

HEADLINES
What You Need To Know

A Chinese AI lab, DeepSeek, has shocked Silicon Valley with AI models that outperform top U.S. counterparts despite being built faster and cheaper using less powerful chips. Their latest open-source model, developed in just two months for under $6 million, outperformed Meta, OpenAI, and Anthropic in critical benchmarks. The breakthrough raises concerns over America’s AI dominance and the effectiveness of export restrictions. DeepSeek’s success suggests China is rapidly closing the AI gap through cost-efficient techniques, sending shockwaves through the industry.

Moderna is advancing its efforts to combat norovirus with a promising vaccine currently in a large phase-three trial. With results expected later this year or in 2026, the company aims to address the seasonal stomach bug that has seen a sharp rise in cases this winter.

President Donald Trump announced a $500 billion AI infrastructure initiative called Stargate, partnering with OpenAI, Oracle, and Softbank. The project aims to bolster U.S. competitiveness against China by investing in data centers, with Texas as the first site. Softbank CEO Masayoshi Son will chair the venture, which includes key partners like Microsoft, NVIDIA, and Arm.

Netflix exceeded expectations in the fourth quarter, adding a record 19 million subscribers and surpassing 300 million paid memberships. The company credited the growth to a strong content lineup, product improvements, and seasonal trends. Including extra member accounts, Netflix estimates its global audience exceeds 700 million.

OPINION
Matt Allen’s Take

This chart presents a long-term problem for the U.S. oil market. Despite production reaching record highs of 13,481 thousand barrels per day, the number of active rigs continues to decline, now standing at just 424. Historically, when rig counts drop, production eventually follows. However, today’s advanced drilling techniques and efficiency gains have allowed companies to sustain output with fewer rigs. While this may seem like a win for now, it poses a significant challenge for future supply.

The Long-Term Problem

Oil wells do not last forever. Shale wells, in particular, experience rapid decline rates. Without reinvestment in new drilling, production will eventually decrease. The continued decline in rig counts suggests that companies are not allocating capital to long-term sustainability. This could result in a major supply crunch in the coming years, potentially pushing oil prices significantly higher.

In previous cycles, such as in 2015 and 2019, falling rig counts led to a delayed decline in production. If the same pattern holds, the current divergence could mean that in a few years, oil prices will rise sharply, contributing to inflation and increasing energy costs for businesses and consumers.

The Short-Term Problem

In the short term, American oil companies have little interest in increasing drilling activity. The reason is simple. It does not make sense for them financially. With oil prices around $75 per barrel, these companies are making substantial profits without the need to spend heavily on new drilling projects. At the same time, gas prices remain relatively inexpensive for Americans, currently around $2.90 per gallon.

Oil prices are determined by supply and demand. If American oil companies ramp up drilling activity, as President Trump has proposed, the increased supply would push oil prices lower. While this would benefit consumers by lowering gas prices, it would reduce profits for oil companies. Despite having 9,000 approved permits available for drilling, companies are choosing not to use them. The demand for oil remains stable, especially in the current strong economy. For oil companies, it is more profitable to maintain current production levels rather than flood the market with additional supply.

From a policy standpoint, it makes sense for the White House to push for more drilling to keep gas prices low and maintain energy independence. However, oil companies are primarily driven by profit motives and have no incentive to expand drilling efforts under the current conditions.

UPCOMING
What You Need To Watch

On Monday, December New Home Sales data will be released, giving insight into how many newly constructed homes were sold and what it says about the housing market's health.

On Tuesday, CB Consumer Confidence data will be released, measuring how optimistic consumers feel about the economy and their spending habits.

On Wednesday, the Federal Reserve will hold its first meeting of 2025, where they will reveal if they are making any rate cuts or not.

On Thursday, Q4 2024 GDP data will be released, showing how much the economy grew (or didn’t) in the final months of last year.

On Friday, December PCE Inflation data will be released, the Fed’s preferred inflation measure, which helps shape interest rate decisions.

Throughout the week, ~20% of S&P 500 companies will report earnings.

TIP
REITs

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CHART
HIGH ROA

TERM
Free Cash Flow Yield (FCF Yield)

Free Cash Flow Yield (FCF Yield) shows how much cash a company generates compared to its market value. It’s a useful way to see if a stock is a good deal based on the cash it brings in after covering expenses. Unlike earnings, which can be adjusted by accounting rules, free cash flow represents real cash the company can use to grow, pay debt, or reward investors. For example, if a company makes $500 million in free cash flow and has a market value of $5 billion, its FCF yield is 10%. A higher FCF yield can mean the stock is undervalued, while a lower yield might suggest it’s pricey. Investors look at this to find companies with strong cash flow that can support future growth.

Actions
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