The Morningstar US Energy Index has returned over 30% in the first quarter of 2026, outperforming every other sector.
Compared with the negative return in the US Market Index, the energy sector has received strong attention due to the conflict in the Middle East and its implications for oil prices. The conflict has created a heady environment for valuations in the space.
We suspect the market underappreciates the risk of a prolonged conflict. Daily news flow translates to an incrementally bleaker outlook for near-term fundamentals in the broader US market. Still, US kinetic strikes have largely avoided vital energy infrastructure so far. Apart from a possible but unlikely severe or tail scenario, such as the destruction of Iran’s Kharg Island terminal, we think prices will revert to our long-term midcycle once the US pivots to the tough task of securing the Strait of Hormuz. If this plays out, we could see energy stock prices deflate, creating attractive entry points.
We still like the story of the US midstream industry, where valuations are driven more by volume rather than price. Pipeline expansions in Texas and the American Southwest, as well as LNG export facilities, should drive above-average growth in the space this decade.
Top Energy Sector PicksEnergy TransferFair Value Estimate: $22.00Morningstar Rating: ★★★★Morningstar Economic Moat Rating: NoneMorningstar Uncertainty Rating: Medium
We see Energy Transfer ET as our only undervalued midstream that also offers an attractive 7% yield. We like its exposure to data center power facilities and LNG export terminals. Its intrastate pipeline network in Texas is ideal for transporting gas from oil wells to local power plants that feed data centers. After increasing its Desert Southwest pipeline connecting its Texas and Arizona markets, Energy Transfer can now serve its end market more efficiently than competitors.
Devon EnergyFair Value Estimate: $55.00Morningstar Rating: ★★★Morningstar Economic Moat Rating: NarrowMorningstar Uncertainty Rating: High
Devon DVN stands to benefit from its Coterra merger, with $1 billion in targeted cost savings implying meaningfully greater free cash flow to a combined entity already generating peer-leading returns from its massive Delaware core. We think the merged firm can achieve 70% of these planned savings, driven by longer drilling across adjacent acreage and lower corporate overhead. Upside risk comes from DevonCoterra selling some of its assets and either buying more attractive assets or returning cash to shareholders.
HF SinclairFair Value Estimate: $58.00Morningstar Rating: ★★★Morningstar Economic Moat Rating: NarrowMorningstar Uncertainty Rating: Very High
Our fair value estimate assumes HF Sinclair DINO achieves lower per-unit costs as the firm improves reliability. Management targets operating costs of $7.25/bbl in the near term from $7.98/bbl in 2024, while achieving $6.50/bbl in the long term. Refining profitability should also improve over time thanks to yield enhancement and reliability investments, driving higher capture rates. Earnings growth should largely come from new renewable diesel capacity reaching its full potential while market margins and credit prices improve from current levels.