Is Karoon Energy the best ASX stock if the US-Iran war lasts all year?

Markets are waking up to the fact that the US-Iran war could last all year.

The past two weeks, the oil futures curve has moved higher with most of the 2027 Brent strip now above $75.

Trump’s demand for “unconditional surrender” leaves no room for the face-saving exits required to cut a conflict short. Iran's government has vowed to keep the Strait of Hormuz closed.

Capital Economics, one of the best economic modellers in the business, said even a three-month conflict could push Brent to demand destruction levels of $150 per barrel over the following six months. If that happens, today’s oil prices hovering around $100 will look incredibly cheap.

For ASX investors, it suggests energy stocks may offer opportunity – even now.

ASX energy stocks haven't priced in a long war

Oil has surged roughly 40-50% since hostilities began. But the rally for ASX energy companies has been surprisingly tame. Most are barely trading above their five-year price averages.

ESG mandates are undoubtedly part of the reason. Institutional investors like super funds are the price setters. And many of them refuse to touch fossil fuel stocks, whatever the dividends on offer. Self-directed retail investors are becoming steadily more influential in ASX price formation, according to the ASX 2023 Australian Investor Study. And younger generations of retail investor often avoid fossil fuel companies too.

But the bigger factor is that the market expects mean reversion. Valuations still embed a return to $70 oil.

For those who think the war could last into 2027, that may be an opportunity.

In that scenario, the ASX stocks with the most sensitivity to oil prices, and with the least production headwinds, are best placed. Karoon Energy (ASX: KAR)  is one of the more useful but less familiar names here.

Karoon – oil price leverage

Karoon is not as well-known as Woodside or Santos as it remains under-covered relative to its size.

Karoon is an upstream producer with operations in Brazil and the Gulf of Mexico. One of the purest oil exposures on the ASX, the company is based in Houston these days.

The firm has hit production cuts this year due to a leak. It’s expansion plans for a new oil project (Neon) in Brazil have also yet to find a partner.

Nevertheless, if high oil prices stretch into 2027, Karoon has the most convexity to the oil price of any ASX energy stock.

This convexity is probably best illustrated by how the ASX’s upstream producers’ free cash flow yields interact with the oil price.

At current 2026 production estimates, Karoon barely produces any free cash flow at $70/bbl on Goldman Sachs’ numbers. Santos (ASX: STO) by contrast, which behaves much more like a deep in the money call option, generates free cash flow yields of almost 10% at those levels.

But when oil hits $100/bbl, Karoon’s FCF yields overtake Santos’s.

This extreme operating leverage is driven by two factors: production mix and a lighter hedging profile.

Karoon is close to a pure play liquids producer, with the vast majority of its production coming from oil. As is typical for mid-sized exploration and production companies, Karoon doesn’t run a trading desk itself. Instead, it outsources it to a major trader like Shell (historically).

Crucially, Karoon’s 9-odd million barrels of guided production are sold to Shell and/or whoever else at global spot-linked rates like WTI/Mars or Brent. Furthermore, Karoon’s latest financial statements show no derivatives. This suggests the company is largely unhedged and very heavily exposed to the upside of a price spike.

In a scenario where Brent hits $150/bbl of the type contemplated by Capital Economics, the financial impact would be transformative. On simple sensitivities from current guidance, a sustained move from $80 to $150/bbl would imply very large upside - possibly doubling - to Karoon’s 2026 EBITDA.

Despite this, Karoon’s valuation is the lowest in its peer group. It currently trades at an very low NTM EV/EBITDA multiple of just 2.1x. This compares to 4.6x for Santos and 5.5x for Woodside, again on GS numbers. On a price-to-NAV basis, Karoon sits at 0.85x, one of the largest discounts in the sector, partly perhaps reflecting the market’s concerns around Brazilian export taxes. 

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