The energy sector just delivered one of its best quarters in years. While crude prices remained supportive, record refining margins and limited global refining capacity drove profits higher.

ExxonMobilXOM

and ChevronCVX

reported a combined $26.6B in second-quarter net earnings, up 316% from the prior quarter, as revenue climbed 38%.

The gains came as the six-month-old Iran war disrupted shipping through the Strait of Hormuz, cutting off a route that once carried about 20% of global oil and gas supplies.

Why crude prices fell as profits soared

Here's what makes this quarter unusual: crude prices actually declined during Q2. WTI futures fell 31.5% over the quarter and Brent dropped 29.8%.

The real profit engine was refining, not upstream production. Exxon's refining unit collected $5.5B in earnings, up from $1.4B in the same period last year. The company made its largest amount of diesel in a single quarter since at least 2014.

Exxon CFO Neil Hansen said the real bottleneck isn't oil flowing through the Strait of Hormuz but the global shortage of refining capacity. Russia and China also restricted some fuel exports during the quarter, tightening supplies further. With US refineries already running near full capacity, they were well positioned to fill the gap.

Chevron's refinery profit was six times larger year-over-year, despite processing less crude and selling fewer products.

Spot oil averaged $104 per barrel in the quarter, up 28% from Q1, giving both companies a margin environment that senior portfolio manager Rob Thummel at Tortoise Capital described simply: "The world is going to be short jet fuel, diesel and gasoline."

Earnings beat, but not for everyone

Chevron's quarter was cleaner. Adjusted earnings per share came in at $6.06, topping the analyst consensus of $5.55.

US oil-and-gas production hit a quarterly record of 2.1M barrels per day, driven in part by assets acquired from Hess. Chevron also cut net debt by roughly 30% and is tracking capital expenses toward the low end of its guidance range.

Exxon's result was more mixed. Adjusted EPS of $3.52 narrowly missed the consensus of $3.56. Revenue of $116B topped expectations, and Permian Basin output hit a record 1.8M barrels per day.

Bank of America upgraded Chevron to a top pick among oil majors and refiners, while downgrading Exxon back to neutral, saying the near-term upside has likely been captured.

Citi noted that Chevron trades at a 20% discount to Exxon on a cash-flow basis despite having similar growth potential, a gap the analyst called "curious."

Where Chevron is investing the windfall

Chevron is using its strengthened balance sheet to pursue new growth in Iraq, Venezuela, and Argentina. In Venezuela, where it's the only active US oil producer, output has risen 15% over the past six months to roughly 280K barrels per day.

It's also exploring a deal for additional Iraqi production and submitted an application for a major shale project in Argentina.

Beyond traditional oil and gas, Chevron signed a 20-year deal to supply natural-gas-fired power to Microsoft for data centers. CFO Eimear Bonner cautioned against reading the current windfall as a strategy shift. "Energy's cyclical, and our business has to perform through the highs and the lows," she said.

Exxon, meanwhile, used part of its Q2 cash to cut net debt by $7B. CFO Hansen said the company isn't in a rush to do deals but "we're always looking," calling Exxon's position one where it can be "very picky, very patient."

The political backdrop adds a layer of risk. Democrats in Congress introduced bills to impose a per-barrel windfall profits tax on companies producing or importing at least 300K barrels per day in 2025.

Exxon CEO Darren Woods warned the measure could curtail future investment, pointing to prior decisions to cancel European projects after similar taxes were enacted there.