Oil Price Forecast

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dan_s
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Joined: Fri Apr 23, 2010 8:22 am

Oil Price Forecast

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Oil Prices Are Primed to Rally -- It's Time to Buy the Dip
By Matthew DiLallo written for Motley Fool < One of his Top Picks is Devon Energy (DVN)

The International Energy Agency's latest oil market report is very bullish for oil stocks.
Oil prices have gone on a roller-coaster ride this year. Brent, which is the global oil benchmark, has bounced around between the low $70s and high $80s. However, crude oil appears primed for a breakout rally during the second half.

The International Energy Agency's (IEA) oil market outlook fuels that view. The firm recently released its May report, which noted that global oil demand is stronger than expected. With expectations for muted supply, oil prices could heat up this summer, which would be a boon for oil stocks.

Drilling down into the IEA's latest oil market report
The IEA now forecasts global oil demand to grow by 2.2 million barrels per day (BPD) in 2023, averaging 102 million BPD. That's 200,000 BPD higher than its forecast last month. The IEA noted, "China's demand recovery continues to surpass expectations, with the country setting an all-time record in March at 16 million BPD."

Meanwhile, supplies remain under pressure. The IEA pointed out that there have been significant outages in Iraq, Nigeria, and Brazil. Supplies are facing additional headwinds this month as wildfires in Canada are causing the industry to shut in some production. On top of that, OPEC+ unveiled an extra production cut last month that went into effect in May.

Despite all this, oil prices have declined by more than $15 a barrel in the past few weeks on continued pessimism that the global economy is barreling toward a recession. Those macroeconomic concerns are driving worries that global oil demand growth could slow.

"The current market pessimism, however," wrote the IEA, "stands in stark contrast to the tighter market balances we anticipate in the second half of the year, when demand is expected to eclipse supply by almost 2 million BPD." That significant gap between supply and demand will likely drive oil prices skyward.

Primed to rally following the recent dip
Higher oil prices would benefit oil companies and their investors, given the correlation between crude and oil stock prices:

Oil stocks rallied as crude prices recovered from their pandemic-driven low to their peak following Russia's invasion of Ukraine last year. However, they've dipped with oil prices over the past several months. Given that correlation, a rally in oil prices this summer would likely drive a rebound in oil stock prices.

The rising tide of higher oil prices would lift all boats. However, some oil stocks appear poised to deliver outsized gains in the next rally because of their bottom-of-the-barrel performance relative to their peers as oil sold off in recent months:

Devon Energy (DVN) and APA Corp (APA) have been the worst performers among oil and gas producers in the S&P 500.

A big factor weighing on Devon Energy has been its declining dividend payment. The company's dividend has fallen for three straight quarters. The recent one was its lowest since late 2021.

That was due to the company's fixed-plus-variable dividend framework, which sees it pay a base quarterly dividend and 50% of its excess cash via variable dividends. With lower oil prices weighing on its free cash, Devon has had less money to pay variable dividends. However, if oil prices rally, Devon Energy's dividend would reverse course, which could send its shares higher.
MY TAKE: Devon and several of our model portfolio companies have increased their stock repurchase programs instead of paying high dividends. Insiders at Devon have also been buying DVN. My current valuation is $67.00/share.

APA Corp has also seen its free cash flow fall with oil prices. The company only produced $272 million of free cash flow in the first quarter. That's a big drop for a company that generated nearly $2.5 billion in free cash in 2022. Because of that, the company had less money to return value to investors through share repurchases and bond buybacks.

APA could only buy back $142 million of its stock during the first quarter after repurchasing $1.4 billion last year. Meanwhile, it only retired $74 million of bond debt after buying back $1.4 billion of its bonds in 2022. If oil prices rally, APA Corp will have more cash to return to investors, which could fuel a rally in its stock.

Higher oil prices could give oil stocks the fuel to rally
Over the past year, oil prices have cooled off on macroeconomic concerns, causing oil stocks to follow them lower. However, oil appears poised to heat back up this summer as demand begins to outstrip supply.

That catalyst would likely drive oil stocks higher. It would enable oil companies to produce more cash to return to their investors. Because of that, now looks like a great time to buy the dip in oil stocks before they rally.
Dan Steffens
Energy Prospectus Group
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