Increasing adoption of electric vehicles and renewable-energy technologies has fueled worries that demand for oil may be nearing its peak. At the moment, however, the need for crude is stronger than it has ever been. In fact, instead of cooling off after a banner year, demand growth has come in hotter than expected so far in 2018, keeping the price of crude higher than many anticipated. If that trend continues, oil producers could reap a windfall of profits this year, and make their investors a lot of money.
Drilling down into the latest demand forecast
The International Energy Agency (IEA) recently released its monthly report on the oil market. What stood out was its outlook for demand, which it sees increasing to an average 99.3 million barrels per day this year, up by 1.5 million BPD from last year's average. That increase is worth noting -- it's about 90,000 BPD higher than the IEA's forecast last month.
Fueling that upward revision has been stronger-than-expected demand growth in China and India, which combined to account for nearly 50% of the incremental demand last year. Add in the impact of frigid temperatures across parts of the northern hemisphere, fueling an increase in heating demand, and the global thirst for oil is at an all-time high. That's one reason crude prices are about 20% above where they were this time last year.
Another factor fueling those higher oil prices is that supplies are currently lower than demand, averaging 97.0 million BPD last month. However, that's by design: OPEC is holding back some of its output to help drain off the excess oil sitting in storage tanks, which had filled up in recent years because producers had pumped more than the market needed. In fact, oil storage levels remain more than 50 million barrels above the five-year average. That number should fall back to a more normal level this year, though, as long as demand stays strong and producers don't turn more pumps back on.
It's a delicate balance, but enough to produce monster profits
The latest IEA report found that, thanks to red-hot demand, oil industry fundamentals are largely balanced. As long as they stay that way, oil prices should remain at or above their current levels, above $60 a barrel. That's an ideal price point for large U.S. oil producers, which spent most of the past few years reducing their costs so that they could thrive on oil prices around $50 a barrel.
With crude well above that point, many producers are on pace to reap a windfall of profits this year; several anticipate that they can generate significant excess cash at current prices. One of those companies is shale leader EOG Resources (EOG -3.90%), which currently estimates that it can produce a whopping $1.5 billion in free cash flow this year with oil at $60. EOG Resources already allocated some of that anticipated windfall, announcing plans to boost its dividend 10% this year and to pay off an upcoming $350 million debt maturity. Beyond that, EOG appears content to let any extra cash pile up on its balance sheet for the time being, potentially using it later this year to make an acquisition.
Marathon Oil (MRO -0.83%) is another producer on pace to generate substantial excess cash if crude remains above $60, anticipating that at that price point, it could produce $500 million more than it needs this year. Like EOG, Marathon hasn't made any firm plans for that money, other than to use it initially to shore up its balance sheet. However, Marathon did say it was looking at raising the dividend or making acquisitions if cash starts piling up.
Fellow shale driller Devon Energy (DVN -0.20%) also anticipates producing a gusher of excess cash this year. Initially, Devon aimed to use that money to bolster its balance sheet, but it recently announced a plan to pay off another $1 billion in debt, buy back $1 billion in stock, and raise its dividend 33%. That buyback could prove to be a major catalyst for Devon's stock, which is down more than 20% this year after the company reported disappointing fourth-quarter results last month due to some temporary issues. Similar programs have fueled big-time outperformance from rival oil stocks.
Anticipating a windfall this year
After several tough years, U.S. oil producers appear poised to finally start making money again in 2018, as briskly growing oil demand could keep crude above $60. That sets several producers up to generate much more cash than they need to expand their businesses -- allowing them to make deals, pay dividends, and buy back their beaten-down stock. Those catalysts could prove to be powerful forces fueling healthy gains in their stocks in the coming year.