Oil has been moving at a torrid pace over the past year, rising from under $50 a barrel to more than $70. While it took a breather over the last month, crude quickly resumed its ascent after OPEC's production hike wasn't as much as feared. That's because new concerns have started arising that the boost won't be enough to offset a growing list of supply concerns.
These new worries could drive oil prices much higher than their current mid-$70 level over the next several months, with analysts at Bank of America/Merrill Lynch believing crude could hit $90 a barrel by early next year. That would be very bullish for oil stocks.
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Drilling down into the scenario
After being awash in oil for the last few years, crude supplies are shrinking fast. Production in Venezuela is in free-fall because of the country's increasing economic instability. After producing 2.3 million barrels per day (BPD) in early 2016, output was only 1.6 million BPD earlier this year and could fall by another half-million BPD in the coming months. Meanwhile, oil supplies in Libya have been under attack because of that country's continued civil unrest. On top of that, a power outage at the Syncrude oil sands facility in Canada will keep the 360,000 BPD complex offline until the end of July.
More supplies could be coming offline soon. The U.S. is demanding that countries stop importing oil from Iran by November as part of a new round of sanctions. While it's unclear yet how much oil will come off the market, one analyst thought the sanctions could remove as many as 700,000 BPD. Meanwhile, pipeline constraints in Western Texas will make it harder for U.S. oil producers to increase output in the Permian Basin that much further until the end of next year, when new pipelines come online.
These factors led Bank of America to conclude that "we are in a very attractive oil price environment." In its view, "oil will hit $90 by the end of the second quarter of next year."
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The gusher few saw coming
That prediction would have been unfathomable just a few months ago. While some oil bulls thought prices could surprise to the upside, the consensus outlook was that crude would be in the low to mid $50s this year thanks to surging U.S. oil production. Because of that, most producers based their budgets on oil averaging $50 a barrel, including EOG Resources (EOG 0.78%), Marathon Oil (MRO 0.09%), and Anadarko Petroleum (APC). In EOG Resources' case, $50 oil would provide it with the cash flow to pay a dividend that was 10.4% higher than 2017's level and drill 690 more wells, which would boost oil production about 18%. Meanwhile, Marathon Oil could produce enough cash at that price point to pay its dividend and fund the new wells needed to boost companywide output 12% compared to last year. Anadarko Petroleum, likewise, could fully fund its dividend and a growth-focused capital plan, which would see it boost oil output 14% this year.
Because this oil-producing trio set their budgets for $50 oil, they stand to generate significant free cash at oil prices above that level. All three provided investors with a glimpse of that potential by forecasting what they could do at $60 a barrel, with Marathon saying it would produce $500 million in free cash, Anadarko anticipating more than $800 million, and EOG predicting that it could haul in $1.5 billion in excess cash at that price point. Those numbers, meanwhile, would rise alongside the price of crude, positioning them to produce an absolute gusher if crude does top $90 a barrel. That would provide them with a boatload of money to use as they wish, including buying back stock, paying higher dividends, retiring debt, and investing in expansion projects.
A great time to consider oil stocks
With most oil producers aiming to run their business on $50 oil this year, they're cashing in on the current surge in crude prices and would reap an even bigger windfall if crude hits $90 a barrel. That outlook suggests that oil stocks could have much further to run, which makes now a good time to consider buying a top oil stock to profit from what appears to be a "very attractive oil price environment."
