Check out the latest Chesapeake Energy earnings call transcript.
This past year has been a challenging one for oil investors, as crude prices went from rebounding to their best levels in nearly five years to crashing below the comfort level of most oil companies in a matter of weeks. Even though I nailed all three of my bold predictions for 2018, investors frustratingly wouldn't have made much money after a late swoon in the market wiped away those gains.
However, I think last year's market volatility sets investors up for a potentially bigger payday during 2019 if my bold predictions come to fruition this year.
Oil supplies tighten faster than expected, sending crude back into the $80s
After starting 2018 around $60 a barrel, the price of oil peaked at more than $85 in early October before collapsing to end the year near $50. Geopolitics fueled crude's wild rise as the Trump administration promised to impose powerful tariffs on Iranian oil exports, only to grant last-minute waivers to most of that country's key buyers. Because of that, the oil supply went from being on the of deficiency to excess, which forced OPEC and several other major oil-producing countries to curb their output heading into 2019.
Despite that support, most who follow the oil market don't expect crude prices to rebound all that much in the coming year, with many forecasting that crude will average about $60 a barrel. However, I think crude will surprise to the upside again this year and top $80 a barrel before the year ends.
Several factors drive that view. First, not only did OPEC and several nonmember nations pledge to reduce their production for 2019, but Canada's top oil-producing province mandated that producers reduce supplies by 8.7% to help ease that region's glut due to a lack of pipeline capacity. Meanwhile, places like Nigeria, Libya, and Venezuela could see renewed production outages in 2019. Combine those supply headwinds with the possibility that demand could grow faster than anticipated if the global economy reaccelerates, and oil could rebound sharply in 2019.
Midstream stocks deliver market-smashing returns
Midstream companies have underperformed the market over the past few years, with the Alerian Energy Infrastructure ETF losing more than 20% of its value in 2018. That slump comes even though these companies are largely immune to changes in commodity prices, since most make their money by collecting fees as oil and gas pass through their systems. Thanks to that structure, many are making as much money, if not more, now as they were when crude was in the triple digits.
Take oil pipeline company Plains All American Pipeline (PAA 1.86%), which expects to haul in more than $2.8 billion in earnings during 2019, 10% more than last year and more than 20% above what it earned during the boom years. However, despite that improved profitability and the steps the company has taken to enhance its balance sheet, Plains All American Pipeline has lost nearly two-thirds of its value since the peak.
It's a similar story across much of the sector, which is why most midstream stocks trade at dirt-cheap valuations. However, I see that trend reversing in 2019, as most midstream companies have expansion projects nearing completion that should boost their cash flow in the coming year. I think that growth, when combined with their much-improved financial profiles, will begin paying off in 2019 as the sector leads the way by delivering top-tier total returns in the coming year.
The Permian takes a back seat to these legacy shale plays
The Permian Basin, which stretches across much of western Texas and southeast New Mexico, has been one of the main drivers of America's oil renaissance in recent years. Oil production has grown so fast that the region's pipelines are at capacity. While companies like Plains All American Pipelines are rapidly expanding their systems to support this region's growth, many producers will need to tap the brakes on the Permian this year.
Instead, they'll likely redirect that capital into legacy plays like the Eagle Ford and Bakken shale, which I believe will be hotbeds of activity during 2019. The Eagle Ford started making headlines again toward the end of last year as Chesapeake Energy (CHKA.Q) and Denbury Resources (DNR) made bold acquisitions in the region. It appears that Chesapeake and Denbury expect the Eagle Ford to be near-term growth drivers. I anticipate that deal activity will continue heating up in 2019 as producers diversify their operations so that they have the flexibility to work around future infrastructure issues.
I think the contrarian view could pay off in 2019
Investors enter 2019 in poor spirits after bears mauled the market at the end of 2018. Because of that, I think most have a dour view on the coming year because they're focused on what could go wrong. I, on the other hand, see this year ending up being much better than it will begin. That's why I believe investors should consider making a contrarian bet on oil stocks, especially those in the midstream sector, which could deliver market-crushing returns in 2019 as they bounce back from 2018's sell-off.