OPEC members, along with several non-member allies, agreed this week to reduce their oil supplies by an additional 500,000 barrels per day (BPD) starting in January. This cut is on top of an output curb of 1.2 million BPD the group agreed to in October of 2018.
This is a positive development for the oil market as it will help keep supplies at or below demand, which has been growing at a slower pace because of the trade war between the U.S. and China. The output reduction should help burn off some of the excess oil that has been piling up in storage as a result of fast-paced production growth in the U.S. As such, it could provide a further boost to crude prices, which have already rallied about 7% this week.
What this news means for the oil market
Crude prices in the U.S. have bounced back this week in anticipation that OPEC might further reduce its output. WTI, the U.S. oil benchmark, has now pushed back above $59 a barrel, which is its highest level since it spiked in September following a drone attack on a Saudi Arabian oil facility.
Oil could have further to run now that OPEC has made its plans official. The supply cut should cause global oil storage levels to fall, which usually boosts prices. Of course, that's assuming demand continues growing as anticipated, and supplies from outside of the OPEC consortium don't grow faster than expected.
There's a reason to be optimistic in both cases. The U.S. and China are reportedly close to solving their trade dispute, which would be a positive development for the global economy and oil demand. Meanwhile, most oil companies in the U.S. plan to reduce their spending on drilling new wells next year due to all the volatility in the oil market. Because of those factors, oil prices could drift into the $60s in the coming months, which would be great news for oil producers.
Cashing in on OPEC's news
If oil prices do push back up into the $60s, it will benefit the entire sector since oil companies would produce more cash flow. Among the biggest beneficiaries would be those with the lowest costs since they'd generate more cash.
U.S.-focused oil producer Devon Energy (NYSE:DVN), for example, only needs oil to average $48 next year to support its spending plans. At that price point, it can pay its dividend and fund its capital spending plan, drilling enough new wells to grow its oil production by 7% to 9%. As a result, it will generate an increasing supply of excess cash if oil is above that level. If crude averages around $60, Devon Energy could produce $675 million in excess cash. To put that into perspective, if it used that money to repurchase shares, it could retire 8.8% of its outstanding stock at the current price.
Diamondback Energy (NASDAQ:FANG), likewise, can produce a gusher of free cash flow next year if oil is in the $60s. The company's current business plan would see it generate enough cash at $45 a barrel to pay its dividend and fund the new wells needed to grow its oil production by 10% to 15% year over year. Meanwhile, at $55 a barrel, it can produce $675 million of pre-dividend free cash next year. That's enough money to retire 5% of its outstanding shares at the current stock price via its repurchase program.
Several other drillers are also set up to generate a lot of free cash if crude prices are over $50 a barrel next year. Both Marathon Oil (NYSE:MRO) and ConocoPhillips (NYSE:COP) are using that oil price level for their 2020 budgets. Both can pay their current dividends and fund their capital programs at that price point. Thus, they're on track to generate significant free cash if oil is in the $60s that they'll return to shareholders via their stock repurchase programs. ConocoPhillips has already said it will spend $3 billion on repurchases next year, using its cash balance if necessary. Meanwhile, Marathon recently boosted its buyback authorization so that it now has $1.45 billion available.
Putting the oil market at ease
Crude prices have been bouncing all around this year due to conflicting views on supply and demand. OPEC, however, is aiming to reduce the supply concerns by further curbing its output. That should help support the price of crude oil in the coming months, which would be a boon for low-cost U.S. oil producers. That could help boost their stock prices, especially since most plan to use the money to repurchase big chunks of their outstanding stock.