Last year was a confounding one for the energy sector. Crude prices bounced back from their sell-off toward the end of 2018, with the U.S. oil benchmark, WTI, surging more than 34% on the year, closing above $61 a barrel. Energy stocks, however, meandered along. The average one in the Vanguard Energy ETF -- an exchange-traded fund that holds more than 140 energy stocks -- rose only about 6% on the year. That means my bold predictions for 2019 fell a bit short.
This year, however, feels as if it could finally be the energy sector's year. The industry has made lots of changes so that it can do a better job of creating value for investors. As such, I see big things ahead for the oil stocks in 2020.
Crude prices continue rallying, spending most of the year in the $70s
While oil prices ended the year on a high note, they were off their highs for the year. West Texas intermediate topped out above $65 a barrel while the global benchmark, Brent, nearly hit $75 a barrel. However, concerns that demand was slowing down cooled off prices.
Producers have worked to counterbalance the consumption concerns by trimming supply. OPEC and its partners agreed to reduce their output further in the early part of 2020 to help burn off some excess inventory. Meanwhile, drillers in the U.S. have tapped the brakes on their activity levels so that they can produce excess cash to return to their investors via dividends and share buybacks.
Add to that the potential for increased tensions in the Middle East -- just recently the U.S. executed a drone strike on an Iranian general -- and crude prices should continue rising in 2020. My bold prediction is that Brent, which currently is around $69 a barrel, will spend most of the year above $70.
Offshore drillers bounce back big time
Offshore drilling stocks have struggled mightily since crude lost its grip on triple-digit pricing about five years ago. Several companies declared bankruptcy, while many others joined forces to cut costs.
Optimism, however, finally started returning to the sector last year as real signs of a recovery emerged. That pickup in industry activity levels, unfortunately, didn't help boost offshore drilling stocks, most of which continued plunging last year:
This year, however, should be a different story. Industry executives have noticed that customer interest in leasing new drilling rigs is improving. The CEO of Transocean (NYSE:RIG), for example, noted on the driller's third-quarter conference call that "as we look at contracting offshore, we are pleased to observe that the recovery is certainly upon us." The company now plans to stop operating its vessels at money-losing rates to keep them working. Moves like that should boost the sector's profitability, which could fuel a big-time rally in offshore drilling stocks.
My bold prediction is that several offshore drilling stocks more than double in the coming year.
More companies abandon the MLP market
Master limited partnerships (MLPs) were popular with yield-seeking investors until the sector ran into trouble during the oil market downturn. Many investors abandoned the vehicle, as the tax advantages weren't worth the headaches. As a result, many energy companies bought back their MLPs, while others converted into corporations.
While several large MLPs remain, the list will probably shrink considerably in 2020. An activist investor is already pressuring MLPX (NYSE:MPLX) parent Marathon Petroleum (NYSE:MPC) to convert it into a corporation, to help narrow the valuation discount between the MLP and large pipeline corporations. Meanwhile, leading MLP Enterprise Products Partners (NYSE:EPD) admitted that the model might not be sustainable and that the company could have no choice but to join its peers and convert into a corporation. Given the widening valuation discount between MLPs and pipeline corporations, investors can expect a wave of transactions in the midstream sector as more MLPs make the switch by either converting into a corporation or accepting a buyout offer from either their sponsor or a third-party.
There are currently 32 MLPs in the Alerian MLP Index, which have a combined market capitalization of around $250 billion. My bold prediction is that the MLP market will shrink by 50% over the coming year as several more companies abandon the vehicle, led by MPLX.
2020 looks to good be a good year for oil stocks
Oil prices are entering 2020 on their best footing in years, and with the support of OPEC and the expected slowdown of the U.S. shale industry, prices appear poised to keep pushing higher. That uptick, when combined with improving market conditions, should drive big gains in offshore drilling stocks. Meanwhile, the midstream market could get a lift from continued consolidation and conversion in the sector. This year therefore looks as if it could finally be the year when investing in oil stocks pays off.