The stock market has taken a breather in recent weeks following a red-hot run. Tech stocks have born the brunt of the sell-off as the tech-heavy Nasdaq Composite Index was down about 10% from its most recent high at one point, putting it near correction territory. Meanwhile, some of the market's highest flyers are down much more from their recent highs.
However, while some stocks have cooled off, energy stocks have gotten even hotter. Several are up sharply this year, fueled by higher oil prices. That upward momentum could continue if crude prices keep cooperating.
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About to be gushing cash flow
Oil prices have been scorching hot this year. West Texas intermediate, the primary U.S. oil price benchmark, is up more than 35% this year, recently topping $65 a barrel. Meanwhile, the global benchmark, Brent, is approaching $70 a barrel. Analysts think crude prices could have further to run. For example, Goldman Sachs recently boosted its Brent price target by $5 a barrel to $75 for the second quarter and $80 by the third. Fueling that view is OPEC's continued support by holding back supply and the expectation that vaccines will give demand a shot in the arm over the coming months.
This surge in oil prices is a gift for producers. Most spent the past few years driving down their costs. Now they're about to generate a gusher of free cash flow in 2021 since they plan to keep a lid on their drilling programs.
For example, Marathon Oil (MRO -2.36%) only needs WTI to average $35 a barrel this year to support its drilling program to keep its production flat with last year's level. That has it on pace to produce $1 billion in free cash flow if oil averages $50 a barrel and even more at higher prices. That upside to oil prices has given its stock the fuel to rocket roughly 95% this year. While the company plans to use about $500 million of its windfall to repay debt, it could return most of the excess to shareholders through share buybacks and higher dividends, so its stock could keep rising. It's still down almost 5% since the start of 2020, even though crude prices are near a two-year high.
Devon Energy (DVN -0.98%) is also cashing in on higher crude oil prices this year. The company needs oil to average only $32 a barrel to fund its drilling program to maintain its current production rate, so it's cashing in on higher crude prices. Devon plans to return most of its windfall to investors via its variable dividend program. It will pay out up to 50% of its excess cash flow each quarter via this framework. Its first payment was a gusher at $0.19 per share, more than double its base quarterly dividend payment. With crude prices continuing to march higher, future payments could be even bigger. That could give its stock -- which is already up more than 60% this year -- even more fuel to continue rallying since it's still down about 1% since the beginning of 2020.
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Still dirt cheap
While shares of most oil producers are up sharply this year, pipeline stocks haven't been quite as hot. But they have significant upside potential as the oil market continues its recovery, since most trade at bottom-of-the-barrel valuations.
For example, oil pipeline master limited partnership Plains All American Pipeline (PAA 0.58%) expects to generate $1.82 per share of cash flow this year. That's assuming its commodity price-sensitive supply and logistics business doesn't produce much income. While Plains All American's unit price has rallied about 18% so far this year, it's still down more than 40% since the start of 2020. Units currently trade at less than $10, implying an absurdly cheap price of about 5 times cash flow. With midstream assets typically fetching a double-digit multiple of their cash flow, Plains All American still has enormous upside potential from here, especially when adding in its 7.4% yielding dividend.
Fellow MLP Crestwood Equity Partners (CEQP) is in a similar boat. The pipeline and processing company currently expects to generate twice as much cash as it needs to cover its 9.7% yielding distribution this year. Despite rallying more than 35% this year, Crestwood's units are still down more than 15% since the start of 2020. It also trades at a dirt cheap price of around 5 times its cash flow. That's why it could have monster upside potential ahead as the energy market continues its recovery.
Red hot with more fuel to rally
Energy stocks have been scorching hot this year, thanks to surging crude oil prices. They might just be getting started since most still trade at lower prices than they did just before the pandemic, even though oil prices are near a two-year high. Energy investors could generate big-time total returns as they benefit from the sector's high yields and massive upside potential as market conditions continue recovering.
