Forecasting what might happen in the oil market in any given year seems like a fool's errand. No one foresaw a global pandemic causing oil demand to fall off a cliff in 2020, sending oil prices into negative territory at one point. Likewise, few would have predicted that oil prices would top $70 a barrel in 2021 as the industry recovered from a brutal 2020.
In short, any prediction of what might happen in the oil market seems bold. Despite the probability of being wrong, I think it's a good idea to have a thesis for what might happen in the oil market over the coming year to help guide investment decisions. With that in mind, here are three predictions for what I believe could occur in the oil market in 2022, given the way things are lining up.
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Oil prices will remain high and could top $100 a barrel
There has been a tectonic shift in the oil industry in recent years. Companies have significantly reduced capital spending on new oil projects. European oil majors like BP and TotalEnergies have shifted spending from oil and gas to renewable energy. Meanwhile, major U.S. producers have pivoted from a focus on expanding production to generating cash flow and returning it to shareholders. Because of this spending shift, the industry discovered the fewest barrels of new oil and gas resources since World War II in 2021.
Most producers plan to keep a lid on capital spending in 2022 despite the rebound in oil prices. At best, many oil producers only plan on delivering modest production growth in 2022. Meanwhile, OPEC has maintained its tight grip on supply despite surging oil prices.
With demand expected to recover to pre-pandemic levels later this year, the oil market will likely remain tight. That should keep prices high. This dynamic sets the stage for a potential price spike if the industry experiences a major supply disruption. Anything from a natural disaster in a leading oil production region to a terrorist attack on a major oil hub could cause prices to top $100 a barrel at some point this year.
The year of the dividend
With oil producers keeping a tight lid on capital spending, they're generating a gusher of free cash flow at current prices. That's giving them the cash to shore up their balance sheets and return more money to shareholders.
Producers are looking at innovative ways to send money back to shareholders. For example, Devon Energy (DVN 0.19%) launched an industry-first fixed plus variable dividend framework last year. It has distributed about 50% of its excess cash to shareholders via an additional dividend payment each quarter.
Others have followed its lead. Pioneer Natural Resources (PXD -2.28%) launched a similar framework, paying out 75% of its free cash flow in dividends. Meanwhile, EOG Resources (EOG 0.25%) paid two sizable special dividends in 2021, and ConocoPhillips (COP 0.10%) launched a variable return of cash program for 2022.
More oil companies will likely launch similar cash return strategies in 2022. Combined with higher oil prices, this strategy shift sets the stage for the oil patch to pay out a gusher of dividends in 2022.
The midstream industry goes green
With oil producers shifting from focusing on production growth to expanding cash flow, it's leaving the midstream industry with dwindling growth prospects. That's leading a growing number of energy infrastructure companies to explore new sources of growth. Their best option is to start going green.
We've already seen some movement in this direction. Natural gas pipeline giant Kinder Morgan (KMI -0.64%) launched a new energy ventures group in 2021. Its first investment was buying a renewable natural gas producer with several facilities under development. Kinder Morgan is exploring other commercial opportunities, including investing in renewable power projects. Energy Transfer (ET 0.12%) also announced an expanded effort to focus on developing alternative energy projects last year.
While the industry started small last year, I believe we'll see midstream companies begin pouring meaningful capital into alternative energy investments in 2022. Large players in the sector will likely unveil sizable projects to repurpose existing assets to handle alternative fuels and large-scale investments to expand into new infrastructure like renewable energy generating assets, hydrogen production, carbon capture and sequestration, and electric transmission. In addition, I think we'll see more acquisitions geared around building a platform for future expansion. That will help give investors more visibility into the sector's future growth, which could help snap the industry out of its doldrums.
2022 could be another big year for the oil patch
The oil industry is notoriously hard to forecast because oil prices are unpredictable. We've seen that clearly over the last two years. However, given the way things look now, it appears as if crude prices will head higher in 2022. That should give oil producers the cash to pay out an enormous amount of dividends. Meanwhile, with producers focusing on generating and returning cash, it's forcing the midstream sector to look elsewhere for growth, with going green its only alternative. If I'm right, then oil stocks could produce strong total returns again in 2022.
