Crude oil prices started off the year red hot. Oil prices rallied from less than $80 a barrel to more than $125 a barrel following Russia's invasion of Ukraine earlier this year. However, crude has cooled off considerably since this summer, steadily falling back into the low $80s on macroeconomic concerns. That more than 20% plunge in crude oil prices means oil is in a bear market.
Wall Street is very bullish on oil
Most oil market analysts believe oil prices are going much higher next year. For example, Jeff Currie, the global head of commodities for venerable investment bank Goldman Sachs, has a $110 forecast for Brent oil (the global benchmark price) in 2023. Rival investment bank Morgan Stanley agrees, expecting Brent to top the $110 a-barrel mark by the middle of next year. While others aren't quite as bullish, the consensus is that oil prices will rebound in 2023.
Analysts note several catalysts that should fuel crude's rebound in 2023. Morgan Stanley summed it up in a note to clients. The bank wrote, "We remain constructive on oil prices driven by recovering demand (China reopening, aviation recovering) amid constrained supply due to low levels of investment, risks to Russia supply, the end of SPR releases, and slowdown of U.S. shale."
The biggest catalyst is China. "The pent-up demand out of China is going to be enormous," according to comments by Energy Aspects director of research Amrita Sen in The Wall Street Journal. Sen believes "that could swing demand by at least a million barrels a day, and that could easily make the difference between an oil price forecast of $95 to $105 versus $120 to $130."
Meanwhile, most oil companies plan to continue keeping a relatively firm lid on investment spending and output. For example, while oil giant Chevron (CVX -0.41%) plans to boost its capital budget by 25% next year to $17 billion, most of that increase is due to inflation and a ramp in lower-carbon investment spending. Likewise, even though ExxonMobil (XOM -0.95%) plans to boost capital spending from $22 billion this year to $23 billion-$25 billion in 2023, it expects its production will remain flat at around 3.7 million barrels of oil equivalent per day. With demand poised to rise amid continued tight supplies, oil prices seem primed to rally.
A boon for oil stocks
This outlook for higher oil prices bodes well for oil companies in 2023. It will enable them to continue producing strong earnings and cash flow. Meanwhile, with most oil companies limiting investment spending, they'll have more money to return to their shareholders via buybacks and dividends.
Oil giants Chevron and ExxonMobil are well positioned to capitalize on higher crude oil prices next year. However, three other producers stand out as even more compelling buys right now. One of them is Marathon Oil (MRO -0.43%). It trades at a bottom-of-the-barrel valuation compared to its peers (the higher the free cash flow (FCF) yield, the lower the price-to-free-cash-flow ratio):
Because of that, Marathon Oil has been using its oil-fueled windfall this year to gobble up its dirt cheap stock. The oil company has already retired 20% of its outstanding shares. It also used its oil-fueled cash flows to buy Ensign Natural Resources for $3 billion. That deal will boost its free cash flow by 15%, assuming recent oil prices, and by an even greater percentage if oil prices soar. That deal could give Marathon more fuel to buy back stock next year.
Diamondback Energy (FANG -0.76%) is another dirt cheap oil stock. That's a big reason it offers investors a high dividend yield, which is currently over 6.5%. The other reason is its variable dividend strategy. What's noteworthy is that Diamondback has shifted its capital allocation strategy over the past quarter, paying out a lower variable dividend so it can buy back more of its shares. The company could continue to pay a big-time dividend and gobble up more of its stock next year. It's in an even better position to capitalize on higher oil prices after recently agreeing to spend $3.3 billion to buy two cash-gushing oil companies. Those deals position it to produce even more free cash next year.
Finally, analysts see a nearly 60% upside potential in Devon Energy (DVN -0.11%). They point to its strong balance sheet, extensive drilling inventory, and variable dividend framework. Another upside catalyst is that Devon recently closed two deals that it expects will boost its cash flow by 25% in the fourth quarter. Those acquisitions put it in an even better position to capitalize on higher oil prices next year.
High-upside oil stocks
Oil appears primed to rally sharply in 2023. While higher prices would benefit all oil stocks, Marathon, Diamondback, and Devon stand out as best positioned to capitalize on higher crude prices. All three recently made cash-gushing acquisitions, which could give them even more money to buy back their cheap stocks and pay dividends. That makes them the top oil stocks to buy heading into 2023.