adminWhat OPEC giveth, OPEC can also take away. That, in a nutshell, is the problem for most oil stocks heading into 2024.
The oil market is currently being propped up by OPEC’s production cuts, which have kept prices high and allowed American producers to keep drilling without fear that they’ll flood the market and cause prices to plunge. But OPEC’s cuts are considered by many investors to be artificial support for an oversupplied market.
OPEC could just as easily withdraw its support, and send prices sharply lower. That is the biggest reason 2024 is shaping up as a difficult year for the energy sector and one factor driving more investors to bet against oil stocks.
Energy went from the best-performing sector in the
S&P 500
in 2022 to the second-worst in 2023, beating only utility stocks. The sector is down 3.5% in 2023, versus a 24% gain for the S&P 500.
Earnings are on track to fall 28.2% from 2022 levels, according to CFRA, while they are projected to grow just 3.5% in 2024.
Yet on some metrics, energy stocks still look attractive. The stocks are trading at 11 times their expected earnings over the next four quarters, making energy the cheapest sector by far, at about half as expensive as the broader market. Energy companies’ balance sheets are in good shape, and big players like
Exxon Mobil
have been boosting their dividends. But given the sector’s tepid earnings growth expectations, their valuations—the amount investors are willing to pay for those profits—will need to rise for investors to be rewarded.
The wild card is energy prices. If a shock internationally causes prices to rise, it would benefit the stocks. The Israel-Hamas and Russia-Ukraine wars could still rattle markets.
Otherwise, the outlook for oil prices next year is highly dependent on OPEC, whose attempts to control the market have lately stopped working. In addition, OPEC risks losing members if it continues to push them to hold back their exports. Angola, one of Africa’s largest oil producers, decided to leave the cartel on Thursday.
Entering 2024, OPEC has committed to substantial cuts that will be hard to unwind. OPEC and allies including Russia, who together control about half the global oil market, agreed in late November to extend production cuts through at least the first quarter of 2024. In total, the cuts are expected to keep more than 5 million barrels of oil, or 5% of global supplies, off the market through the first quarter. Most of that reduction is expected to continue through the end of the year.
OPEC’s strategy has helped the stocks of independent oil producers like Exxon and
Chevron,
which are poised to take market share from large national oil companies. Both announced big acquisitions in 2023 and have plans to ramp up production in the next two years.
But investors have historically been wary of oil when so much supply is available, sitting on the sidelines. “History is unkind to oil equities when there is spare capacity in the system,” wrote
Citi
analyst Alastair Syme.
“Since 2000, in 9 out of the 10 years in which spare capacity has been above 3 million barrels of oil per day, oil equities have underperformed the market. We forecast 4 million barrels of oil per day of spare capacity in 2024,” he said.
The one exception was in 2022, when Russia invaded Ukraine at the same time that OPEC was cutting production, causing oil prices to jump. Citi expects oil prices to fall to the low $70s by the end of 2024.
That’s a more bearish view than most other analysts’, however. The median price target for Brent crude for 2024 is $84.80, according to Bloomberg. That implies an 8% gain from current prices.
RBC Capital Markets analyst Michael Tran is somewhat more bullish than Syme. He expects Brent to average $82.50 per barrel in 2024. But he also thinks that the direction of prices is dependent on OPEC and whether countries adhere to the cartel’s announced cuts.
“Oil has become a ‘show me’ type market,” he writes. “Prices will remain volatile and directionless until the market sees clear data points pertaining to the voluntary output cuts.”
Tran also sees problems for refiners ahead, because refining capacity is starting to grow after several years where few new refineries opened.
While the post-Covid era has been very profitable for energy companies so far, Tran expects 2024 to resemble a much more downbeat era. “Despite fewer bearish demand surprises for the year ahead, we see next year as one that more closely resembles the decade leading into COVID rather than the demand-led market in the post-pandemic era,” he writes.
The 2010s were a miserable era for energy stocks. They rose 30% even as the broader market more than tripled. The sector’s weighting in the
S&P 500
fell from nearly 15% to 5%.
That doesn’t mean there will be no investment opportunities in oil in the year ahead. Even in the 2010s, several oil stocks outperformed. Shale-oil producer
Diamondback Energy,
for instance, quintupled in that era.
For 2024, Morgan Stanley analyst Devin McDermott likes stocks that can increase their free cash flow and have significant scale. His top picks are
ConocoPhillips,
Occidental Petroleum,
Diamondback,
Devon Energy,
and
Cenovus Energy.
Citigroup analyst Scott Gruber also sees opportunities in oil, particularly for stocks that can become more efficient through technological innovations such as drilling horizontally in shale for long distances. His favorite names include Coterra Energy, Ovintiv, Permian Resources, and
Chord Energy.
Natural gas could be in a better position than oil next year. Gas prices are likely to rise later in 2024, because the U.S. is building export terminals to ship more gas to Europe and Asia. Growing exports should help U.S. producers.
The average price target among analysts for natural gas in 2024 is $3.35 per million British Thermal Units, according to Bloomberg. That implies significant gains, given that current prices are around $2.50. Gruber’s favorite natural gas stocks for 2024 are
EQT
and
Southwestern Energy.
Write to Avi Salzman at [email protected]
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