Can Oil Stocks Bounce Back In 2021

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There’s no way to sugar coat things; 2020 was an abysmal year for the oil market. Crude oil prices are on track to decline more than 20% on the year, though that doesn’t even begin to tell the story considering that oil prices crashed into negative territory at one point in the year. Given all the turbulence in the oil market, it’s no surprise that oil stocks struggled, with the average one in the S&P Oil & Gas E&P ETF losing nearly 40% of its value.

However, we’ll soon turn the page on a year that many can’t wait to forget. With each new year bringing a fresh dose of optimism, here’s a look at whether oil stocks can rebound from their rough patch in 2021.

An offshore oil rig platform with the sun rising on a frozen sea.

Demand recovery ahead
The biggest weight on the oil market in 2020 was demand, which fell off a cliff because of the COVID-19 outbreak. According to the U.S. Energy Information Administration (EIA), the global economy is on track to consume an average of 92.4 million barrels per day (BPD) of oil and other liquid fuels this year. That’s a significant decline from its average of more than 100 million BPD in 2018 and 2019.

The outlook for 2021 is quite a bit brighter. The EIA sees global fuel demand recovering to an average of nearly 98.2 million BPD in 2021. Meanwhile, the International Energy Agency (IEA) anticipates that oil consumption will average about 96.9 million barrels per day. That’s a 5.7 million BPD increase from 2020’s average or about two-thirds of the lost demand. Further, it sees robust demand for gasoline and diesel, which it believes will return to about 99% of their pre-COVID levels.

However, while consumption is on track to recover close to its pre-COVID level, there’s a massive amount of excess supply sitting in oil storage tanks around the world. According to the IEA, there are about 625 million more barrels of crude oil in storage than before the pandemic. It could take the economy a year to burn off all this excess inventory, given the IEA’s demand projection and production estimates for OPEC and other producers.

That supply overhang will likely keep a lid on oil prices in 2021. In the EIA’s view, the global benchmark price, Brent, will average around $49 a barrel next year, which isn’t much higher than its expected average of $43 a barrel for the current quarter. It sees oil starting the year around $47 and eventually topping out at an average of around $50 by the fourth quarter of 2021.

What this means for oil stocks
Neither forecast is overly bullish for oil stocks. While demand should recover sharply, the current glut of supply will sop up much of that incremental consumption. On top of that, there are risks to both supply and demand. On the consumption side, it could take longer to roll out vaccinations worldwide due to potential production issues, adverse side effects, trial failures, and resistance, which could impact the economic recovery and weigh on demand. Meanwhile, OPEC might bring back production too soon, which would keep inventory levels elevated, weighing on oil prices.

Given all this uncertainty, oil companies are taking an extremely cautious approach to 2021. Oil giants like ExxonMobil (NYSE:XOM) and Chevron (NYSE:CVX) have already pledged to keep spending down in the coming year. Exxon plans to invest $16 billion to $19 billion into capital projects in 2021. That’s down from its 2020 budget of $23 billion, which was $10 billion below its initial spending plan. Meanwhile, Chevron only expects to invest about $14 billion next year. That’s below the $16 billion it planned to spend this year, which doesn’t include the capital spending of Noble Energy that it acquired in 2020.

In addition to cutting investment spending, most oil companies are focused on reducing costs in 2021 by growing their scale through mergers. Chevron kicked off the current merger wave by acquiring Noble for $13 billion in July, driven in part by the anticipation that it can capture $300 million in cost savings. Other notable deals included ConocoPhillips’ (NYSE:COP) $9.7 billion tie-up with Concho Resources (NYSE:CXO) and Pioneer Natural Resources’ (NYSE:PXD) $7.6 billion purchase of Parsley Energy (NYSE:PE). More deals are likely in 2021 as the industry consolidates to survive oil price volatility and the continued threat of renewable energy.

On a more positive note, these cost-cutting moves could pay big dividends in 2021. If oil prices improve to around $50 a barrel, and these oil companies achieve their cost-reduction targets, they could generate a gusher of excess cash in the coming year. That could give them the funds to repay debt and buy back their beaten-down stock.

2021 could be a bumpy year for oil stocks
Oil consumption should recover most of what it lost this year, which, thanks to OPEC’s help keeping back supplies, should enable the oil industry to burn off its current glut by the end of 2021. That should take some of the pressure off of oil prices. Add that to the cost-cutting initiatives across the sector, and oil stocks could rebound this year.

However, it likely won’t be smooth sailing. The sector could face renewed selling pressure if vaccines don’t roll out quickly enough or supplies rise faster than anticipated. Investors should buckle in for what could be a bumpy ride.

– The Montey Fool

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