Oil Stock Gains in 2H 2022

As crude oil prices cool slightly, value remains high for select large caps

Russia’s invasion of Ukraine in late-February 2022 sent oil prices through the roof… spiking to an interim high of $139 per barrel in early-March and sending gasoline prices to record highs across the United States.

The last time we saw something like that was in July 2008 when crude set an all-time high of $147 per barrel amid global supply worries, growing tensions over Iran, and a weak US currency.

The situation is starkly different in today’s macro environment with a strong US dollar and a highly hawkish Fed. 

With the prospects for a long, drawn out war in Ukraine — coupled with the arrival of what promises to be a very busy summer travel season amid constrained global refinery capacity — we expect crude oil prices to remain in a relatively tight $95 - $115 per barrel range over the next few months, with a slight bias to the downside as slowing growth manifests in the US.

 

What About Oil Demand?

Although choppy, oil demand looks to be robust for the remainder of 2022.

Even with inflation at 40-year highs, the summer 2022 travel season looks to be exceedingly strong, particularly with this being the first summer in two years without significant travel restrictions in place. 

COVID lockdowns in China have somewhat cooled oil demand in that part of the world but we see that as being temporary. 

A newly-released report by OPEC maintained its forecast of world oil demand rising by 3.36 million barrels per day (bpd) in 2022 — extending a recovery from 2020’s COVID-induced slump.

The report expects world oil consumption to surpass the 100 million bpd mark in the third quarter, in-line with earlier projections, and for the 2022 average to reach 100.29 million bpd, just above the pre-pandemic rate in 2019.

 

Choppy Output Amid Constrained Refinery Capacity

OPEC and its allies — which include Russia, known as OPEC+ — are ramping up output in monthly increments following record cuts that were put in place during the height of the pandemic.

At its most recent meeting on 2 June 2022, OPEC+ increased crude production to offset Russian losses and ‘smooth the way’ for a visit to Saudi Arabia by US President Joe Biden despite ongoing fallout from the Jamal Khashoggi situation.

Still, OPEC+ has been undershooting the increases due to underinvestment in oilfields by some OPEC members and, more recently, losses in Russian output primarily as a result of sanctions imposed by the West.

OPEC's report showed that trend continued in May and said OPEC output fell by 176,000 bpd to 28.51 million bpd due to losses in Libya, Nigeria, and other countries.

The growth forecast for non-OPEC supply in 2022 was reduced by 300,000 bpd to 2.1 million bpd. OPEC cut its forecast for Russian output by 250,000 bpd and left its US output growth estimate steady.

OPEC expects supply of US tight oil — another term for shale — to rise by 880,000 bpd in 2022 despite high prices which, in previous years, have encouraged growth.

On the refinery front, oil refiners worldwide are struggling to meet global demand for gasoline and diesel, exacerbating high fuel prices and aggravating shortages.

Adding to record high fuel prices in the US, the capacity to refine crude into fuel and other products here at home fell below 18 million bpd at the beginning of 2022 — representing a drop of more than 1 million bpd versus 2020 levels and reaching the lowest level in 8 years. 

 

How to Best Play the Oil Market in 2H 2022

Several factors, including Russia’ invasion of Ukraine and COVID-related supply chain bottlenecks, converged to send crude oil prices above $135 per barrel in Q1 2022. 

Oil is now hovering right around $110 per barrel — or almost double where it was just one year ago.

From our vantage point, we expect select large caps with proper diversification to continue to outperform broader markets in the current high oil-price environment.


ExxonMobil Corp. (NYSE: XOM)  

We particularly like some of the top dividend paying companies such as Irving, Texas-based ExxonMobil Corp. (NYSE: XOM). 

ExxonMobil is an integrated energy firm that has grown to become a leader in almost every aspect of the energy and petrochemical manufacturing sector. 

That includes both upstream (exploration and production) and downstream (manufacturing, refining, and distribution) segments as well as a chemicals segment. 

That diversification aids in softening the blow of the industry’s wild price gyrations since downstream businesses tend to benefit when oil prices are low while upstream businesses tend to prosper when they're high. 

At present, ExxonMobil’s downstream segment generates the most revenue while its upstream segment generates the most profit.

ExxonMobil also pays a strong quarterly cash dividend of $0.88 per share (~4.2% divided yield) and has increased its dividend annually for roughly four decades.

Shareholders can opt for a DRIP (Dividend Reinvestment Plan) wherein they can automatically have their cash dividends reinvested in additional, or fractional, shares of the company on the dividend payment date. 

 

Marathon Petroleum Corp. (NASDAQ: MPC)  

From the downstream market segment, we like Findlay, Ohio-based Marathon Petroleum Corporation (NASDAQ: MPC).

Marathon pays a solid quarterly cash dividend of $0.58 per share (~2.7% divided yield), which can be converted into a DRIP.

In the petroleum sector, the refining process can take place either in the midstream or downstream market segment. 

In the case of Marathon, the company is a leading integrated downstream energy company that operates the nation’s largest refining system with 13 refineries and 2.9 million barrels per day of refining capacity. 

The company’s refineries are integrated via pipelines, terminals, and barges to maximize operating efficiency. That allows the company to utilize its processing capacity to optimize operations and produce higher margin products while offsetting some of the increased operating expenses resulting from ongoing supply chain bottlenecks. 

Marathon’s marketing system includes 6,900 independently owned retail outlets across the United States.

Marathon also owns the general partner and majority limited partner interest in MPLX LP — a midstream company focused primarily on the transport, storage, and distribution of crude oil and refined products. 

As primarily a downstream energy company with a substantial midstream component, Marathon Petroleum remains highly flexible, making it uniquely positioned to capitalize on the current oil-price environment amid persistent supply chain disruptions brought on by the pandemic and exacerbated by Russia’s invasion of Ukraine. 

 

Long and Short ETFs

To play the direction of oil’s price to the up or downside in the short-term, you might look at leveraged ETFs designed to reflect twice the daily price movement of the oil and gas exploration and production subsector.

Using our expected range of $95 to $115 for the next six months, you could go long near the low end and short near the high end. 

The Direxion Daily S&P Oil & Gas Exp. & Prod. Bull (NYSE: GUSH) is designed to deliver 200%  to the upside. 

The Direxion Daily S&P Oil & Gas Exp. & Prod. Bear (NYSE: DRIP) is designed to deliver 200% of the inverse of the downside. 

Two important notes: 

  1. These funds do not track oil’s price. Their underlying index is the S&P Oil & Gas Exploration & Production Select Industry Index, which generally moves higher or lower with oil prices.
     
  2. These would be short-term trades not to be held more than a week or two.

 

Wrapping Up… 

Our flagship broad market monthly premium newsletter, Foundational Profits, turned bullish on oil and select oil stocks in late-2020 when oil was around a third of where it’s trading today.

We warned of the impending “Return to $100+ Oil” and positioned our readers accordingly. 

We bought oil stocks when oil was trading close to $40 per barrel and held them for a year until it was closer to $85 per barrel. 

We did that first via the Energy Select Sector SPDR Fund (NYSE: XLE) and then with the SPDR Oil & Gas ETF (NYSE: XOP) — owning one or both of them from November 2020 through December 2021, and harnessing the bulk of the inflationary move in energy that most government officials and pundits said was “transitory” until very recently. 

And although we couldn’t predict an outbreak of war in Europe, our forecast for rising oil prices proved highly accurate and lucrative.

So what’s next in the oil space? 

We are anticipating choppy trade in the oil sector over the summer months followed by a slight cooling off period as we head into the fall and winter seasons, despite ongoing concerns over constricted refinery capacity both at home and abroad. 

As noted, we still see plenty of long-term value upside in select diversified large-caps with robust dividends. 

Some of that upside will be tempered slightly due to the increased likelihood of a recession hitting the US economy in the second half of 2022. 

Yet, those taking a long-term value approach by establishing positions in select, well-diversified oil firms with solid projects, robust dividends, and healthy balance sheets should be well-rewarded over the longer-term. 

As always, establish your positions incrementally and look for opportunities to buy the dips. 

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