Oil Prices: Is the Bear-Market Mauling Finally Over?

Oil prices have plummeted 30% since early October. The global oil benchmark, Brent, which topped $86 a barrel at the start of the fourth quarter, tumbled back down to $58 a barrel in just 37 days. Fears that there wouldn't be enough oil to meet growing demand evaporated overnight after the U.S. allowed Iran to continue exporting oil to several of its key buyers even after imposing new sanctions, and oil traders started worrying that there would be too much crude sloshing around the global market.

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The bear-market mauling of oil prices, however, could be over. At least, that's the view of the International Energy Agency (IEA) in its latest oil market report, in which it noted that actions from several major oil-producing nations could have put a floor under oil prices in the near term.

Drilling down into the oil market

The IEA's latest outlook for oil demand hasn't changed from the previous month. It still anticipates that global consumption will expand by 1.3 million barrels per day (BPD) in 2018 and another 1.4 million BPD next year. While that's a slower pace than its view from earlier in the year due to a slowing global economy, it's still healthy growth.

What has changed is the supply picture. The IEA noted that OPEC -- along with 10 nonmember nations, dubbed OPEC+ -- agreed to reduce output by 1.2 million BPD starting in January to address the growing surplus of crude on the market. In addition to that group's decision, the Canadian province of Alberta issued a mandated production cut due to that region's constrained pipeline capacity. Alberta, which sits in the heart of Canada's oil sands region, ordered its producers to cut production by 8.7% starting in January, which amounts to 325,000 BPD. That output reduction will last until regional storage levels begin draining, at which time the mandated cut will drop to an average of 95,000 BPD until the end of next year.

Those production curtailments should push supplies slightly below demand during the first quarter of next year, with the gap widening in the second quarter, which will allow the market to start burning off some of the excess inventory it built up over the past few months. The IEA noted that this would help the market achieve some sense of relative stability and bring it back toward balance. As such, the IEA stated that "the Brent crude oil price seems to have found a floor" at around $60 a barrel, while the U.S. oil benchmark, WIT, has stabilized near $52 a barrel. However, it did warn that only "time will tell how effective the new production agreement will be in rebalancing the oil market."

Digging through the wreckage

If the price of crude has found its footing, that provides investors with a reference point to use when considering oil stocks, which have plummeted over the past few months. Several big-name drillers have nosedived more than 35% from their October highs, which gives investors some interesting names to consider.

Marathon Oil (NYSE:MRO), for example, has shed 36% of its value during the recent oil market sell-off. While the company's cash flow will fall along with oil prices, it's well positioned to handle an environment in which WTI oil is around $50 a barrel. At that oil price point, Marathon can generate the $2.3 billion in cash flow necessary to grow its production by more than 10% while also funding its $170 million dividend outlay. Meanwhile, thanks to higher oil prices earlier in the year as well as the proceeds from asset sales, Marathon Oil had more than $1.5 billion of cash on its balance sheet. That gives it a nice cushion to handle lower oil prices as well as the funds to continue buying back its stock.

Devon Energy (NYSE:DVN), meanwhile, has tumbled about 35% from October's peak. However, the oil company is also well suited to handle $50 WTI oil in 2019. Devon currently expects to invest $2.4 billion to $2.7 billion on drilling new wells next year, which should grow its oil production 15% to 19% from 2018's rate. The company can fund that plan with cash flow as well as cash on the balance sheet, which stood at more than $3.1 billion at the end of the third quarter. Devon also plans to use about $1.3 billion of those funds to finish its industry-leading $4 billion stock buyback plan. It can now retire a larger portion of its outstanding shares since they're cheaper following the recent sell-off.

If the IEA is correct that oil should find a floor around its current level, then now seems like a good time for investors to consider doing some bargain hunting for beaten-down oil stocks that are set up to prosper at current prices. That means seeking companies that can grow their production at a fast clip on the cash flows produced at $50 to $60 oil while also having cash-rich balance sheets to provide them with some cushion should crude fall further as well as the funds to repurchase their beaten-down stock. Oil stocks with those characteristics should be able to easily maneuver through any near-term challenges while potentially generating outsized returns on the next oil price rally.

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