Oil Prices: Mixed Signals From the Oil Market Are Heightening Uncertainty

Matthew DiLallo, The Motley Fool

Oil prices have been gut-wrenchingly volatile over the past six months. Crude crashed 40% during the last three months of 2018 as supplies started running well ahead of demand. Oil, however, quickly corrected in early 2019, experiencing its best quarter in a decade.

These wild swings leave oil analysts unsure about crude's next move, especially since the oil market is now sending mixed signals. That suggests the next few months could yield more volatility.

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Giving off mixed signals

One of the major authorities on the oil market is the International Energy Agency (IEA). The organization puts out a closely watched report each month, giving its view on supply, demand, and oil prices. Its latest one showed just how confounding the oil market can be to analysts. The IEA noted that "as far as 2019 is concerned, among the analyst community there is an extraordinarily wide divergence of view as to how strong growth will be," both for the global economy and oil demand.

That led the organization to tepidly reaffirm its forecast. The IEA wrote that "we maintain our forecast of 1.4 million barrels per day [for oil demand growth], but accept that there are mixed signals about the health of the global economy, and differing views about the likely level of oil prices." As a result, the IEA's head of the oil industry and markets division, Neil Atkinson, doesn't think anyone should put too much stock in oil price forecasts. He recently told CNBC that "in a world where we saw Brent at $86 a barrel in October, $50 a barrel in December and now back to over $70, I think it is a very brave person that attempts to forecast what the price will be at the end of the year."

Still, some try. The U.S. Energy Information Administration (EIA), for example, sees the global oil benchmark, Brent, averaging $65 a barrel in 2019. Meanwhile, it expects the U.S. oil benchmark, WTI, to hover around $59. That's up from its initial 2019 oil price forecast that Brent and WTI would average $61 and $54 per barrel, respectively, though it's below their current prices. While the EIA's latest outlook suggests that crude prices will cool off, others believe they could continue rallying.  

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Image source: Getty Images.

Oil stocks for an uncertain environment

The sharp rebound in oil prices so far this year has fueled big-time rallies in many oil stocks. Some top-tier producers, however, haven't yet bounced back and trade at more reasonable valuations compared to their red-hot peers. That makes them among the best options for investors to consider buying given the mixed signals in the oil market.

Three notable laggards that should be on investors' radar are ConocoPhillips (NYSE: COP), Concho Resources (NYSE: CXO), and Occidental Petroleum (NYSE: OXY). That trio is up less than 8% on average this year. That's significant underperformance compared to the 35% rebound in crude oil and the roughly 17% return of stocks in top oil ETF SPDR S&P Oil and Gas Exploration and Production ETF.

That trio's lackluster performance in 2019 doesn't make much sense given that they all set their budgets to generate free cash flow on sub-$50 oil. ConocoPhillips, for example, only needs oil to average about $40 a barrel to fund its $6.1 billion budget for 2019. That's enough money to boost the oil giant's production by about 5%. Meanwhile, it intends on using a combination of free cash flow produced on oil prices above that level and its cash-rich balance sheet to pay its 1.8%-yielding dividend and repurchase another $3 billion in shares. Because ConocoPhillips can thrive at $40 oil, it's in a strong position for an uncertain oil market.

Occidental Petroleum, meanwhile, only needs $40 oil to fund enough new wells to maintain its current production rate and pay its 4.9%-yielding dividend. The company plans to use its excess cash above that level to grow output, with it able to increase production 8%-10% at $50 oil and by 11%-13% if crude averages $60 a barrel. Occidental Petroleum's low-cost operations and flexibility give it a competitive advantage over many rivals if turbulence returns to the oil market.

Concho Resources also took a cautious approach entering 2019. The Permian Basin-focused oil producer reduced its spending range from $3.4 billion-$3.6 billion down to $2.8 billion-$3 billion. That will enable Concho Resources to generate free cash flow at lower oil prices so that it can pay its recently initiated dividend while still growing output at a healthy 21% to 25% rate. Because Concho Resources can prosper at lower oil prices, it can easily handle a choppy oil market.

Turbulence doesn't need to rattle oil investors

Oil prices have made gigantic moves over the past few months. As a result, even the market's best analysts aren't sure what's next. As more conflicting data emerges, it could cause oil prices to bounce around quite a bit. That's why investors might want to avoid the oil sector's hottest stocks. Instead, they should consider top-tier names like Conoco, Concho, and Occidental that have surprisingly lagged despite their ability to thrive in any market environment.

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Matthew DiLallo owns shares of ConocoPhillips. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.