Oil prices are rising. Look for bigger returns in 2022.

Photographic illustration by Sam Kelly; Dream time (2)

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The average energy stock is set to gain over 50% this year, a startling result for an industry that has lagged the market for most of the past decade. The outlook is also good for 2022, especially in oil.

International crude prices rose 43% in 2021, and U.S. crude is up 46%, emerging from the hole created during the worst of Covid-19.

But the latest oil windfall is unlike many of the booms and recessions that have characterized a century of wildcat. Companies are slowly bringing production back, both in the United States and overseas, as investors demand better returns. Credit research firm Fitch Solutions does not expect capital spending on oil and gas to return to pre-pandemic levels until 2025.

So what will energy companies do with all this money they make from rising oil prices if they don’t spend it on drilling wells? They’re going to send a lot more back to investors.

Morgan Stanley analyst Devin McDermott expects oil companies to deliver a 6% redemption and dividend yield next year, with the big names integrated offering an 8% yield. He expects stocks to outperform the overall market, as they trade at a 65% discount to the S&P 500 Index – double their historical discount.

Several other analysts are also optimistic. Michael Tran of RBC Capital Markets sees Brent crude averaging $ 79.50 a barrel next year and $ 86.50 in 2023.

Two big questions still loom. The first is whether Covid will decline in 2022, leading to a full rebound in travel. The other is whether the oil companies and the Organization of the Petroleum Exporting Countries will really stick to their plans to slowly increase capital spending.

Historically, expansion cycles end when producers get greedy, pumping money into projects just as prices start to peak. In these cases, the next step may be a wave of bankruptcies. Most analysts don’t bet on this cycle repeating itself.

Discover the future of these sectors in 2022

Write to Avi Salzman at avi.salzman@barrons.com

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Felix J. Dixon