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The Oil Market Is “Stretched to the Limit”

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Matthew DiLallo, The Motley Fool
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Global oil demand was scorching hot to start 2018, rising by an average of 2 million barrels per day (BPD) during the first quarter, to 98.4 million BPD, according to data provided by the International Energy Agency (IEA). While demand growth cooled off a bit in the last three months, it's on pace to re-accelerate in the second half and continue growing at a brisk pace in 2019 when it's expected to hit an average of 101.6 million BPD by the fourth quarter, according to the IEA's latest forecast.

At the same time that oil demand is marching higher, oil supplies are having trouble keeping up due to myriad issues that cropped up around the world. Because of that, the IEA warned in its latest report that the oil market is "stretched to the limit."

That leaves it very vulnerable to a spike in oil prices in the coming year. While that's a boon to oil stocks, it could hit consumers hard.

An oil pump with the sun shining through.
An oil pump with the sun shining through.

Image source: Getty Images.

From an overabundance to stretched thin in less than a year

Not more than a year ago, analysts remained worried that there still was too much oil flowing into the market due to rapidly growing output from U.S. shale plays. In fact, analysts at Seaport Global warned that oil supplies could exceed demand by a whopping 2.2 million BPD in 2018, which led them to believe that crude could tumble back below $40 a barrel this year.

However, OPEC and Russia initially agreed to stick to their plan to hold back 1.8 million BPD from the market in 2018, and fears of an oversupply problem this year were eased. Instead, the market has begun growing increasingly concerned that there might not be enough oil to meet demand, due to a growing number of supply outages around the world.

Production in Venezuela, for example, has fallen off a cliff due to its economic crisis. Meanwhile, renewed fighting in Libya cut into that country's oil exports, and a power outage knocked a major oil-producing facility in Canada offline, taking 10% of the country's oil output off the market.

On top of those trouble spots, there's the potential for additional supply issues to crop up in the coming months. New sanctions on Iran could remove a significant portion of that country's production from the market. Meanwhile, producers in the Permian Basin of Texas are running out of room on pipelines, which could stunt the region's growth until new ones come online near the end of next year.

These supply issues recently led OPEC and its non-member partners to hike their output by 1 million BPD. However, the increase leaves OPEC's spare capacity -- which is its cushion to meet supply crunches -- dangerously thin, according to the IEA. Because of that, the IEA and others in the industry are growing increasingly concerned that an unexpected supply outage from a major oil producer -- such as the impact from a natural disaster, armed conflict, or mechanical problem -- could leave the world short of the oil it needs and cause crude prices to go haywire.

A man in a suit counting money while filling up a gas tank.
A man in a suit counting money while filling up a gas tank.

Image source: Getty Images.

Winners and losers

Oil producers around the world are already cashing in now that oil prices are in the $70s. Leading U.S. shale driller EOG Resources (NYSE: EOG) is one of them, since it built its business to thrive on $50 crude. Because of that, the company is on pace to generate more than $1.5 billion in free cash flow this year if oil averages $60 a barrel and even more above that level. This windfall has helped drive EOG's stock up more than 37% over the past year and could give it the fuel to keep going higher.

Marathon Oil (NYSE: MRO) also has cashed in on the improvement in oil prices. Shares of the U.S. oil company are up more than 80% over the past year -- making it one of the best-performing oil stocks of 2018 -- due to the impact higher oil prices are having on its cash flow. Like EOG, Marathon Oil set its budget to run on $50 oil, which has it on pace to produce $500 million in free cash at $60 a barrel and even more at current prices.

While the uptick in oil prices has been a boon for oil stocks, it's having a negative impact on other industries. Airline stocks, for example, are down double digits this year, due, in part, to the higher costs from rising jet fuel prices. Meanwhile, consumers are starting to feel the pinch from the uptick in the cost of a gallon of gasoline. If oil prices keep rising, it will only increase the pain at the pump, which could dent consumer discretionary spending on things like restaurants and clothing. That would likely weigh on consumer-facing stocks.

Turbulence could be ahead

With OPEC stretched thin, there's a growing risk that oil prices could go much higher in the wake of an unexpected supply outage in the future. It's something that investors need to keep in mind since it could negatively impact the stocks of companies tied to consumer spending. On the other hand, oil stocks would thrive, which is why investors might want to consider adding one to their portfolio, with this trio currently standing out.

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