3 Things to Watch for Oil in 2021

This past year didn’t play out as most anticipated. A raging global pandemic wasn’t on anybody’s radar at the end of 2019. The virus outbreak devastated the global economy and the oil market. The devastation might continue until enough vaccines are rolled out to fully end the pandemic, which could take some time. 

Given that backdrop, here are a few things to keep an eye on in the oil market this year.

Image source: Getty Images.

See if demand bounces back as expected

Oil demand fell off a cliff earlier this year as governments limited travel and business activity to slow the virus’ spread. That caused an enormous glut of oil, with crude filling storage terminals around the world. The oil market will enter 2021 with 625 million more barrels in storage than it had before the pandemic, according to the International Energy Agency (IEA). 

On a more positive note, the IEA anticipates that oil demand will bounce back sharply in 2021. It currently expects the global economy’s oil consumption to rise by 5.7 million barrels per day (BPD) to an average of 96.9 million BPD. That forecast implies the economy will recover about two-thirds of the lost demand.

If this demand doesn’t return in 2021, oil prices could weaken again, putting more pressure on oil stocks.

Keep an eye on OPEC’s supply agreement

Supply is the other side of the oil market equation. OPEC and other major oil-producing nations are currently planning to hold back 7.2 million BPD from January through March to help the economy burn off its excess inventory. That’s up from a 9.7 million reduction that began in May, which tapered to 7.7 million BPD in August. 

The group plans to stagger additional supply increases over the year, aiming to bring back 2 million BPD by year-end. However, the group has had disagreements along the way, which caused it to add 500,000 BPD of additional supply in January quicker than some countries wanted. If the group brings back supplies faster than demand recovers, oil prices could tumble, which could upend oil stocks once again.

Look for more oil mergers

This year’s crash in the oil market forced oil companies to shift gears. They need to get costs down to weather the continued turbulence in the oil market. One way they can do that is through mergers that increase their scale and reduce expenses. The sector has seen a wave of mergers in 2020 designed to reduce costs.

Oil giant Chevron (NYSE:CVX) kicked off the current wave in July by acquiring Noble Energy in an all-stock deal valued at $13 billion, including Noble’s debt. Chevron expects that combination to generate $300 million in annual cost savings. ConocoPhillips (NYSE:COP), Pioneer Natural Resources (NYSE:PXD), Devon Energy (NYSE:DVN), and Diamondback Energy (NASDAQ:FANG) followed that blueprint by agreeing to acquire rivals in similar deals that will increase their scale while reducing their costs. 

More mergers will likely come in 2021. Analysts believe that oil producers Cimarex Energy (NYSE:XEC), Continental Resources (NYSE:CLR), Marathon Oil (NYSE:MRO), and Apache (NASDAQ:APA) would all benefit from increased scale. Meanwhile, the midstream sector could start consolidating in 2021. It lacks organic growth because the oil industry probably won’t need too much new infrastructure in the coming years. That could lead to tie-ups between MLPs focused on gathering and processing oil and gas with larger integrated players, as well as corporate mergers between large pipeline companies. Such moves would increase their scale, allowing them to leverage their existing footprints and squeeze more cash out of those assets.

2021 could be another turbulent year

The oil market hopes to get a big shot in the arm in 2021 as vaccines roll out, which should fuel a recovery in demand. As long as OPEC doesn’t move too fast, oil prices should continue improving, which could give oil stocks the fuel to bounce back in 2021, especially as the industry continues its consolidation wave.

However, the oil market is in a fragile state. Issues rolling out the vaccines or surging supplies from OPEC could put renewed pressure on oil prices in the coming year. Given those risks, investors should brace themselves for another challenging year in the oil market.