Expect energy stocks to face headwinds in 2024 as spare oil capacity puts downward pressure on the crude markets, according to Citi analysts.
"Pressure on oil prices is coming from rising spare capacity," wrote Alastair Syme, managing director at Citi, in a note to investors.
Spare capacity, as defined by the Energy Information Administration, is an estimate of the volume of oil production that can be brought online quickly and sustained for at least three months. Essentially, it's a country's ability to dial up oil production if needed.
Since 2000, in nine out of the 10 years in which global spare capacity has been above 3 million barrels per day, oil equities have underperformed the broader market, according to a note published by Citi. The analysts forecast 4 million barrels per day in 2024, with oil prices falling into the low $70s by the end of next year.
"Some have argued that the oil industry is underinvesting, but this view is simply not backed up by the data. Since the formation of the expanded OPEC+ in 2016, global spare capacity has built by 1.5 mbpd [million barrels per day], 80% of which has come from the US," reads the Citi note.
The analysts went on to say "building spare capacity breeds both commodity and asset price-deflation."
Oil is down about 4% year to date, despite efforts by the Organization of the Petroleum Exporting Countries and their allies — known as OPEC+ — to maintain a pricing floor through supply reductions.
West Texas Intermediate (CL=F) and Brent (BZ=F), the international benchmark price, were trading at about $73 and $78 per barrel, respectively, on Tuesday.
Analysts expect demand next year to be met by increased supply from producers outside OPEC+, like the US and Guyana.
“OPEC+ will likely continue to act to limit the extent of price-deflation but finds itself in a vicious circle of sacrificing market share to defend a price that, evidenced by growing supply, is still above marginal costs,” said the Citi note.
The S&P 500 Energy select ETF (XLE) is down about 3% year to date while the broader markets are up 18% during the same period.
One saving grace for the sector in 2024 is the strong financial position for many of the companies within the energy space.
“As other sectors are faced with the prospect of re-financing at significantly higher costs of debt, the oil sector can use balance sheet strength to protect shareholder distributions and/or to exploit M&A [mergers and acquisitions],” read the note.
In October, ExxonMobil (XOM) announced a near-$60 billion acquisition of Pioneer Natural Resources (PXD) and ExxonMobil (XOM) announced a merger with Pioneer Natural Resources in a deal valued at $60 billion.
ExxonMobil is down roughly 6% year to date while Chevron is down almost 20% during the same period.
Oil-related stocks were among the best performers last year amid skyrocketing oil prices.
Ines Ferre is a senior business reporter for Yahoo Finance. Follow her on Twitter at @ines_ferre.
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