Brent Crude Topped $109, and Inventories Are Draining at a Record Pace. These Energy Stocks Could Win.

Futures contracts for Brent oil (the international oil benchmark) for delivery in June rose more than 3% on Monday, topping $109 a barrel at one point. The rise in crude oil signaled the market’s growing unease with the current standoff between the U.S. and Iran. Iran continues to prevent ships from passing through the Strait of Hormuz, while the U.S. Navy is blockading Iranian-linked ships.

As a result, oil flows through that crucial waterway are basically at a standstill. The world is bridging the gap by tapping into emergency oil stockpiles, which are draining quickly. Here are the energy stocks that could win if oil inventories keep falling.

Draining the barrel

Before the war, the 32-member nations of the International Energy Agency (IEA) held over 1.2 billion barrels of oil in emergency stockpiles, including more than 400 million barrels in the U.S. Strategic Petroleum Reserve (SPR). Additionally, another 600 million of industry stockpiles were under government obligation, while energy companies also held significant commercial oil inventories. Meanwhile, many non-IEA members held emergency oil reserves, with China holding the world’s biggest stockpile at 1.4 billion barrels.

The world has been tapping these reserves since Iran effectively closed the Strait of Hormuz at the beginning of the war by attacking ships and laying sea mines. That led IEA members to agree to release a record 400 million barrels from their emergency inventories in early March, including 172 million barrels from the SPR. Overall, global inventories are draining at a record pace of 11 million to 12 million barrels per day, according to Goldman Sachs. This pace can’t continue indefinitely. In Goldman Sachs’ view, if oil flows out of the Strait don’t normalize before the end of July, Brent will likely remain over $100 through the end of the year.

Winners from the oil inventory drawdown

The inventory drawdown will benefit energy midstream companies and oil producers. Pipeline companies play a crucial role in helping the U.S. get oil supplies from the SPR to refineries and global markets. The country’s four storage sites along the Gulf Coast connect to three distribution systems and three marine terminals. Enterprise Products Partners (EPD +0.82%) and Enbridge (ENB 1.59%) co-own the Seaway Pipeline and related Seaway terminals that connect the SPR to refineries and global export markets. Volumes on that pipeline will increase as the U.S. releases oil from the SPR, while export volumes at the two linked Gulf Coast terminals will also rise as the U.S. supplies the world with more energy during the closure. That will enable Enterprise and Enbridge to generate more fee-based income from those higher volumes. Additionally, both companies operate separate oil pipelines and storage terminals, which should see higher throughput volumes this year.

Energy Transfer (ET +0.08%) is another likely winner of the oil inventory draws. The energy midstream giant owns the Nederland Terminal, which connects to the SPR. It also operates a terminal in Houston, which should benefit from higher export volumes. Additionally, Energy Transfer owns over 17,950 miles of crude oil pipelines and oil terminals with 73 million barrels of storage, which should see higher utilization this year and generate more fees for the midstream company.

Meanwhile, oil producers will benefit from higher prices. For example, major U.S. oil and gas producer EOG Resources (EOG +0.07%) initially expected to generate about $4.5 billion in free cash flow this year, assuming WTI, the primary U.S. oil benchmark, was in the low $60s. It planned to return up to 100% of that money to shareholders through dividends and share repurchases. The oil company estimates that for every $1-per-barrel increase in oil prices, its annual cash flows will rise by $223 million. With WTI currently in the mid-$90s, EOG Resources is on track to generate nearly $6.7 billion in additional pre-tax cash flow this year. It will likely return all that money to shareholders through repurchases and special dividends. Most other U.S. oil producers will also generate more cash this year, with many returning the bulk of their windfall to shareholders through dividends and repurchases.

Oil companies should be big winners this year

The Strait of Hormuz closure is creating one of the biggest oil supply shocks in decades. Countries are covering the shortfall by tapping into their emergency stockpiles at record levels. That inventory drawdown will benefit midstream companies, which should report higher volumes and fee-based income. Meanwhile, higher oil prices will benefit oil producers, enabling them to generate more cash to return to shareholders. This market environment suggests that oil pipeline companies and producers should be winning investments this year.