Brent Oil Drops Below $90 as the U.S. Closes in on a Peace Deal With Iran. What it Means for Oil Stocks.

The price of Brent oil, the global benchmark, slumped nearly 4% on Friday, closing at $86.88 per barrel. At one point, Brent touched its lowest point since early March. It fell 7.7% for the week, which is the third weekly decline in the past four weeks.

Driving the decline were reports that the U.S. and Iran are closing in on a peace deal that could be signed in the next few days. The reported deal would, among other things, fully reopen the Strait of Hormuz to ship traffic. Here’s what it would mean for oil stocks.

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The long road to recovery

Iran has effectively closed the Strait of Hormuz since the U.S. and Israel launched military attacks against the country more than three months ago. Before the war, 20% of global oil supplies moved through the narrow waterway each day. That has fallen to a trickle, though recent reports suggest that oil has been quietly escaping the Persian Gulf. In addition to those flows, Saudi Arabia and the UAE have ramped up volumes on bypass pipelines.

However, despite those workarounds, demand has significantly outpaced supply, causing the global economy to burn through oil inventory and emergency stockpiles. According to some estimates, the world has lost over 1 billion barrels of supply since the war began. It will take the oil industry time to recover from this massive supply shortfall. Persian Gulf countries need to restart the oil wells they shut in due to the war, which could take several months. Meanwhile, the economy will need to rebuild inventory levels and emergency stockpiles to cushion the blow of a future supply crisis.

As a result, oil prices will likely remain elevated long after the Strait of Hormuz fully reopens to tanker traffic. For example, Goldman Sachs expects Brent will average $90 a barrel in the fourth quarter of this year and $80 a barrel next year as the oil market recovers.

A constructive environment for oil stocks

That outlook bodes well for oil companies. For example, U.S. oil giant ConocoPhillips (NYSE:COP) only needs oil in the mid-$40s to breakeven (generate enough cash to fund its operations and capital spending plan) and $10 more to cover its dividend payments. As a result, it can make a lot of money when oil is in the $80s. Last year, it produced $7.3 billion in free cash flow after capital spending when Brent averaged around $69 a barrel. ConocoPhillips initially expected to generate an additional $1 billion in free cash flow this year at $70 oil, driven solely by cost savings. It’s now on track to significantly exceed that level with Brent likely to remain elevated the rest of this year, even if the peace deal goes through.

Chevron (NYSE:CVX) expects to produce an even bigger gusher of additional free cash flow this year. The oil company initially estimated that recently completed expansion projects, its Hess merger, and cost-savings initiatives would boost its free cash flow by $12.5 billion this year at $70 oil. However, Chevron will now likely produce even more excess free cash this year if oil remains above $80 a barrel.

Oil stocks remain attractive investments

The U.S. appears to be on the verge of securing a peace deal with Iran that would also reopen the Strait of Hormuz. That would enable oil to freely flow out of the Persian Gulf again.

However, while oil prices are down on the news, the industry has a long recovery ahead. As a result, oil prices will likely remain above $80 a barrel well into 2027. That positions oil companies like ConocoPhillips and Chevron to generate a bigger gusher of excess free cash flow, making them still look like strong investments right now.

Matt DiLallo has positions in Chevron and ConocoPhillips. The Motley Fool has positions in and recommends Chevron and Goldman Sachs Group. The Motley Fool recommends ConocoPhillips. The Motley Fool has a disclosure policy.