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Lower Aussie A Boost For Oz Oil & Gas

Australia | Jun 19 2013

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– AUD fall benefits energy exporters
– Benefits vary among stocks
– Oil price fall must also be considered


By Greg Peel

It is well understood that the Australian dollar has long been a “commodity currency”, implying that the exchange rate with the US dollar closely tracks the value of US dollar-denominated commodities, such as iron ore, coal, copper and oil. It is also understood that over the past year or more, the Aussie dollar has broken its relationship and remained stubbornly high even as commodity prices have fallen.

To understand why we must appreciate that while the Aussie dollar, and the New Zealand and Canadian dollars, are known as commodity currencies, exchange rate determination ultimately comes back to short term interest rate differentials. If commodity prices are strong, the Australian economy is strong. If the Australian economy is strong, chances are the Reserve Bank will raise the cash rate. If the RBA raises the cash rate, the interest rate differential between Australian and US rates widens. If the differential widens, the exchange rate rises.

The point is that investors can borrow in their home currencies at lower rates and invest in Australian assets (bonds, yield stocks) at higher rates. To do so they must sell their own currency to buy Aussie assets, thus pushing up the exchange rate. Because markets move much faster than economies or central banks, the Aussie will move as soon as commodity prices move, ahead of the chain of events which will eventually fall into place. Hence the tag of “commodity currency”.

Over the past year or so, the interest rate differential on Australian yields and US yields, as well as Japanese and other developed world yields, has been so pronounced the demand for Aussie assets has remained supported even as commodity prices have fallen. The spell was broken, nevertheless, when yields in both the US and Japan began to rise (the former on “Fed taper” talk, the latter on Bank of Japan stimulus concerns) at the same time data showed a softer than expected Chinese economy. A sudden exit out of Aussie assets sent the Aussie dollar tanking.

To date, the correction in the Aussie has not been matched by similar commodity price falls. The currency has merely begun to close the gap to the long-established relationship with commodity prices. This is good news for Australia’s export economy, and not just in the resources sector. The risk for the resources sector is that a stronger US dollar affects both a weaker Aussie and even lower commodity prices.

This is not yet the case. Energy sector analysts have nonetheless run some modelling on the valuations of Australia’s listed oil & gas stocks based on different currency and commodity price scenarios.

UBS has taken the simple route, and set its currency input to valuation models at a new spot of US$0.96. Based on the decline to this level, UBS’ target price for Caltex ((CTX)) would increase by 3.1%. Target prices increases for other stocks would be: Woodside Petroleum ((WPL)) 4.6%; Beach Energy ((BPT)) 6.9%; Horizon Oil ((HZN)) 8.3%; Oil Search ((OSH)) 8.6%; Roc Oil ((ROC)) 9.1%; Santos ((STO)) 9.6%; AWE ((AWE)) 9.7%; Drillsearch Energy ((DSL)) 10.0%; and Tap Oil ((TAP)) 10.6%.

The target price for Karoon Gas ((KAR)) would fall by 5.0%. It is important to note that the impact of exchange rates on valuations is dependent on reporting currencies, country(s) of operation, level of payables in US dollars and so forth. UBS notes further that while Woodside’s earnings would not be impacted given the company reports in USD, its AUD dividend yield would rise to 6.1% from 5.1%.

Macquarie has specifically revised its Aussie dollar forecasts, cutting its 2013 average estimate to 0.90 from 1.02, 2014 to 0.89 from 1.02, and 2015 to 0.87 from 1.01. The analysts have then looked at the impact of these downgrades on energy stock 2014 earnings.

The biggest beneficiary is Santos, which sees 2014 earnings rise by 26%. Companies reporting in USD, such as Woodside, Oil Search, Horizon and Roc see a more muted impact. In the mid-caps, AWE and Beach lead with earnings increases greater than 10%, while sector-wide (of Macquarie’s coverage universe, down to small caps), earnings rise by an average 22%.

Macquarie already believed the energy sector to be undervalued, and the benefits of a lower currency only emphasise undervaluation. In the large caps Macquarie prefers Santos and Oil Search, while in the mid-caps the analysts like Beach, AWE, Horizon and Karoon.

BA-Merrill Lynch and Credit Suisse have looked at it another way, considering both a fall in the Aussie and commodity price falls.

Merrills believes lower global demand, rising supplies and higher inventories will lead to lower oil prices. To date, LNG prices are indexed to oil (Brent crude). The analysts have lowered their average Brent price forecast for the second half of 2013 to US$103/bbl from 111, and 2014 to 105 from 112.

When applying an Aussie reduction to 0.96 from 1.06, the valuation impact on energy sector stocks is minimal. Credit Suisse arrives at the same conclusion, applying an expectation that USD commodity prices will decline by 30% over the next five years, and reducing its Aussie expectations to 0.92 in three months and 0.85 in twelve months.

When we amalgamate the different broker’s approaches, we can conclude that Australian energy stocks will be boosted in valuation by a lower currency, or at the very least, valuations will be maintained by a lower currency in the face of lower oil prices, were that to be the case.
 

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