Commodities | Jan 18 2018
As oil prices show resilience above US$60/bbl several brokers are confident that 2018 will be a more positive year for the energy sector.
-Asian LNG demand to be a key feature of 2018
-Production growth should lead to a more balanced market in 2019/20
-Investors now appear more willing to pay for risk
By Eva Brocklehurst
Deutsche Bank enters 2018 constructive about the potential for the oil sector. The broker's positive tone reflects a view that, after three challenging years, major oil and gas companies have re-positioned businesses to work in a US$50/bbl environment and the cash flow from projects will start to accelerate.
The broker expects Asian LNG demand to be a feature of 2018. The improved outlook emerging in the Pacific Basin is, in part, driven by seasonal factors but also reflects wider structural changes, particularly in China.
Deutsche Bank believes this will be a transition year for LNG, moving to a seller's market from a buyer's market and potentially bringing forward from 2023-24 the commonly-accepted inflection point where demand overtakes supply.
Sector analysts at Extreme Petroleum Technology are not so enthusiastic and suggest Saudi Arabia is draining US crude inventory to manipulate the higher price of oil and the market should not get too comfortable with West Texas Intermediate in the mid US$60 price range.
When OPEC meets in June production cuts are likely to end and another downturn in prices ensue as the market re-establishes stability. Demand may be trending higher but so is US shale production, and the analysts at Extreme Petroleum Technology suggests these trends should be watched carefully.
Morgan Stanley, on the other hand, suggests the oil market is likely to be undersupplied in 2018 and prices should remain resilient this year. The broker asserts that financial flows matter and the return prospects from oil futures are sharply improved with a market in backwardation.
Brent, WTI and Dubai futures all moved into backwardation late last year (further out futures are higher priced) and this curve has become steeper subsequently. Backwardation is likely to remain intact in the Brent and WTI curves and this, Morgan Stanley believes, will attract capital into oil futures and drive the price higher.
While oil prices have rallied beyond levels required for long-term supply/demand matching, and a correction is certainly possible at some point, Morgan Stanley believes prices will be higher towards the end of the year than they are today. The broker raises its Brent oil price forecast for the September quarter to US$75/bbl.
Oil prices in line with forecasts should drive an acceleration of production growth, particular from US shale, and this should lead to a more balanced market in 2019/20. The broker expects oil prices in those years in line with long run marginal costs, at around US$65/bbl.
As oil prices have recovered much faster than most analysts expected, UBS anticipates significant improvements to broker price targets and estimates for earnings per share. OPEC is expected to be successful in bringing oil inventories back to 5-year averages this year, although a re-balanced inventory will make oil more susceptible to geopolitical effects.
In the longer term the broker believes the Brent oil price will return to US$70/bbl, a level required to incentivise sufficient new supply. UBS has a 2018 Brent forecast of US$60/bbl, if Middle East concerns abate and US shale activity accelerates. LNG demand growth will continue to surprise to the upside but the broker suggests new supply in 2018 could dampen spot pricing.
Australian Energy Stocks
Despite the strong rally in oil, UBS expects the increase in revenue for Australian major stocks will be more muted because of lower contracted LNG prices, given the three-month lagged Japanese customs-cleared oil price in the December quarter fell -7.0% versus the preceding quarter.
A strong rally in spot LNG prices in the December quarter will only partly offset the impact of lower oil-linked contract prices. The broker believes Beach Energy ((BPT)), unlike the other majors, is the best positioned from the rally in oil as it is not exposed to contracted LNG prices.
Macquarie envisages the sector will rally hard from strong oil and LNG prices and investors are now willing to pay for what they have avoided since the oil price slumped in 2014 – risk. In the broker's coverage, the biggest beneficiary should be Oil Search ((OSH)), with 20% spot cargoes that typically receive a premium to reported spot prices.
The broker suspects companies will attempt to maximise volumes early in 2018 as many operations have major outages that are scheduled. Santos ((STO)) is expected to try lift Fairview volumes after a disappointing finish to 2017.
Woodside ((WPL)) is expected to minimise T2 start up maintenance at Wheatstone and avoid unplanned outages after a lacklustre 2017. The broker suggests Woodside has rallied into territory that could set it up for disappointment.
Senex Energy ((SXY)) remains a preference in the mid to small caps space, with the full field development of the WSG project expected this year.
Macquarie is also more positive on Sino Gas & Energy ((SEH)) but, with Chinese gas prices expected to fall after the winter, remains cautious about buying the stock ahead of the quarterly result, because the company has been bought as a China gas proxy.
Citi credits Oil Search as the only major energy stock which screens positively regarding capital discipline, believing Santos, Beach Energy and Origin Energy ((ORG)) have all destroyed value in various ways, although resulting changes in management provide hope for better discipline going forward.
Oil Search has done best through exploration over the last six years, appearing to break even after Muruk, which shows how one good well can move results to feast from famine.
The broker asserts Woodside, which singled out exploration as a key strategy for growth, has destroyed value through exploration over the last six years. The company has done well historically as a top tier operator and Citi suggests money should be returned to shareholders in the absence of exploration growth.
Citi removes "exploration upside" value from its target prices, reducing these by around -5-15% across the sector.
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