Analysts Predict More Resilient Oil Sector In 2018

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.

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