Commodities | Nov 30 2020
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A robust outlook for oil prices is emerging after a volatile and difficult 2020, as high levels of inventory are wound back and producers adjust to the absence of supply investment.
-Fundamentals suggest oil prices can climb higher
-US oil industry, the swing producer, facing tough times
-Is there value in Australian oil stocks?
By Eva Brocklehurst
As OPEC and friends hold the line on oil production quotas and a global economic recovery gets underway in 2021, what are the prospects for the oil price?
Morgans is bullish on oil & gas, believing the energy industry will be a major beneficiary of further US dollar weakness heading into 2021 as investors seek leverage with oil prices near the low of the cycle.
Oil is the largest most liquid commodity market and has a fragmented supply/demand spread. While the market is currently well supplied, a gap of -2-4% per annum is expected to materialise and result in a rise in future oil prices.
Complicating factors that could accelerate the recovery in oil prices include a major loss of access to capital for the indebted US oil industry, which has been the swing producer of oil over the last decade.
Longview Economics echoes this sentiment, noting compliance with OPEC quotas remains reasonably strong and instability in Libya continues to hamper production there. Moreover, US President-elect Joe Biden, has promised to ban new oil & gas drilling on federal land, which is expected to result in a significant reduction in US oil production growth.
Even without a ban on drilling, US shale oil production is likely to be weak and undermine overall US production growth in coming months, the analysts suggest. Morgans agrees, highlighting the poor state of balance sheets amongst US oil producers and the damage dealt to the oil service industry by the pandemic.
Beyond 2023 the broker expects current limitations on new supply investment will emerge as the factor affecting supply/demand fundamentals. Despite the steady march of renewables, the pace of substitution will be unable to fill the expanding gap left behind by the absence of industry investment in new oil supply.
The broker assesses US shale oil production will rapidly lose competitiveness because of a permanent reduction in available capital and this sets up a bullish view for oil prices.
Oil pricing was very sensitive to the coronavirus as it spread globally, given 60% of oil demand comes from transportation. The rapid loss of so much demand meant a supply overhang emerged that caused oil prices to plunge in the first half of 2020.
As OPEC et al cut supply it was not enough to support a full recovery and global inventory rose to above 1bn barrels over the course of the year. Now a marginal decline is occurring which suggests the supply is moving back towards balance. To Morgans this means a move past "peak negativity" in oil and improving investor demand should be underpinned further by a weakening US dollar.
The broker envisages Brent prices out to 2022 will recover to just above an average of US$50/bbl versus the current spot rate of US$46/bbl. Upside risk comes with the potential for a delayed supply response from the US, in both shale and conventional oil.
Citi, on the other hand, does not rule out a pull-back in oil prices if demand is less than robust over the short term. The upcoming OPEC meeting is likely to focus on market rebalancing, and higher crude prices could mean the group softens output quotas, having previously signalled a willingness to consider 3-6 months of quotas at current levels.
If OPEC production returns to pre-pandemic levels, Credit Suisse calculates fair value for oil is US$80/barrel. Even accounting for risks such as the build up in inventory, lack of storage and political uncertainty, the broker envisages oil prices can climb back to US$60-65/bbl if global industrial production recovers, or at the very least doesn't collapse again.
The broker's energy analysts believe the sector is under-priced. World industrial production is up more than 22% from its low in April, consistent with a much stronger level of oil demand compared with the previous period of negative oil prices.
Credit Suisse defends world industrial production as a timely indicator of activity, as opposed to global GDP which arguably captures more sources of oil demand and is yet to show such a recovery.
In exploring the issue for energy stocks as trade re-opens and a covid-19 vaccine is delivered in 2021 Credit Suisse asserts there is value in oil.
Even in a worst-case scenario in which volatility increases, and the transition to normality from stimulus-driven growth is difficult, there is enough momentum in energy stocks to outperform crowded quality and growth stocks.
In the case of its preferred exposures, the broker envisages 20-50% upside across Beach Energy ((BPT)), Santos ((STO)), Oil Search ((OSH)) and Woodside Petroleum ((WPL)) in a scenario where oil prices rise to US$65/bbl by 2022 and growth is de-risked.
The broker acknowledges the market is not "particularly friendly" towards these exposures as 2020 draws to a close… but herein lies the buying opportunity.
Shaw and Partners is less enthused for the short term at least and, given the “extraordinary run” in the sector since August, downgrades the sector to Equal-weight, with Woodside Petroleum, Santos and Oil Search on Neutral recommendations. The broker believes, at current levels, these three are pricing in Brent oil at US$66-69/bbl in perpetuity.
Shaw and Partners' preferred exposure is Beach Energy, with a Buy rating, believing it can capitalise on distressed asset sales as well as gas opportunities in Western Australia.
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