Forecasts For Volatile Oil & Gas Markets

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Brokers weigh the opposing impacts of a potential recession and supply disruptions upon the future direction for oil and gas prices.

-The International Energy Agency cuts crude oil demand growth estimates 
-Chinese lockdowns outweigh the impact of gas-to-oil switching 
-ANZ expects supply issues may help offset demand concerns 
-Will shale boost US oil production?
-Preferred ASX-listed shares for rising gas price forecasts

By Mark Woodruff

One thing seems certain for the crude oil market: ongoing volatility. 

Downside risks for crude oil prices may arise as supply grows and a recession sets in, or a combination of weather and supply disruptions may result in higher prices for longer. 

An overlay of geopolitics is creating further uncertainty. While the OECD is contemplating a price cap on Russian oil exports, the country is deploying its own gas weapon in retaliation.

The International Energy Agency (IEA) recently cut its 2022 crude oil growth estimates via its monthly oil market report, as renewed Chinese lockdowns offset gains from greater gas-to-oil switching, explains UBS.

China's oil imports are now -3-4mb per day below the trend that was in place before covid, according to Morgan Stanley. 

Citi also notes gasoline and diesel demand in the US has fallen to 2011-14 levels, when year-to-date West Texas Intermediate (WTI) prices averaged over US$90/barrel. This falling demand is one factor that leads the broker to raise its probability of lower future oil prices to 25%, compared to 10% previously.

While macro-economic conditions remain so weak, Morgan Stanley is not expecting an imminent oil price rally either and lowers near-term price forecasts. Once demand picks up, however, the oil market's structural outlook remains tight and the analysts' price forecasts rise from the second quarter of 2023 onwards.

Overall, the broker feels the outlook for the Brent oil price has improved, with a softer demand outlook already incorporated into last week’s US$94/barrel price, after a correction from around US$130/barrel.

While a deteriorating oil demand outlook is weighing on market sentiment, ANZ believes supply disruptions will offset some of these demand concerns. Under-investment by many OPEC member countries is also expected to constrain production.

Geopolitical unrest is behind supply outages in Libya, Nigeria and Ecuador, while European sanctions on Russian oil begin on December 5. 

To date, the US, South Korea and Japan have reduced imports from Russia to zero, but the slack has been taken up by India, Turkey and to a limited extend China, explains Morgan Stanley. It’s forecast Russian oil imports into the EU will fall by around -3mb/d in coming months and alternative markets for the Russian oil is considered limited.

Providing further pricing support for oil prices, nuclear deal negotiations have stalled in Iran, reducing expectations for additional Iranian oil, explains Morgan Stanley, while OPEC also recently announced it would cut its October output quota, after warning that crude oil prices did not reflect fundamentals. 

However, Citi believes US shale will remain a thorn in OPEC’s side as it looks to review its output policy in the months ahead. 

US oil production

Shale oil from the Permian Basin offers the largest source of non-OPEC growth in supply, accounting for around 65% of crude pumped across the US this year, up from circa 40% five years ago, notes ANZ Bank.

The basin is about 250 miles wide and 300 miles long, and spans parts of west Texas and south-eastern New Mexico.

Led by Permian, Citi estimates the US shale industry can deliver profitable growth that is underpinned by over 50 years of inventory. On current activity levels, more than 2mb per day of US liquids growth is expected between now and the end of 2023. 

However, current investment and activity levels indicates to Citi some reluctance by major players in the Permian Basin to accelerate growth. 

ANZ places more weight on this reluctance than Citi and believes US oil production is likely to remain weak and will keep the oil market tight. US shale oil output in the fourth quarter is only expected to be marginally higher than current levels.

Capital discipline objectives have resulted in companies reluctant to plough record profits back into operations, and rising costs are compounding the shortfall this is creating, notes ANZ.

Investors have increasingly pushed oil companies to start returning capital to shareholders, rather than spending heavily to increase production. ANZ points out that when WTI broke above US$100/barrel in 2014, drillers had twice the current level of horizontal drill rigs operating across the US.

The recurring costs of operating wells and equipment in the US, also known as lease operating costs, have doubled due to cost inflation over the past few quarters, according to ANZ. In addition, oil services companies are warning about the lack of equipment for new wells, and the Permian Basin has recorded three consecutive quarterly falls in the number of drill rigs operating.

Morgan Stanley concurs with the ANZ concerning the slowdown in store for US production growth.

While growth is expected to accelerate in the second half of this year, the broker still lowers its forecast for crude condensate growth in 2022 to 0.7mb/day from 0.9mb/day. For 2023, growth of 0.9mb/day is assumed, but risks to both forecasts are considered skewed to the downside.

Support for production will potentially come from Washington, notes Citi, with media reports suggesting officials are considering purchasing oil for the strategic petroleum reserve (SPR), should prices fall below US$80.

Non-US oil production 

Morgan Stanley also highlights the lack of rig count growth in core oil-producing countries in the Middle East. 

The combined rig count from Saudi Arabia, Kuwait and the UAE is still down by about a third compared to pre-covid and has barely increased from its covid low.

Spare capacity is low by historical standards and provides only a small margin of safety, according to the broker. That capacity is also considered highly concentrated in Saudi Arabia and the UAE.

Global and domestic gas

Citi has raised its price forecasts for Asian, European and US natural gas amid ongoing geopolitical instability, which has seen an extension to the shutdown of Nord Steam 1, Germany’s main source of Russian gas.

Short-term futures prices have risen to reflect the ongoing escalation of the natural gas supply crisis in Europe, and a deterioration in hydro and nuclear power generation, mostly due to drought. The decline in generation from these sources has lifted natural gas demand for power generation.

For Australian east coast wholesale prices, the broker lowers short-term forecasts in the expectation industry and government will combine to prioritise gas supplies.  The longer-term wholesale gas price is increased to $10/GJ from $9/GJ due to rising marginal costs of production, accelerating reserve depletion and deteriorating well productivity.

Should oil supply tightness continue, Citi sees further upside potential for prices and suggests Woodside Petroleum ((WDS)) is best placed from among its oil research coverage to benefit via LNG sales on the spot market and increased trading activity in its Marketing division.

The company has exposure to international markets via both LNG (more than 50% of energy production) and international piped gas. The broker raises its rating to Buy from Neutral and increases its 12-month target price to $36.50 from $33.30. 

Next preferred is Buy-rated Santos Energy ((STO)) with spot LNG exposure (around 10% for FY22) via PNG LNG and the Bayu-Undan facility, which is located within the Timor-Leste offshore waters, and Citi’s target is raised to $9.00 from $8.30. 

The target for Neutral-rated Beach Energy ((BPT)) is also increased to $1.88 from $1.85, on the revisions to east coast.
 

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