OUTLOOK
Crude Oil
High U.S. crude and fuel stocks, worries about North America and
Europe’s growth outlook, a strong dollar and an impending fight
over raising the U.S. debt ceiling have weakened oil prices to
around low-$90s a barrel. Partly offsetting this unfavorable view
has been a demand uptick from developing countries.
The immediate outlook for oil, however, remains tepid given the
commodity’s fairly positive supply picture. In particular, while
Saudi Arabia is likely to cut back on its production, global oil
output is expected to get a boost from sustained strength in North
America, Iraq, Nigeria and Angola. On the other hand, the growth in
global liquids fuel demand will be relatively soft in the absence
of a strong global recovery.
According to the Energy Information Administration (EIA), which
provides official energy statistics from the U.S. Government, world
crude consumption grew by an estimated 0.9 million barrel per day
in 2012 to a record-high level of 89.2 million barrels per day.
The agency, in its most recent Short-Term Energy Outlook, said
that it expects global oil demand growth by another 0.9 million
barrels per day in 2013 and by a further 1.4 million barrels per
day in 2014. Importantly, EIA’s latest report assumes that world
supply is likely to go up by 1.0 million barrels per day this year
and by 1.7 million barrels per day in 2014.
In our view, crude oil prices in the first half of 2013 are
likely to exhibit a sideways-to-bearish trend. With domestic demand
relatively soft and the global economy still showing signs of
weakness, the fact that supply will be outpacing consumption
appears to be evident.
As long as sharp crude output growth from North America
continues and the world demand is unable to keep up with that, we
are likely to experience a pressure in the price of a barrel of
oil. We assume that crude will trade in the $90-$95 per barrel
range for the near future.
Natural Gas
Over the last few years, a quiet revolution has been reshaping
the energy business in the U.S. The success of ‘shale gas’ --
natural gas trapped within dense sedimentary rock formations or
shale formations -- has transformed domestic energy supply, with a
potentially inexpensive and abundant new source of fuel for the
world’s largest energy consumer.
With the advent of hydraulic fracturing (or fracking) -- a
method used to extract natural gas by blasting underground rock
formations with a mixture of water, sand and chemicals -- shale gas
production is now booming in the U.S. Coupled with sophisticated
horizontal drilling equipment that can drill and extract gas from
shale formations, the new technology is being hailed as a
breakthrough in U.S. energy supplies, playing a key role in
boosting domestic natural gas reserves.
As a result, once faced with a looming deficit, natural gas is
now available in abundance. In fact, natural gas inventories in
underground storage have persistently exceeded the five-year
average since late September 2011 and ended the usual summer
stock-building season of April through October at a record 3.923
trillion cubic feet (as of October 31, 2012).
This prompted natural gas prices to dive approximately 63% from
the 2011 peak of $4.92 per million Btu (MMBtu) to a 10-year low of
$1.82 per MMBtu during late April 2012 (referring to spot prices at
the Henry Hub, the benchmark supply point in Louisiana ).
Looking forward, EIA expects average total production to rise
from 69.2 billion cubic feet per day (Bcf/d) in 2012 to 69.8 Bcf/d
in 2013, while total natural gas consumption is anticipated to
remain relatively flat this year at 69.7 Bcf/d.
However, with the U.S. winter set to be colder than the
unusually warm last one, we might expect some balancing of the
commodity’s supply/demand disparity on the back of its more
normalized use for space heating by residential/commercial
consumers.
But until then, the weak fundamentals are going to continue to
weigh on natural gas prices, translating into limited upside for
natural gas-weighted companies and related support plays.
OPPORTUNITIES
Considering the turbulent market dynamics of the energy
industry, we always advocate the relatively low-risk conglomerate
business structures of the large-cap integrateds, with their
fortress-like balance sheets, ample free cash flows even in a low
oil price environment and growing dividends.
Our preferred name in this group remains Chevron
Corp. (CVX). Its current oil and gas development project
pipeline is among the best in the industry, boasting large,
multiyear projects. Additionally, Chevron possesses one of the
healthiest balance sheets among peers, which helps it to capitalize
on investment opportunities with the option to make strategic
acquisitions.
Within the contract drilling group, we like Helmerich
& Payne Inc. (HP). Supported by a superior and
diversified drilling fleet, together with a healthy financial
profile, we expect the company to sustain its profitability over
the foreseeable future. We believe Helmerich’s
technologically-advanced FlexRigs will continue to benefit from an
upswing in U.S. land drilling activity and the shift to complex
onshore plays that require highly intensive solutions.
Buoyed by the favorable trends in the refining sector, we are
more optimistic on the industry than we were 12 months ago. An
uptick in economic activity overseas (mainly in developing
countries) and prospects for lower feedstock costs are likely to
push 2013 industry margins higher than last year's levels. Against
this backdrop, we are particularly bullish on Tesoro
Corp. (TSO), Valero Energy Corp. (VLO)
and Marathon Petroleum Corp. (MPC).
China's CNOOC Ltd. (CEO) is also a top pick.
CNOOC remains well-placed to benefit from the country's growing
appetite for energy and the turnaround in commodity prices. In
particular, the company enjoys a monopoly on exploration activities
in China's very prospective offshore region in addition to having a
growing presence in the country's natural gas and liquefied natural
gas (LNG) infrastructure. The impending acquisition of Canadian
energy producer Nexen Inc. (NXY) will further
improve CNOOC’s growth profile by augmenting proven reserves by
30%, while helping it to vastly expand its holdings in Canada.
Finally, despite the depressing natural gas fundamentals and the
understandable reluctance on the investors’ part to dip their feet
into these stocks, we would advocate to opt for Cabot Oil
& Gas Corp. (COG). The company’s recent results have
been driven by its exposure to the high-return Marcellus and Eagle
Ford Shale plays, as well as its above-average production growth. A
relatively low-risk profile and longer reserve lives are other
positives in the Cabot story.
WEAKNESSES
We recommend avoiding Weatherford International
Ltd. (WFT), a major oilfield services provider. Of late,
the company has been pegged back by certain tax accounting and
goodwill impairment issues, forcing it to defer its income tax
reporting. Further, Weatherford expects poor-margin Iraqi contracts
to hurt operations and shrink its near-term average output. Low gas
prices also remain a concern. Given these headwinds, we expect
shares of Weatherford to be under pressure.
We are bearish on Brazil 's state-run energy giant
Petroleo Brasileiro S.A. (PBR), or Petrobras S.A.
The Rio de Janeiro-headquartered company has been suffering on the
back of lower production, rising costs and heavy fuel imports. We
also remain concerned by Petrobras’ huge investment requirements,
the possibility of heightened state interference and caps on local
fuel prices.
We are also skeptical on Canadian energy explorer
Talisman Energy Inc. (TLM). Taking a cautious view
of gas prices, Talisman’s capital program specifically focuses on
the promising North American liquids-rich areas, which is a major
shift away from dry natural gas development. While subscribing to
management’s outlook, we believe the realignment of Talisman will
take some time to bear results. Questions about the company’s
sustainable operational efficiency and execution abilities also
remain key areas of concern, in our view.
Based upon the number of near-term challenges, we remain
pessimistic on the near-term prospects of Nabors Industries
Ltd. (NBR). The land drilling contractor is facing
headwinds in the pressure pumping market on the back of collapsing
prices and lower utilization. The recent weakness in the North
American onshore rig count has also been a negative. As usual, we
remain concerned about weak natural gas fundamentals, which are
likely to limit the company’s ability to generate positive earnings
surprises. Nabors’ fairly debt-heavy balance sheet also remains an
issue.
Chinese refining giant China Petroleum and Chemical
Corporation (SNP) -- also known as
Sinopec -- is another company we would like to
avoid for the time being, mainly due to slower domestic growth.
Moreover, increases in the price of international crude oil -- amid
government caps on fuel prices -- has been preventing the company
from fully passing on spiraling costs to consumers, and thereby
hurting refining margins.
Lastly, we expect ADRs of another Chinese heavyweight,
PetroChina Co. Ltd. (PTR), to be under pressure in
the near future. The Beijing-based integrated outfit recently
posted weak quarterly results on the back of a challenging
operating environment and persistent refining losses. We also
remain concerned by PetroChina’s oil production growth prospects,
considering its heavy exposure to significantly mature-producing
areas. Other near-term headwinds include high-priced gas imports
amid low domestic gas sale prices, policy uncertainty and an
ambitious investment program.
BP PLC (BP): Free Stock Analysis Report
CONOCOPHILLIPS (COP): Free Stock Analysis Report
CHEVRON CORP (CVX): Free Stock Analysis Report
EOG RES INC (EOG): Free Stock Analysis Report
NABORS IND (NBR): Free Stock Analysis Report
NATL OILWELL VR (NOV): Free Stock Analysis Report
PETROBRAS-ADR C (PBR): Free Stock Analysis Report
PHILLIPS 66 (PSX): Free Stock Analysis Report
ROBBINS & MYERS (RBN): Free Stock Analysis Report
SCHLUMBERGER LT (SLB): Free Stock Analysis Report
CHINA PETRO&CHM (SNP): Free Stock Analysis Report
SASOL LTD -ADR (SSL): Free Stock Analysis Report
TESORO CORP (TSO): Free Stock Analysis Report
WILLIAMS COS (WMB): Free Stock Analysis Report
WESTERN REFING (WNR): Free Stock Analysis Report
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