OUTLOOK
Crude Oil
Signs of progress in resolving Europe's long-running sovereign debt
crisis and a tightening global supply picture in view of the
geopolitical fallout over Iran's alleged nuclear ambitions have
been keeping oil prices at elevated levels. Partly offsetting this
favorable view has been high U.S. crude stocks and worries about
China’s growth outlook.
As such, crude oil’s near-term fundamentals remain mixed, to say
the least. The long-term outlook for oil, however, remains
favorable given the commodity’s constrained supply picture. In
particular, while the Western economies exhibit sluggish growth
prospects, global oil consumption is expected to get a boost from
continued strength in the major emerging powers like India, China
and Brazil that continue to grow at a healthy rate.
According to the Energy Information Administration (EIA), which
provides official energy statistics from the U.S. Government, world
crude consumption grew by more than 1 million barrel per day in
2011 to a record-high level of 88.1 million barrels per day. In
2010, oil demand increased by over 2 million barrels per day to
87.1 million barrels per day, which more than made up for the
losses of the previous 2 years and surpassed the 2007 level of 86.3
million barrels per day (reached prior to the economic downturn).
One might note that global demand for 2009 was below the 2008
level, which itself was below the 2007 level -- the first time
since the early 1980’s of two back-to-back negative growth
years.
The agency, in its most recent Short-Term Energy Outlook, said that
it expects global oil demand growth of 1.3 million barrels per day
in 2012 and 1.5 million barrels per day in 2013. EIA’s latest
forecasts assumes that demand will be essentially flat in North
America and Europe but this will be more than made up by impressive
consumption surge coming from China, the Middle East and
Brazil.
Separately, the Organization of the Petroleum Exporting Countries
(OPEC) -- which supplies around 40% of the world's crude --
predicts that global oil demand would increase by 1.1 million
barrels per day annually, reaching 88.9 million barrels a day in
2012 from last year’s 87.8 million barrels a day.
Lastly, the third major energy consultative body, the Paris-based
International Energy Agency (IEA), the energy-monitoring body of 28
industrialized countries, said that it expects world oil
consumption to grow by 1.1 million barrels per day in 2012 to 90.0
million barrels per day.
In our view, crude oil prices in 2012 are likely to witness
significant upside -- rather than downside -- given the
considerable supply tightness in the market. While domestic demand
is relatively soft and the global economy still showing signs of
weakness, the fact that demand is outpacing supply appears to be
palpably evident.
As long as growth from the developing nations continues and the
global output is unable to keep up with that, we are likely to
experience a surge in the price of a barrel of oil. With a
seven-billion-strong world population and all the easy oil being
already discovered and expended, we assume that crude will trade in
the $95-$105 per barrel range in the near future.
Natural Gas
Over the last few years, a quiet revolution has been reshaping the
energy business in the U.S. Known as ‘shale gas’ -- natural gas
trapped within dense sedimentary rock formations or shale
formations -- it is being seen as a game-changer, set to usher in
an era of energy independence for the country. The success of this
unconventional fuel source 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, gas stocks -- currently 25.4%
above the 5-year average and 24.6% higher than the same period last
year -- are at their highest level for this time of the year,
reflecting low demand amid robust onshore output.
Looking ahead, EIA expects average total production to rise by 2.2%
in 2012 (to an all-time high 67.3 billion cubic feet per day,
easily eclipsing 2011's record high estimate of 65.9 billion cubic
feet per day), while total natural gas consumption is anticipated
to grow by just 2.0% next year. We believe these supply/demand
dynamics -- the projected lower consumption growth compared to
production -- will weigh on natural gas prices, translating into
limited upside for natural gas-weighted companies and related
support plays.
In the absence of major production cuts or a stronger economy to
boost industrial demand, which is responsible for almost a third of
the gas consumption, we do not expect much upside in gas prices in
the near term. In other words, there appears no reason to believe
that the supply overhang will subside and natural gas will be out
of the dumpster in 2012.
In the past, winter weather has played a factor in boosting prices
with demand for domestic natural gas exceeding available supply.
But with no dearth of new supply, even this association is becoming
more and more obsolete.
OPPORTUNITIES
In this current turbulent market environment, we advocate the
relatively low-risk energy 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.
The current oil price environment should also benefit producers,
particularly those international players having attractive growth
opportunities in their home markets. One such standout name is
PetroChina Company Limited (PTR), which remains
well-placed to benefit from the country’s growing appetite for
energy and the turnaround in commodity prices. PetroChina -- one of
two Chinese integrated oil companies -- is poised to capitalize
from the country’s impressive economic growth that has
significantly increased its demand for oil, natural gas and
chemicals.
Within the oilfield services group, we like Halliburton
Company (HAL). We are a fan of the Houston, Texas-based
player’s leading position in the global oilfield services market,
its broad and technologically-complex product/service offerings,
and its robust financial profile. The company has been benefiting
from increased activity in the unconventional shale plays in North
America, which has more than made up for the drop in deepwater Gulf
of Mexico activity and disruptions in North Africa.
Denbury Resources Inc. (DNR), a leading CO2
‘Enhanced Oil Recovery’ (EOR)-focused company targeting a large
attractive market, is also a top pick. With its unique profile,
compelling economics and an unmatched infrastructure, Denbury is
nicely positioned to deliver long-term sustainable growth.
Additional positives for Denbury include a strong financial
position, low-risk investments and an active divestment policy.
Further, we remain optimistic on the near-term prospects of South
African petrochemicals group Sasol Ltd. (SSL). We
like Sasol for its diverse portfolio of assets that produce a wide
array of chemical and liquid fuels. The company specializes in
gas-to-liquids (GTL) and coal-to-liquids (CTL) technologies, which
convert natural gas and coal to diesel and other liquid fuels.
Recently, these technologies have been attracting attention because
they provide an alternative to traditional oil. Additionally,
Sasol’s deleveraged balance sheet and strong cash position keeps
the group well-equipped to weather the global economic storm and
fund its growth program in tough credit markets.
Canada's biggest energy firm and the largest oil sands outfit
Suncor Energy Inc. (SU) is also worth a look. We
like the company’s impressive portfolio of growth opportunities,
unique asset base and high return potential in the long run. Suncor
has significant oil sands and conventional production platform,
huge long-lived oil-sands reserves and a robust downstream
portfolio.
The company's asset base includes substantial conventional reserves
and production at offshore Eastern Canada and in the North Sea,
which generate strong margins and should provide free cash flow to
fund future oil sands expansion.
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 EOG
Resources Inc. (EOG), a former natural gas exploration and
production (E&P) company that has made significant headway into
the more profitable oil space with the introduction of the
commercial viability of shale oil.
WEAKNESSES
We are bearish on Italian energy company Eni SpA
(E). The integrated player -- with a large presence in Libya -- has
seen its total production drop by 13% during the most recent
quarter, primarily due to operational disturbances at several
fields in the North African nation.
Additionally, Eni's upstream portfolio carries greater political
risk than its peers, since it has the highest exposure to the OPEC
countries. Given these concerns, we expect Eni to perform below its
peers and industry levels in the coming months. As such, we see
little reason for investors to own the stock.
Calgary, Alberta-based oil and gas outfit Talisman Energy
Inc. (TLM) is another company we would like to avoid for
the time being. With core operations in the North Sea, Talisman has
been adversely affected by last year’s tax hike in the region,
along with maintenance/production issues that have created investor
concerns about the company’s sustainable operational efficiency and
execution abilities.
We are also skeptical on independent energy exploration firm
Cabot Oil and Gas Corp. (COG). Cabot was the best
performing S&P stock for 2011, gaining almost 100% during the
period. The natural gas producer defied weak commodity prices to
set a scorching pace in a year that saw the overall index decline
0.6%.
Most of the gain was driven by its exposure to the high-return
Marcellus and Eagle Ford Shale plays, as well as its above-average
production growth. But given natural gas’ weak fundamentals and
Cabot’s high exposure to the commodity, we do not believe that the
stock will be able to sustain the momentum in the near future.
Cabot’s steep valuation and miniscule payout also keep us
worried.
Further, we remain cautious about natural gas-focused energy firm
Questar Corporation (STR). The expected bearish
natural gas fundamentals over the next few quarters and excessive
domestic gas supplies is likely to restrict near-term growth
prospects at Questar Pipeline. We also believe that upside
potential will remain limited until the company has fully reaped
the benefits of the spin-off of its unregulated E&P
business.
We recommend avoiding names like Sunoco Inc.
(SUN), whose East Coast-based downstream units have been performing
poorly during the last few years, hampered by higher crude prices,
while their Mid-Continent competitors continue to benefit from the
lower oil prices caused by the crude glut in Cushing. Though the
company is planning to exit its refining business on or before July
2012, we believe the realignment of Sunoco will take some time to
bear results.
Lastly, we expect shares of offshore driller Noble
Corp. (NE) to be under pressure in the near future. In
particular, the company’s old and less efficient fleet in a
cutthroat environment could prove detrimental.
On the arrival of newbuild rigs into the market, many of the
company's older rigs, floaters as well as scores of jackups, will
face the threat of departure, resulting in a risk of earnings
dilution from the retirement of older specification rigs.
Additionally, with core operations in the Gulf of Mexico, Noble has
been adversely affected by continued delays in normalized activity
in the region following the oil spill, along with the introduction
of new and more stringent regulations.
CABOT OIL & GAS (COG): Free Stock Analysis Report
CHEVRON CORP (CVX): Free Stock Analysis Report
DENBURY RES INC (DNR): Free Stock Analysis Report
ENI SPA-ADR (E): Free Stock Analysis Report
EOG RES INC (EOG): Free Stock Analysis Report
HALLIBURTON CO (HAL): Free Stock Analysis Report
NOBLE CORP (NE): Free Stock Analysis Report
PETROCHINA ADR (PTR): Free Stock Analysis Report
SASOL LTD -ADR (SSL): Free Stock Analysis Report
QUESTAR (STR): Free Stock Analysis Report
SUNCOR ENERGY (SU): Free Stock Analysis Report
SUNOCO INC (SUN): Free Stock Analysis Report
TALISMAN ENERGY (TLM): Free Stock Analysis Report
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