Crude Oil
The improving economic scene – both here in the U.S. as well as
worldwide – and the continued unrest in producing countries had
been the main driver of the oil rally, which saw the commodity zoom
past the $110 per barrel level earlier this year.
However, apprehensions about high U.S. crude stocks, the release
of emergency oil supplies from government-held strategic reserves
into the world market, and uncertainty over oil supply disruptions
in the Middle East have been weighing on investor sentiment,
weakening oil prices to less than $100 a barrel.
But far too many factors weigh on oil prices to definitively
size up each one of them for their respective impact on prices.
Some of those factors include OPEC decisions, geostrategic tensions
the value of the U.S. dollar and seasonal variables, etc.
As per the latest release by the Energy Information
Administration (EIA), crude supplies are higher than the
year-earlier level and are above the upper limit of the average for
this time of the year. This has led to domestic demand concerns
against a backdrop of persistently slow job growth. At the same
time, global oil consumption is expected to grow at a healthy rate
this year, buoyed by the continued strength in the major emerging
market economies.
As such, crude oil's near-term fundamentals remain patchy to say
the least. The long-term outlook for oil, however, remains
favorable, given the commodity's constrained supply picture.
According to the EIA, world crude consumption grew by an
estimated 2.2 million barrels per day in 2010 to 86.6 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
1980s of two back-to-back negative growth years.
The agency added that average global consumption growth over the
next 2 years is likely to return to rates seen before the onset of
the global downturn in 2008. The EIA, in its Short-Term Energy
Outlook, said that it expects the current economic recovery to
contribute towards global oil demand growth of 1.4 million barrels
per day in 2011 and 1.6 million barrels per day in 2012. However,
the EIA's most recent demand growth forecast for 2011 is 270,000
barrels per day, lower than in the earlier version, as the agency
sees world economic growth lagging expectations.
Recently, the Organization of Petroleum Exporting Countries
(OPEC) – the oil cartel that supplies around 40% of the world's
crude – also trimmed its 2011 world oil demand outlook, citing the
unsteady global economy that has added risks to the forecast. OPEC
predicts that global oil demand will increase by 1.36 million
barrels per day annually, reaching 88.18 million barrels a day in
2011 from last year's 86.82 million barrels a day. The
organization's current estimate for 2011 is lower by a marginal
20,000 barrels a day from its last report, issued in June 2011. In
2012, OPEC expects global oil demand to grow at a slightly lower
1.32 million barrels per day.
However, the third major energy consultative body, the
Paris-based International Energy Agency (IEA), forecasted
marginally stronger-than-previously-anticipated global oil demand
in 2011. In its latest ‘Oil Market Report’, the IEA, an
energy-monitoring body of 28 industrialized countries, said it
expects world oil demand to grow by 1.2 million barrels per day in
2011, reflecting an upward revision of 200,000 barrels a day over
the previous assessment, mainly driven by the non-OECD
(Organization for Economic Cooperation and Development) economies.
The agency – in its first 2012 forecast in a monthly report – added
that global oil demand next year is expected to rise by 1.5 million
barrels per day year-over-year to a hefty 91.0 million barrels per
day.
We expect crude oil to trade in the $100-$110 per barrel range
in the near future, supported by the continued tightening of world
oil markets. But this does not mean that we will not see any
short-term pullbacks. On the whole, we expect oil prices in 2011 to
be higher than 2010 levels, but remain significantly below 2008
peak levels.
Natural Gas
A supply glut pressured natural gas futures for much of 2010, as
production from dense rock formations (shale) remain robust,
thereby overwhelming demand.
As per the U.S. Energy Department, domestic gas output increased
significantly in 2010 by an estimated 2.4 billion cubic feet per
day, or 4.1%, as production declines in Alaska and the Gulf of
Mexico were offset by a healthy increase in lower-48 onshore
volumes. Storage amounts hit a record high of 3.840 trillion cubic
feet in November, while gas prices during the year fell 21%.
However, stocks of the commodity slid approximately 2.261
trillion cubic feet (Tcf) during the five-month period (November 5,
2010 to April 1, 2011) on the back of a colder-than-normal end to
this past winter, production freeze-offs in January/February and
the steadily declining rig count. These factors cut into the U.S.
supply overhang, thereby creating a deficit in natural gas
inventories after erasing the hefty surplus over last year's
inventory level and the five-year average level.
But with the end of the winter's peak in heating demand, natural
gas prices continue to be under pressure against the backdrop of
sustained strong production. Producers are now hoping that the gap
between supply and demand will further narrow in the coming months
as they bet on a hotter-than-expected summer and an active
hurricane season.
Looking forward, the EIA expects average total production to
rise by 5.8% in 2011 and by 0.9% in 2012, while total natural gas
consumption is anticipated to grow by 2.0% this year and decline
slightly (by 0.2%) during the next year.
We believe these supply/demand dynamics – the projected lower
production growth and almost flat consumption – will lead to the
strengthening of natural gas prices in 2012.
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
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
Royal Dutch Shell plc (RDS.A).
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
China's CNOOC Ltd. (CEO), which remains well-placed to
benefit from the country's growing appetite for energy and the
turnaround in commodity prices. CNOOC 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 LNG infrastructure.
Within the oilfield services group, we like Core Laboratories
N.V. (CLB). We are a fan of Core Labs' leadership position in
the reservoir optimization niche, along with its global footprint
and deep portfolio of proprietary products and services.
Furthermore, the company's low asset intensive operations and
limited capex needs allow it to generate substantial free cash
flows.
Halliburton Co. (HAL), the world's second-largest oil
services firm after Schlumberger Ltd. (SLB), is also a top
pick. We like Halliburton's leading position in the global oilfield
services market, along with its broad and technologically-complex
product and service offerings, and its robust financial profile.
Since the last few quarters, the company has been benefiting from
increased activity in the unconventional oil and gas shale plays in
North America, which have more than made up for the drop in
deepwater Gulf of Mexico activity.
We are also positive on Canada's biggest energy firm and the
largest oil sands outfit Suncor Energy Inc. (SU), reflecting
the company's impressive portfolio of growth opportunities, unique
asset base and high return potential in the long run. Suncor has a
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.
Another company we like is independent energy exploration and
production firm Cabot Oil and Gas (COG). Notwithstanding its
high natural gas exposure, the growth momentum from the company's
drilling efforts should help generate steady volume increases going
forward. We also like Cabot's relatively low risk profile and
longer reserve life asset base. Following last year's capital
infusion of over $200 million and strong operating results, we
believe that the outlook at Cabot has improved significantly.
Onshore contract driller Patterson-UTI Energy Inc. (PTEN)
is also worth a look. The company, which had a heavy spot market
exposure, was hit badly by the financial crisis with operators
tending to release land rigs to preserve cash. However,
Patterson-UTI Energy has recovered almost all its lost market
share, benefiting from its growing premium land rig fleet and the
current boom in pressure pumping services (an umbrella term used to
describe a number of vital services performed on new and existing
wells).
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 China and India)
and prospects for higher fuel demand in the U.S. are likely to push
2011 industry margins higher than last year's levels. Against this
backdrop, we are particularly bullish on Valero Energy Corp.
(VLO), Tesoro Corp. (TSO), and Western Refining Inc.
(WNR).
WEAKNESSES
We are bearish on South African petrochemicals group Sasol
Ltd. (SSL), concerned by the group's unfavorable operating
environment – characterized by a strong domestic currency and
weaker refining margins – and its expensive growth strategy, which
will stretch Sasol's medium-term returns significantly.
Engineering and construction firm McDermott International
(MDR) is another company we would like to avoid for the time being,
mainly due to the tentative commodity price scenario and the
company's clouded post-split outlook. Near-term bookings remain
lumpy at McDermott, as the current uncertain environment has
adversely affected the economics of building new oil and gas
infrastructure.
We are also skeptical on integrated energy firm Marathon Oil
Corporation (MRO), following its recent split into two separate
entities, by separating its downstream business into an independent
company. We believe that transfer of the downstream assets
(post-split) will leave Marathon with a less diversified business.
As a result, the business risk profile of the reorganized Marathon
will be weaker than that of the pre-spin-off company. The recent
decision by ConocoPhillips (COP) to follow Marathon's lead has
effectively raised question marks about the entire business model.
But it may be a too soon to write off the integrated oil company
model.
Lastly, we expect shares of independent oil and gas company
Forest Oil Corporation (FST) to be under pressure in the
near future. Though the Granite Wash play continues to perform well
with an increasing acreage position, we are concerned with the
company's debt-heavy balance sheet, as well as its weak reserves
growth profile. Additionally, with natural gas accounting for
approximately 77% of total production (as of March 31, 2011),
Forest Oil is exposed to the tentative outlook of the North
American natural gas market.
CNOOC LTD ADR (CEO): Free Stock Analysis Report
CORE LABS NV (CLB): Free Stock Analysis Report
CABOT OIL & GAS (COG): Free Stock Analysis Report
FOREST OIL CORP (FST): Free Stock Analysis Report
HALLIBURTON CO (HAL): Free Stock Analysis Report
PATTERSON-UTI (PTEN): Free Stock Analysis Report
SCHLUMBERGER LT (SLB): Free Stock Analysis Report
SASOL LTD -ADR (SSL): Free Stock Analysis Report
SUNCOR ENERGY (SU): Free Stock Analysis Report
TESORO CORP (TSO): Free Stock Analysis Report
VALERO ENERGY (VLO): Free Stock Analysis Report
WESTERN REFING (WNR): Free Stock Analysis Report
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