Oil & Gas Stock Outlook - Jan 2013 - Industry Outlook
January 17 2013 - 11:22AM
Zacks
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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