OUTLOOK
Crude Oil
The improving economic scene, both here in the U.S. as well as worldwide, has been the main driver of the oil rally that saw the commodity breaching the $85 per barrel level earlier this month.
However, in recent days, concerns about the European debt crisis and China’s growth outlook have renewed apprehensions about the global growth and energy demand. As a result, oil prices have slumped to a 3-month low. Additionally, high levels of product inventories (gasoline and distillate stocks remain above the upper boundary of the average range for this time of year), along with soaring commercial oil supplies, has further dragged down crude prices, in our view.
But way too many factors weigh on oil prices — from OPEC decisions and geostrategic tensions to the value of the U.S. dollar and seasonal variables — to definitively size up each one of them for their respective impact on prices.
In its latest release, the Energy Information Administration (EIA) reported a higher-than-anticipated increase in crude stockpiles, which rose by 1.9 million barrels for the week ending May 7. The inventory increase was the fourth in as many weeks, which has left supplies at their highest levels in almost a year. At 362.5 million barrels, crude supplies are 8.1 million barrels below the year-earlier level, but remain above the upper limit of the average for this time of the year. As such, crude oil’s near-term fundamentals remain weak, to say the least.
According to EIA’s Short-Term Energy Outlook, world crude 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.
However, the agency also provided some positive news in this otherwise bleak supply-demand picture. According to EIA, the decline in oil demand bottomed out in the middle of 2009, as the world economy began to rebound in the latter half of the year. The agency expects this recovery to continue in 2010 and 2011, contributing to global oil demand growth of 1.6 million barrels per day in each of the years.
Recently, the Organization of the Petroleum Exporting Countries (OPEC), an intergovernmental organization that supplies around 35% of the world’s crude, raised its forecast for global oil demand this year. In its monthly oil report, OPEC said it now expects world oil demand to grow by 950,000 barrels per day in 2010, 50,000 barrels per day higher than its previous assessment.
However, the third major energy consultative organization, the Paris-based International Energy Agency (IEA), the energy-monitoring body of 28 industrialized countries, reduced its global oil demand forecast for 2010, citing weaker-than-expected growth in Asia and the Middle East. IEA predicts that oil demand will average 86.4 million barrels a day in 2010, or 1.6 million barrels a day more than in 2009.
Our view is that the current decline in oil prices is momentary in nature. We expect the commodity to trade in the $70 – $80 per barrel range in the near future, supported by the rising consumption in emerging and developing economies, led by Asia. But this does not mean that we will not see any short-term pullbacks (like the present one). On the whole, we expect oil prices in 2010 to be higher than the 2009 levels, but remain significantly below the 2008 peak levels.
Natural Gas
The three-month cold snap (from Dec ‘09 through Feb ’10) led to a surge in natural gas demand, in the process erasing a hefty surplus over last year’s inventory level and significantly trimming the excess over the five-year average level.
As a result of the sustained inventory drawdown, the commodity staged a phenomenal recovery, breaching the $5.70 per million Btu (MMBtu) level during early Feb. 2010 (referring to Henry Hub spot prices), up significantly from the 7-year-low level of sub-$2 per MMBtu in Sept. 2009. Things appeared to be getting better for the natural gas players, with cold weather slowly cleaning up the storage surplus. But with winter cold now gone, demand for natural gas for heating and power-plant fuel has reduced.
In its latest weekly release, EIA reported some positive news in the form of less-than-expected growth in natural gas supplies that send prices to an eight-week high of over $4.30 per MMBtu. However, the current storage level, at 2.09 trillion cubic feet (Tcf), is up 4.9% from last year’s level and more importantly, 18.4% above the five-year range. As such, the specter of a continued glut in domestic gas supplies still exists.
Further pressurizing the commodity is the rapid rise in the number of drilling rigs working in the U.S. (natural gas rig count has climbed more than 40% from a seven-year low reached last July) that signals a supply glut later this year in the face of sluggish industrial demand. Meanwhile, production from dense rock formations (shale) remains robust.
There are concerns among traders that the market will be oversupplied in the near-to-medium term, with rig counts going up and industrial demand still struggling due to the weak economy. These factors translate into limited upside for natural gas-weighted companies and related support plays.
OPPORTUNITIES
Despite the current ongoing weakness, the current oil price environment should benefit producers, particularly those international players having attractive growth opportunities in their home markets. Two such standout names are Brazil’s Petroleo Brasileiro S.A. (PBR), or Petrobras, and China’s PetroChina Company Limited (PTR), both of which remain well-placed to benefit from their respective country’s growing appetite for energy.
Petrobras, the largest integrated energy firm in Brazil, stands to benefit from the continuous demand growth in Brazil (expected to outperform developed countries in the next few years). Additionally, we expect the company’s expertise in deep-water operations, huge recent discoveries (which could double its resource base), and the growing domestic refined products market to fuel its medium-term earnings outlook.
China’s impressive economic growth has significantly increased its demand for oil, natural gas and chemicals. This growth momentum presents attractive opportunities for industry players that can meet the country’s fast-growing energy needs. Being one of the two integrated oil companies in China, PetroChina is well-positioned to capitalize on these favorable trends.
Within the oilfield services group, we are positive on London-based Acergy S.A. (ACGY). With a healthy backlog, significant cash balances, and no near-term refinancing requirements, Acergy should weather the challenging business environment. Our favorable recommendation on Acergy ADRs also reflects the company’s strong leverage to the still very favorable outlook for deepwater oilfield activities and the quality of its client base, which mostly includes well-capitalized oil majors or national oil companies.
Another service provider we like is Core Laboratories N.V. (CLB). We like 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.
Among the oil drilling equipment makers, we are particularly bullish on FMC Technologies Inc. (FTI). The company has a diversified product portfolio, specialty service capabilities and proprietary technological expertise. Additional positives in the FMC Technologies story include a strong backlog position, growing international operations and the still-favorable outlook for deepwater offshore markets.
WEAKNESSES
We continue to feel strongly that Transocean, Inc. (RIG) — the world’s largest offshore driller — should be avoided for the time being. The company recently reported robust first quarter 2010 results, helped by contributions from newbuild operations.
However, Transocean’s earnings beat was overshadowed by the announcement that it will lose more than $500 million in revenue, and its finances will be hampered by hefty fees from a growing pile of lawsuits, as the company is entangled in the huge oil spill accident in the Gulf of Mexico, the Deepwater Horizon. The cloud of uncertainty regarding the liability and likely litigation following the Horizon incident keeps us on the sidelines.
We also maintain our cautious view on oil refiners. Utilization rates are likely to hover around the high 80’s/low 90’s during the near-term amid too much supply of petroleum products. Supply is expected to swell further as more conversion units resume operations from their turnaround activities over the next few weeks.
As such, we have a bearish stance on companies like Sunoco Inc. (SUN), Tesoro Corp. (TSO), Valero Energy Corp. (VLO) and Western Refining Inc. (WNR), given that the overall environment for refining margins is likely to remain poor. Refining margins have been significantly lower for quite some time now, as a result of narrower spreads on crude oil and oil products. We believe that this imbalance between supply and demand will remain in place for the next 6 – 12 months and will negatively impact the bottom line.
In the integrated energy space, we would avoid Canada-based Suncor Energy Inc. (SU), reflecting its weak near- to medium-term production outlook and the Petro-Canada acquisition-related risks. Recently, the company cut its 2010 targeted oil sands output following an upgrader fire in February. Post Petro-Canada acquisition, we also remain worried about Suncor’s high debt level and significant anticipated capital expenditure requirements.Zacks Investment Research
