OUTLOOK
Crude Oil
The improving economic scene, both here in the U.S. as well as worldwide, is the main driver of the current oil rally that has seen the commodity breaching the $80 per barrel level.
But 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, will limit any sustained gains, in our view. 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.
For the week ending Mar. 5, the federal government’s Energy Information Administration (EIA) reported that crude stockpiles rose by 1.4 million barrels. The inventory increase was the sixth in as many weeks that has left supplies at their highest level since August of last year. At 343.0 million barrels, crude supplies are 8.3 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.
Incidentally, 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 EIA’s ‘Short-Term Energy Outlook’ has provided some positive news in this otherwise bleak supply-demand picture. According to the agency, 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 EIA expects this recovery to continue in 2010 and 2011, contributing to global oil demand growth of 1.5 million barrels per day and 1.6 million barrels per day, respectively.
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 900,000 barrels per day in 2010, roughly 100,000 barrels per day higher than its previous assessment.
The third major energy consultative organization, the Paris-based International Energy Agency (IEA), the energy-monitoring body of 28 industrialized countries, also raised its global oil demand forecast for 2010, citing growth in developing economies, led by China. The IEA predicted that oil demand will average 86.6 million barrels a day in 2010, or 1.6 million barrels a day more than in 2009.
Our view is that oil should be able to hold onto its recent gains and consolidate around current levels, provided this favorable economic view remains in place. But this does not mean that we will not see any short-term pullbacks. 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 ongoing surge in natural gas demand has finally started to erode the record-high storage amounts, as steady cold weather continued to kick up demand in major gas-consuming regions in the U.S.
As a result of the sustained inventory drawdown, the commodity staged a phenomenal recovery, breaching the $5.70 per million Btu (MMBtu) level (referring to Henry Hub spot prices) during early Feb. 2010, up significantly from the 7-year-low level of sub-$2 per MMBtu in Sept. 2009. Things appear to be getting better for the natural gas players, with cold weather slowly cleaning up the storage surplus.
However, the specter of a continued glut in domestic gas supplies (storage levels remain above their five-year average) still exists, and inventories are likely to exit the current heating season very near (or even above) the five-year average.
With winter cold subsiding (the cold-weather-demand period ends this month), demand for natural gas for heating and power-plant fuel will reduce. Already, warmer spring weather appears to have arrived in the U.S. Northeast.
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 roughly 40% from a seven-year low reached last July) that signals a production increase later this year in the face of sluggish industrial demand. Meanwhile, supplies from dense rock formations, also known as shale formations, remain robust.
In particular, earlier this month, prices had fallen to their lowest levels since late November (currently trading in the range of $4.40 – $4.50 per MMBtu), pressured by milder-than-normal weather at the end of the heating season.
There are concerns among traders that the market will be oversupplied as winter draws to a close, 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
The strengthening 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 still healthy backlog, significant cash balances and no near-term refinancing requirements, Acergy should be able to 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 company we like is contract drilling services provider Helmerich & Payne Inc. (HP). With its young, efficient drilling fleet, Helmerich & Payne has been able to snag market share and maintain a relatively higher utilization due to stronger drilling demand — and longer duration of term contracts — for their technologically sophisticated FlexRigs.
A relatively conservative financial policy and the quality of its client base, which mostly includes well-capitalized oil majors or large independents are other positives in the Helmerich & Payne story. The recent turnaround in domestic drilling activity also bodes well for the company.
WEAKNESSES
We continue to feel strongly that industry players in the servicing and drilling ends of the business with substantial natural gas-focused and North America-centric operations should be avoided. While we currently don’t have any Underperform rated stocks in this group, we remain skeptical of land drillers like Nabors Industries (NBR) and Patterson-UTI Energy (PTEN), as well as natural gas-centric service providers such as Halliburton Company (HAL). Although we expect the land rig count to continue with its steady rise during 2010, the large amount of excess capacity in the sector will weigh on dayrates and margins well into the year.
We also maintain our cautious view on oil refiners, with utilization rates hovering around historic lows for this time of the year amid too much supply of petroleum products in the face of sharply lower demand. 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. The sharply lower refinery utilization (at just around 80% of capacity) provides enough evidence that refineries are cutting back on production because the economy is still struggling on the demand side.
In the integrated oil and gas space, we would avoid Repsol YPF (REP), Spain’s largest energy company, with significant operations in Argentina and the rest of Latin America. We are particularly worried about Repsol’s downstream business (that contributed approximately 65% of its 2009 operating revenue).
Refining margins were significantly lower last year, especially in the fourth quarter, dropping more than 80% 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 in the near term and negatively impact the bottom line.
