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Attractive opportunities among ASX energy stocks

Anthony Fensom  |  08 Aug 2017Text size  Decrease  Increase  |  

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Oil prices have more than halved since 2014, weakening the outlook for energy producers. However, Morningstar still sees opportunities among the ASX-listed energy companies, with some now "attractively priced" in a lower-cost oil environment.

 

On 3 August, Brent crude was trading at US$52.54 a barrel in London, while West Texas Intermediate (WTI) was at US$49.76 in New York. Despite supply cuts by the oil producers' cartel, the Organisation of Petroleum Exporting Countries (OPEC), analysts expect the downturn to extend into the next decade as the days of US$100 oil prices recede into distant memory.

"The era of lower-cost oil is here to stay," says Morningstar's Mark Taylor, senior equity analyst, oil and gas and mining services.

Taylor points to the influence of US shale production as constraining any potential oil price gains, noting that the break-even price of shale production has dropped from US$90 a barrel (WTI) in 2013 to around US$44 last year.

"Because of US shale's marginal position on the global oil cost curve, shale break-evens are a key determinant of our below-consensus long-term oil price expectation of US$60 per barrel Brent," Taylor says.

As a result, Morningstar expects the oil price to average US$56 a barrel this year, dropping to US$48 in 2018 before recovering to US$60 from 2019.

"We're in a zone where there will be enough supply incentivised to meet demand, but the price isn't so attractive to cause a massive build-up of shale that could result in oversupply," he says.

"OPEC are between a rock and a hard place--they're just going to have to live with the US being the marginal-cost producer and dictating the price."

Cartel members have found it difficult to restrict output despite their commitment to withhold almost 2 per cent of global daily supply. Seven of 11 OPEC members that pledged to cut supply have been producing more than promised, given the importance of oil in balancing national budgets, according to The Wall Street Journal.

OPEC's share of the global oil market has shrunk to 40 per cent from 55 per cent in the early 1970s, when its sales embargo to the West quadrupled prices. In contrast, US shale producers have helped to nearly double US oil production since 2008, pushing prices lower.

Following OPEC's latest meeting in Russia last month, resource analysts Wood Mackenzie said the outlook was for continued weak prices.

"Global supply will increase by 1.9 million b/d [barrels per day] next year without an extension of the OPEC agreement to cut production beyond March 2018. We forecast demand growth at 1.2 million b/d. There will be oversupply and sustained downward pressure on prices," Wood Mackenzie's Simon Flowers says.

The UK-based consultancy expects the oil price to average US$51 per barrel this year and US$50 in 2018, suggesting that "lower-for-longer is becoming a reality".

However, the International Energy Agency (IEA) argues that global oil supply could lag demand after 2020, "risking a sharp upturn in prices, unless new projects are approved soon".

The IEA's medium-term oil market report points to a tighter oil market next decade, with spare production capacity in 2022 seen falling to a 14-year low. It sees developing countries such as India accounting for much of the growth in demand, which could pass 100 million b/d in 2019.

Yet Morningstar's Taylor points to such factors as the electrification of transport as another factor limiting oil demand. The number of electric or hybrid cars and buses is expected to reach 27 million by 2027, up from 3 million this year, according to consultancy IDTechEx.

"Oil has enjoyed a premium fuel status as it has a lot of energy contained in a small volume, which is ideal for transport. But if you're packaging it differently and using electrons to fuel cars, then all sorts of other fuels come in, like renewables and gas and coal, and oil could lose its premium status," Taylor says.

Gas gains

Taylor sees oil losing market share to renewables, with gas a likely beneficiary in the medium term.

Helped by new liquefied natural gas (LNG) export projects in Queensland, Australia has emerged as the world's second-largest LNG producer behind Qatar. Australia's LNG exports are seen rising to $37 billion over 2018-19, up from $23 billion this year, according to the Department of Industry, Innovation and Science.

While a buyer's market has emerged in LNG due to a glut of supply, rising Asian demand is expected to curb oversupply by early next decade, despite the influence of US gas exports on prices.

"Even were the longstanding oil-LNG pricing mechanism to erode faster than anticipated, we still think strong Asia-Pacific demand growth will support US$8.50 LNG prices on a cost basis. US gas is cheap, but considerably more expensive to ship to Asia than for well-placed Australian exports," Taylor says.

"Our mid-cycle Australian domestic gas price assumption remains A$7.60, important for Santos (ASX: STO) and juniors like AWE (ASX: AWE), where lower-priced domestic contracts are rolling off."

In a 29 June report, Taylor argued that Santos was approaching "50 per cent undervalued" and was the best-valued of its peers including Oil Search (ASX: OSH) and Woodside Petroleum (ASX: WPL).

"We believe Santos is being discounted for something more than just spot pricing, most likely declining reserves and resources, and unfairly so. In our opinion, Santos has greatly improved its balance sheet, and should enjoy a similar reserve life to peers, supporting long-term production growth," he says.

Taylor also points to AWE, saying "it comes under our scale of high risk, but is a quality outfit and its Waitsia gas project in Western Australia is looking very promising".

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Anthony Fensom is a Morningstar contributor. This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind. Opinions expressed herein are subject to change without notice and may differ or be contrary to the opinions or recommendations of Morningstar as a result of using different assumptions and criteria. The author does not have an interest in the securities disclosed in this report.

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