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Hope for energy companies lies with gas

Nicki Bourlioufas  |  13 Jul 2017Text size  Decrease  Increase  |  

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While energy companies have been slammed on the stock exchange this year due to a weaker oil price, analysts say higher gas demand from Asia could see many of these stocks move higher over the medium to longer term.


According to Mark Taylor, senior resources analyst with Morningstar, the longer-term outlook for oil and gas companies is positive given growing demand from rapidly developing economies.

"While we can't say whether or not share prices will continue to fall, over the longer term, I think that the outlook is reasonably good for gas and energy companies," says Taylor.

"With rapidly rising energy use in Asia, where demand from countries such as Vietnam, Indonesia, and India is taking over from strong Chinese demand, you've got rising wealth leading to rising energy usage.

"Moreover, a lot of these countries don't have domestic coal stores, such as China does, so there is going to be a great opportunity for LNG exporters from Australia over the coming years."

That will benefit energy exporters such as Woodside Petroleum (ASX: WPL), Oil Search (ASX: OSH), and Santos (ASX: STO), which is the most undervalued of the three, says Taylor.

"We think no-moat-rated Santos is approaching 50 per cent undervalued, and rate it the best value of the three large Australian exploration and production companies, including Woodside Petroleum and Oil Search," he says.

Santos will eventually reprice towards its fair value of $5.20, well above its current pricing of around $3, says Taylor.

"Stocks that are undervalued can reprice at any time," he adds. "The main reason for the weakness in Santos' price is the fall in the oil price, but Santos has also had a lot of debt with its Santos GLNG project at peak expenditure."

"We believe concern around reserves and resources for Santos is unjustified ... We think the underlying drivers are resolving.

"Debt has eased significantly and sharply lower upstream development and operating costs are likely to support renewed reserve and resource growth ... Project and dedicated third-party gas contracts already underpin a healthy 20-plus years of reserve life for GLNG," Taylor says in a recent research note.

Taylor puts a fair value of $35.50 on Woodside, which is currently trading at around $29.30. He adds that Woodside is the least risky of the three major oil stocks, with the lowest debt, more projects, and a more diversified revenue base. It too will benefit from LNG exports.

"Woodside has operatorship and a one-sixth share in the North West Shelf Joint Venture. Under its watch, the number of LNG trains has grown from one to five, taking gross output to 16.4 million metric tons per year. This pedigree is unmatched in the Australian oil and gas space," says Taylor.

"We don't think the market sufficiently credits for expansion potential, particularly given recent developments by Woodside and third parties regionally to Pluto and other hubs. The more hubs Woodside has, the better the options for accretive build-out and the greater leverage for doing deals."

In contrast, Oil Search looks overvalued, currently trading around $6.55, compared to Taylor's fair value of $4.50. Taylor doesn't believe the market sufficiently discounts for PNG sovereign risk, and over-credits for gas resources not yet approved for development. More than 98 per cent of Oil Search's oil and LNG assets are in PNG.

Taylor doesn't expect any rebound in the oil price to help the energy companies. He expects the oil price to average around US$55/barrel this year, before falling to an average of US$50/barrel next year on greater supply, with the price to rise to US$60/barrel by 2019. US shale production will prevent gains beyond that.

"We see US$60/barrel as a cap, and if OPEC tries to support the price by restricting supply, that will only encourage US shale producers to increase supply, which will keep a cap on the price," he says.

Oil prices are currently hovering at near nine-month lows around US$45/barrel on oversupply concerns. While oversupply risks were met with several producers temporarily sidelining production in 2016-17, US oil producers, which account for 10 per cent of global supply, could continue to lift supplies.

"US shale oil supply remains the other most important structural driver for oil prices. Saudi Arabia and OPEC have underestimated just how quickly US shale oil producers can respond to profit margins," said a July research note from the Commonwealth Bank's Global Markets Research division.

What that means for energy companies is that while greater gas exports in coming years will help to support their prices, the weaker oil price overall will cap gains in prices over the short to medium term.

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Nicki Bourlioufas 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.

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