Glenn Freeman: I'm Glenn Freeman for Morningstar, and I'm joined here today by Morningstar Energy Analyst, Mark Taylor.
Mark, thanks for joining us.
Mark Taylor: Good morning, Glenn.
Freeman: We've heard a lot about the protracted low in oil prices. Has the oil price now reached its terminal price? What's your view on this?
Taylor: Our view is that oil has hit its nadir. It probably went lower than a lot of people, us included, were expecting simply because it's taken a lot longer for producers to start cutting production. There has been a great deal of inertia in business models, particularly since the advent of shale gas, because once these wells get up and running, they keep going and then it's a considerable lag between when companies start cutting expenditure on drilling new wells. And at long last, you are starting to see a supplier response and once again that inertia is probably going to work in the other direction as well. There is probably going to be a shortage in the near-term, if anything, simply because it's going to take some time for companies to ramp up again when the demand comes.
Freeman: Australian E&P companies, Woodside, Santos and Beach are regarded as being relatively fair-valued by Morningstar, while others like AWE as undervalued and Oil Search as overvalued. So, are there fundamental differences in these companies which impact that and especially, given low oil price – can you explain that?
Taylor: Well, there's absolutely fundamental differences in the nature of the businesses that the larger players like Woodside and Santos are very export-focused companies, gas exporters. They have export LNG infrastructure which means they attract an export price for their gas. They also have very substantial reserves and very, very substantial infrastructure bases. So, to a considerable extent, they are very much a revenue model business.
And then when you get to the smaller companies, they are more domestic players rather than export-focused. So they are attracting a lower price for their product, so they are often lower margin. Because they are smaller, they have smaller reserve bases, shorter field lives, that sort of thing. And the exploration programs are much, much more significant for the smaller players because if you get a reasonable-sized exploration hit, it can be very meaningful to their share prices as can the addition of a new project, which is potentially not going to be the case with the larger companies.
In our AWE, fair value estimate, for example, almost a third of that is predicated on the successful development of the Ande Ande Lumut oil field in Indonesia. We think it's going to go ahead. But if it doesn't, that's a considerable portion of value that could be expunged from the company.
Freeman: The Morningstar view is that production in OPEC countries and the U.S. won't increase over the next decade. Are you expecting the same sort of assessments to apply here in Australia?
Taylor: Well, very definitely on the oil front, we're a country who was not particularly oil-rich in the first place. We have used a considerable portion of our oil reserves as it were and our E&P companies are becoming more and more gassy with time. It's to the point now where most of the Australian companies have something like 90% of their hydrocarbon reserves are gas and only 10% are oil, AWE being the exception. So gas is very much what matters in terms of pricing. But having said that, at the moment gas, especially export gas prices, is very much a function of the oil price and we expect that to remain the case for some considerable time, although you're likely to see a gradually increasing component of Henry Hub pricing creeping into the Asia market as U.S. LNG exports crank up.
Freeman: Mark, lastly, with all the talk of oversupply with a gradual winding down of production levels that we've seen, could we ultimately end up having actually a shortage of oil and gas suppliers?
Taylor: Absolutely. I think you have to look at energy holistically. There is a temptation to look too closely at one component of primary energy and oil as a case in point. But there are multiple energy sources, renewables, hydro, nuclear, gas, oil, coal, and they all play their part and they are not mutually exclusive. There is a crossover between them and we expect increasingly so in the future as transport becomes more electrified, it means that you're going to be able to power your car from renewables, coal, gas, multiple sources from a primary perspective whereas that's chiefly been an oil and gas dominant market today.
So, I think it's important to look at the energy mix, where it's coming from and also the other drivers of demand like population growth, which is expected to rise very considerably over the next 30 years. Most pundits have it rising from 7.6 billion global population to 11 billion, something of that order and also rising energy intensity as per capita wealth increases. You're seeing that happen very, very much in the Asia markets which are particularly important from Australian producer perspectives. China has just gone through a very energy-intensive phase, but there are another 2 billion people, most notably in India, Philippines, Bangladesh, Vietnam, those sorts of places, who are just sort of starting to hit the wealth levels that China entered, to really drive that big increase in energy consumption.
So, we're expecting strong energy demand growth to continue and if anything, it could be a struggle for the world to support that level of demand growth, particularly when you are seeing things like having seen very limited increase in oil supply over the last 10 years. Despite having had very, very high oil prices, there has been a very muted response.
Freeman: Mark, thanks very for your time.
Taylor: Thanks, Glenn.
Freeman: I'm Glenn Freeman for Morningstar. Thanks for watching.