Energy crisis will be short-lived

Glenn Freeman: We're talking energy stocks today with our senior equity analyst Mark Taylor. Thanks for your time today.

Mark Taylor: You're welcome.

Freeman: Now, we've seen a big drop-off in oil prices recently. They're at 18-year lows. There's a glut of oil because the coronavirus has halted activity. And energy is the lifeblood of the economy. Should we assume that energy firms will bounce back?

Taylor: Absolutely. This is the crisis that's – it's going to exist for a short period but it's not going to go on indefinitely. And energy is at the foundation of all economies. You can't survive without reliable and consistent energy supply.

Freeman: Morningstar currently rates four oil and gas companies as 5-Stars, so undervalued. Which of these do you prefer?

Taylor: That kind of a question – there's always a purely value answer to the question and then there's also a quality answer to the question and you try to strike a balance. The best value on offer at the moment is probably in Santos and Woodside which makes it easier because they are at the same time the two best-quality names from our perspective. Woodside has a pristine balance sheet, very low debt levels and it's also a low-cost producer. So, it is very well positioned to weather any short-term (routing) in oil price but it's also an attractive longer-term buy because it is a low-cost high-quality producer.

Santos sits similarly into that boat as well, but its balance sheet is not quite as attractive as Woodside's. It is more leveraged than Woodside, although it definitely doesn't have excess leverage and it is comparatively low-cost producer as well. So, those two would be the companies that we'd be recommending most overall or across a broad range of considerations.

Freeman: And Mark, are Australian oil and gas companies positioned differently to some of the offshore oil majors?

Taylor: Yes, in multiples ways. It's always best to have low costs as your ultimate line of defense and these companies are clearly very low cost. But the other aspect that's interesting is that the Australian gas companies are very gas-exposed as opposed to liquids-exposed. That means they are potentially less reliant on transport and airline derived demand for the fuels, gas sold into Asia and domestically is important for industrial purposes and domestic heating and cooking and that sort of thing. So, you'd expect demand or volumes at least to weather a coronavirus storm better than liquids even though the price can obviously be very aligned with the Brent price. So, you're not so much getting price protection as volume protection through the contracts and the nature of the market that you're serving. A company like Santos, however, with its considerable domestic gas business does potentially get some more price protection because domestic gas prices are less immediately exposed to a weakened crude price.

Freeman: Mark, how important is the decision by Saudi Arabia and Russia to finally agree to reduce their oil production to this – the price of oil that we've seen?

Taylor: Well, in an immediate sense, it's very important because you've got this situation with an excess of supply into a demand scenario that's been completely routed out by coronavirus causing lockdowns, people to stay at home, so they are not driving as much. You're not travelling. So, airlines grounded. That's about a sixth of oils consumption there gone away. And then, on top of that, you've had the Saudis and Russians breakdown in agreement to curtail supply. So, excess of supply into the market as well. So, in the short term, it's very important that they've come to this agreement. I don't expect that it will result in some magical rebound in oil price back to where it was because the coronavirus effect is going to persist for some time yet. But eventually, you should see a recovery in oil price to some of semblance of a sensible level which we think is about $60 a barrel Brent.

Freeman: Because it's currently at around $30 a barrels, isn't it?

Taylor: Yeah, that's right. At $30 a barrel, a fast way that the global production is not even washing its face let alone being incentivized to invest to increase production or sustain production, particularly U.S. shale producers for whom a $40 a barrel price is where they start to breakeven on average and it's certainly well below the level that they would require to be incentivised to drill and sustain and increase production.