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Corona: Oil price plunge won't last, says Morningstar

Glenn Freeman  |  31 Mar 2020Text size  Decrease  Increase  |  
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The price of Brent crude will level out at around US$60 a barrel over the longer-term, Morningstar says, despite oil hitting 17-year lows of under US$25 in recent days.

Energy stocks were the biggest percentage losers among the 11 major sectors covered by the S&P 500 late last week, dropping 6.9 per cent.

Morningstar anticipates oil prices will bounce back through 2021. On a global level, debt levels among the biggest offshore exploration and production companies aren't expected to blow out.

This comes amid flagging oil demand as coronavirus prompts cross-sector shutdowns around the globe. Around 3 billion people are in lockdown. This could slash demand for oil by as much as 20 per cent, says the International Energy Agency head Fatih Birol.

Brent was trading as high as US$68 a barrel in mid-January, before the first coronavirus cases appeared outside China. Since then, the price has crashed to less than $25 a barrel, driven lower still by Russia and Saudi Arabia's refusal to cut output.

Morningstar Australia senior equity analyst Mark Taylor says oil price volatility in recent weeks reflects two key uncertainties:

  • how long coronavirus and the widespread shutdowns will last
  • how permanent the economic damage will be.

"The cost curve is so flat…whatever happens, the oil price is going to swing around a lot," he says.

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Brent prices are also shifting up and down as it appears "more or less likely that Russia and Saudi Arabia will be coming to the table to talk to each other."

"But we think vested interests should soon see order return to oil markets," Taylor says.

Five oil and gas companies, including two from Australia, are among 40 stocks discussed in a special coronavirus report by Morningstar's global team of equity analysts. Coronavirus: Market Temperature Check can be accessed by subscribing to Morningstar Premium or taking up a free four-week trial.

oil and gas

Taylor and his Morningstar US colleague David Meats compiled the chapter on oil and gas companies:

"Before the meeting on 6 March, investors were anticipating, at minimum, that OPEC+ would agree to extend the current cuts through 2020, instead of letting them expire at the end of March 2020.

"But as Russia refused to participate, the opposite happened. With no new agreement in place, cartel members are now free to ramp production to capacity and worsen the current supply-demand imbalance.

"The situation was further exacerbated when Saudi Arabia started selling crude at heavy discounts, essentially igniting a price war. However, we anticipate these issues will only affect cash flows in the next one to two years."

Meats and Taylor believe Russia and OPEC are unable to displace the supply provided to global markets by US shale oil and gas producers.

"This means the marginal supply cost is still $60 per barrel for Brent. And we think vested interest should eventually see order return to oil markets.

"In the meantime, oil and gas companies will suffer across the board.

"Those most at risk with current low prices are companies with leveraged balance sheets and those with higher operating costs."

More detailed information on integrated oil majors, many of which are currently undervalued, can be found in Morningstar's 17 March report Integrated Oils: Yields Are Spiking, So Are Dividends Safe? Also, we detail our reasons for keeping our midcycle oil price forecasts unchanged in our 19 March report, After Coronavirus and OPEC+ Chaos, Can Energy Come Back?

"In Australia, most companies fortunately have comparatively low operating costs. We estimate free cash flow break-even Brent prices of Australian E&Ps at approximately $20-$30 per barrel," say Meats and Taylor.

"This contrasts favourably with US shale producers, for example, where $40 per barrel and higher is the mark. Further, most Australian companies have comparatively healthy balance sheets, ranging from unleveraged to moderate leverage."


is senior editor for Morningstar Australia

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