Material Matters: Oil And Equities

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– Middle East uncertainty driving oil prices
– Stockbrokers have lifted oil price forecasts
– Volatile prices a time for caution
– Australian equities tend to perform well during oil price spikes

By Chris Shaw

In the view of Barclays Capital, market reaction to events in the Middle East and North Africa region are likely to remain key drivers of commodity price movements in the short-term. This implies individual commodity market developments will take something of a back seat.

From an overall view, Barclays suggests the potential upside risk to oil and gold prices if the situation worsens are much greater than the downside risk from any improvement, but the unpredictability of the situation is such now is not the time to be seeking outperformance.

To reflect this view Barclays has moved to a neutral commodity sector ranking for March. On oil, Barclays remains positive on fundamentals but expects significant volatility in coming weeks. This implies a less favourable risk/reward trade-off at current levels.

Expectations of similar volatility in the precious metals sees Barclays move to a neutral position on this sector as well, while among the base metals some increases in inventory has seen Barclays turn less positive on lead. Copper, tin and nickel remain the favoured base metal exposures given the strongest fundamentals in the sector. 

The volatility predicted by Barclays in oil prices has been evident in recent sessions, Danske Bank noting fears of further increases in tension in the MENA region were enough to send Brent Crude to US$118 per barrel in recent trading.

With the geopolitical risk premium on oil likely to stay elevated in coming weeks, Danske has increased oil price forecasts. Danske analysts now expect Brent prices will range between US$95-$125 per barrel for most of 2011. For the year an average price of US$111 per barrel is now expected, up from US$94 previously, rising slightly to US$112 per barrel in 2012 against US$101 per barrel previously. 

Others in the market have followed suit, with ANZ Banking Group lifting quarterly price forecasts for Brent Crude through 2012. Having previously expected Brent prices to range from US$98-$103 per barrel this year, ANZ is now forecasting prices of US$108-$110 per barrel across 2011, rising to a range of US$112-$116 per barrel in 2012. This is up from previous estimates of US$106-$111 per barrel for next year.

While the MENA issues have been the major driver of the increases, ANZ notes prices should remain firm in the second half of 2011 given expectations of an improving US economy and a tightening in the global oil market as stockpiles are gradually drawn down.

Citi has similarly lifted oil price forecasts, though its estimates remain a little more conservative than those of ANZ. Citi is now forecasting average prices for Brent in 2011 of US$105 per barrel and for 2012 of US$100 per barrel, both up from US$90 per barrel previously. 

Citi's assumptions are based in the view the current market disruptions continue into the second quarter and that OPEC's current spare capacity of around 5.2 million barrels per day is effectively implemented in response to market conditions. There remains a risk of further disruptions according to Citi, so a fear premium for prices is likely across the balance of 2011.

UBS suggests the recent gains in oil prices have been entirely supply driven, reflecting heightened security of supply concerns arising from the tensions in the Middle East and Northern Africa. Whether this is justified is the question, as the broker agrees with Citi current OPEC capacity is estimated to be around 5.2 million barrels per day.

But this may be a conservative estimate as while Saudi Arabia is believed to have around 3.5 million barrels of that space capacity in its operations, this could likely be lifted to around 4.0 million barrels per day. Overall, UBS estimates global producers could lift output by as much as 6.0 million barrels per day from current levels.

Deutsche Bank has recently switched its oil price benchmark to Brent rather than West Texas Intermediate (WTI), forecasting average Brent prices of US$101 per barrel this year and US$102 per barrel in 2012. Given the difference in prices between the two there have been adjustments to earnings estimates for Australian oil plays.

Deutsche's preference is still for the oil leveraged names in the sector. Top pick is Woodside ((WPL)), while Oil Search ((OSH)), Australian Worldwide Exploration ((AWE)) and Eastern Star Gas ((ESG)) are also rated as Buy.

Among the stocks with a Hold rating Deutsche has Origin Energy ((ORG)), Caltex ((CTX)), Nexus Energy ((NXS)) and AED Oil ((AED)). By way of comparison, the FNArena database shows Sentiment indicator readings for these companies of 0.1 for Woodside, 0.4 for Oil Search, 0.3 for AWE, 0.5 for Eastern Star and Origin, minus 0.2 for Caltex, minus 0.3 for Nexus and minus 1.0 for AED. 

Looking at how higher oil prices may impact on the metals sector, Danske Bank suggests the current MENA situation is unlikely to derail a global recovery and push the world economy into a new recession.

Given such an outlook, Danske expects base metal prices will gradually regain the ground recently lost, especially if Chinese buyers return from their New Year holidays with a renewed appetite for raw materials. As a result, Danske has not adjusted base metal forecasts to account for higher oil price expectations.

Goldman Sachs has also examined the impact of higher oil prices but on equities, noting historically the ASX200 has performed well during previous oil price spikes, posting strong gains in five of the last six such periods.

Having reviewed the past two years, Goldman Sachs notes steel by way of BlueScope ((BSL)) and OneSteel ((OST)) and resource companies Fortescue ((FMG)), Rio Tinto ((RIO)) and Paladin ((PDN)) have provided greater leverage to the oil price than large cap energy companies.

FNArena Sentiment Indicator readings for these stocks stand at 0.6 for BlueScope, 0.7 for OneSteel, 0.8 for Fortescue, 1.0 for Rio Tinto and 0.0 for Paladin.

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