Oil Price Forecasts Continue Decline

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This story features SANTOS LIMITED, and other companies.
For more info SHARE ANALYSIS: STO
The company is included in ASX20, ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

By Chris Shaw

As more and more data flows through suggesting the world economy will be even weaker than economists have been forecasting, commodity prices are continuing to come under pressure. Nowhere is this more apparent than in the oil price, which is now threatening to fall below US$50 per barrel.

As the price slides and as weaker demand from slowing economic growth is factored in, forecasts for the oil price continue to be lowered. Both Citi and Commonwealth Bank have cut their estimates this week, with CBA suggesting price risk remains to the downside in the shorter-term.

CBA commodity strategist David Moore thinks the recent moves by OPEC to restrict supply, which potentially will be followed up by further cuts to production, will eventually provide some support to prices, but this won’t flow through until sometime in 2009.

The main risk to this view is whether or not the OPEC nations comply with any changes to production levels. History shows they are not so good at doing so and if this were to happen again, it could limit the upside for oil prices. The bank’s quarterly forecasts call for an average of around US$66 per barrel in the December quarter followed by a gradual recovery in prices through 2009 to an average of something around US$80 per barrel this time next year.

Citi has been more aggressive in cutting its 2009 estimates, lowering its average price forecast for next year to US$65 from US$90 per barrel, while also cutting its forecast for this year to an average of US$102 from US$110 previously and in 2010 to an average of US$75 per barrel, down from US$90 per barrel.

The broker’s long-term price has also been cut to US$85 per barrel from US$100 previously. The moves reflect a view the demand slowdown will be greater than previously expected, which is a direct reflection of weaker global growth.

As evidence of this the broker notes it recently cut its global GDP forecast for 2009 to 1.2% growth from 2.6% previously, and this translates into a 1.3% cut in its oil demand estimates. In terms of the global supply and demand picture, this change means spare productive capacity is now around 7%.

As with CBA, Citi sees the key for prices as lying with the ability of OPEC members to adhere to their revised production quotas, as the need for OPEC to fill the shortfall of non-OPEC producers is falling as global demand weakens. This means there remains some shorter-term risks to prices in Citi’s view.

Longer-term it paints a more positive picture for the oil price, as lower current prices are causing projects to be deferred, which means supply will be hard pressed to meet demand when conditions eventually turn more positive than they currently are. This sets the stage for another future price spike.

Shorter-term, then the broker suggests investors in the sector continue to focus on the more defensive exposures, which among the larger plays means Santos ((STO)) and Woodside ((WPL)) remain favoured, as evidenced by the Buy ratings on both stocks.

While trimming its price target and earnings estimates for both companies, the broker likes the strategic potential of Santos given its coal seam gas exposure and the long-term growth that offers. It likes Woodside given its business remains robust even at lower prices and operational concerns surrounding the company are being priced in at current levels.

At the smaller end, Oil Search ((OSH)) and Arrow Energy ((AOE)) are also rated as Buys, with the broker noting the former has significant upside from its PNG LNG project, while Arrow continues to focus on turning the resources in its significant acreage position into actual reserves. This should deliver solid earnings growth over the next couple of years in particular.

Roc ((ROC)) is also rated as a Buy, albeit a more speculative one, as in the broker’s view there is significant value at current levels. However, the falling oil price may mean it takes some time before the market recognises this value, especially if there is no consolidation among the smaller plays in the oil sector.

Taking a broader view of the stocks mentioned, the FNArena database shows sentiment indicator readings for Woodside of 0.2, Santos of 0.8 and Oil Search of 1.0, while Arrow scores a reading of 0.5 and Roc a reading of 0.2.

With respect to average price targets according to the database Roc offers upside of more than 100% compared to its overnight close, Woodside around 32%, Oil Search and Arrow almost 50% and Santos better than 65%. All of the stocks are trading higher today, though in early trading Roc was up less than 1% compared to a gain of almost 6% for Santos.

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