Subdued Outlook For Energy Stocks

This story features ORIGIN ENERGY LIMITED, and other companies. For more info SHARE ANALYSIS: ORG

-Supply reductions in oil still needed
-Lack of conviction in mid cap performance
-Risk of buyers turning to spot gas
 

By Eva Brocklehurst

Against a background of weak oil prices most energy companies have been intent on reducing costs and curtailing capital expenditure.

Yet the supply overhang continues to grow, Macquarie observes, with concerns stemming around weakening demand from China. There was some bounce in Brent prices late in August, the broker observes, with the entry of Russia into the Syrian conflict and a rise in US output.

Many mid cap energy companies enjoyed a resultant rebound in share prices but the broker notes this was despite Brent prices only rising US$5/bbl and the forward curve remaining unchanged. With little prospect of a recovery in the oil price in the next 12 months, Macquarie finds it difficult to have any conviction that mid-cap energy stocks will outperform.

Renewed hedging by corporates suggest there is widespread uncertainty regarding the duration of oil price weakness. The broker's preference lies with those stocks that have high operating margins, supported by low sustaining capex, solid balance sheets and a high proportion of developed reserves.

ANZ analysts expect further declines in crude prices, led by West Texas Intermediate, over the next six months. The pressing need in the medium term is a reduction in supply to balance the market and rallies are expected to be capped.

US shale producers continue to lower costs and the analysts suspect they used the October rally in WTI to add significant hedging cover. In other energy products the analysts note conditions are soft. Coal markets were exceptionally weak in the September quarter, with weak demand limiting Chinese imports. ANZ analysts expect some relief for thermal coal as the northern winter approaches but highlight the fact Australian exporters are ramping up supply.

In the case of gas, Goldman Sachs has an increasingly bearish medium-term outlook. The broker downgrades east Asian spot price forecasts by 13% for 2016. The broker flags an expanding temptation to access cheaper spot cargoes versus existing contracts, particularly if oil prices recover.

Goldman expects, as new capacity starts up in Australia and the US, an unprecedented surplus will exist in the spot market and there will a greater than usual discount to contract prices. Buyers may try to obtain savings by breaking contracts.

In this scenario Origin Energy ((ORG)) is considered the most vulnerable, with 20% downside to the broker's price target if it had to divert all contracted cargoes meant for China into the spot market instead.

Most traditional buyers are expected to honour their contracts thus this is probably a worst case scenario. Still, the broker suspects some emerging market buyers may look to re-negotiate contracts, citing Petronet reportedly taking only 70% of its contracted volume from Qatar, in breach of contract.

Goldman has downgraded Woodside Petroleum ((WPL)) to Neutral from Buy. This view is predicated on the difficulties in commercialising additional LNG trains and the drag now envisaged for spot LNG revenue from the North West Shelf and Pluto, the broker noting Woodside has more spot LNG exposure than its peers.

Macquarie believes for those stocks with oil exposure, the sector is discounting an oil price of US$44/bbl, which compares to spot Brent at US$50/bbl and Macquarie's long-run forecast of US$80/bbl. Based on current forecasts, the broker envisages all-in cash costs for mid-cap energy compares are ranging between US$22-41/boe over 2015.

Exploration expenditure fell 38% in the September quarter and represents the lowest rate of spending since early 2011. Macquarie forecasts development capex to be largely flat in the December quarter, signalling 2015 in total is likely to be down around 37%. This reflects a combination of deferrals, completions and cost savings.

Cooper Basin companies – namely Beach Energy ((BPT)), Drillsearch ((DLS)) and Senex Energy ((SXY)) underperformed in the latest quarter, while explorers which have little exposure to the deteriorating spot prices outperformed, the broker observes. Macquarie's preferred exposures remain AWE ((AWE)) and Sino Gas & Energy ((SEH)). The broker has downgrades its rating on Buru Energy ((BRU)) to Neutral from Outperform.
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

Click to view our Glossary of Financial Terms