High U.S. crude and fuel stocks, worries about North America and
Europe's growth outlook, a strong dollar and an impending fight
over raising the U.S. debt ceiling have weakened oil prices to
around low-$90s a barrel. Partly offsetting this unfavorable view
has been a demand uptick from developing countries.
The immediate outlook for oil, however, remains tepid given the
commodity's fairly positive supply picture. In particular, while
Saudi Arabia is likely to cut back on its production, global oil
output is expected to get a boost from sustained strength in North
America, Iraq, Nigeria and Angola. On the other hand, the growth in
global liquids fuel demand will be relatively soft in the absence
of a strong global recovery.
According to the Energy Information Administration (EIA), which
provides official energy statistics from the U.S. Government, world
crude consumption grew by an estimated 0.9 million barrel per day
in 2012 to a record-high level of 89.2 million barrels per day.
The agency, in its most recent Short-Term Energy Outlook, said that
it expects global oil demand growth by another 0.9 million barrels
per day in 2013 and by a further 1.4 million barrels per day in
2014. Importantly, EIA's latest report assumes that world supply is
likely to go up by 1.0 million barrels per day this year and by 1.7
million barrels per day in 2014.
In our view, crude oil prices in the first half of 2013 are likely
to exhibit a sideways-to-bearish trend. With domestic demand
relatively soft and the global economy still showing signs of
weakness, the fact that supply will be outpacing consumption
appears to be evident.
As long as sharp crude output growth from North America continues
and the world demand is unable to keep up with that, we are likely
to experience a pressure in the price of a barrel of oil. We assume
that crude will trade in the $90-$95 per barrel range for the near
Over the last few years, a quiet revolution has been reshaping the
energy business in the U.S. The success of 'shale gas' -- natural
gas trapped within dense sedimentary rock formations or shale
formations -- has transformed domestic energy supply, with a
potentially inexpensive and abundant new source of fuel for the
world's largest energy consumer.
With the advent of hydraulic fracturing (or fracking) -- a method
used to extract natural gas by blasting underground rock formations
with a mixture of water, sand and chemicals -- shale gas production
is now booming in the U.S. Coupled with sophisticated horizontal
drilling equipment that can drill and extract gas from shale
formations, the new technology is being hailed as a breakthrough in
U.S. energy supplies, playing a key role in boosting domestic
natural gas reserves.
As a result, once faced with a looming deficit, natural gas is now
available in abundance. In fact, natural gas inventories in
underground storage have persistently exceeded the five-year
average since late September 2011 and ended the usual summer
stock-building season of April through October at a record 3.923
trillion cubic feet (as of October 31, 2012).
This prompted natural gas prices to dive approximately 63% from the
2011 peak of $4.92 per million Btu (MMBtu) to a 10-year low of
$1.82 per MMBtu during late April 2012 (referring to spot prices at
the Henry Hub, the benchmark supply point in Louisiana ).
Looking forward, EIA expects average total production to rise from
69.2 billion cubic feet per day (Bcf/d) in 2012 to 69.8 Bcf/d in
2013, while total natural gas consumption is anticipated to remain
relatively flat this year at 69.7 Bcf/d.
However, with the U.S. winter set to be colder than the unusually
warm last one, we might expect some balancing of the commodity's
supply/demand disparity on the back of its more normalized use for
space heating by residential/commercial consumers.
But until then, the weak fundamentals are going to continue to
weigh on natural gas prices, translating into limited upside for
natural gas-weighted companies and related support plays.
Considering the turbulent market dynamics of the energy industry,
we always advocate the relatively low-risk conglomerate business
structures of the large-cap integrateds, with their fortress-like
balance sheets, ample free cash flows even in a low oil price
environment and growing dividends.
Our preferred name in this group remains
). Its current oil and gas development project pipeline is among
the best in the industry, boasting large, multiyear projects.
Additionally, Chevron possesses one of the healthiest balance
sheets among peers, which helps it to capitalize on investment
opportunities with the option to make strategic acquisitions.
Within the contract drilling group, we like
Helmerich & Payne Inc.
). Supported by a superior and diversified drilling fleet, together
with a healthy financial profile, we expect the company to sustain
its profitability over the foreseeable future. We believe
Helmerich's technologically-advanced FlexRigs will continue to
benefit from an upswing in U.S. land drilling activity and the
shift to complex onshore plays that require highly intensive
Buoyed by the favorable trends in the refining sector, we are more
optimistic on the industry than we were 12 months ago. An uptick in
economic activity overseas (mainly in developing countries) and
prospects for lower feedstock costs are likely to push 2013
industry margins higher than last year's levels. Against this
backdrop, we are particularly bullish on
Valero Energy Corp.
Marathon Petroleum Corp.
) is also a top pick. CNOOC remains well-placed to benefit from the
country's growing appetite for energy and the turnaround in
commodity prices. In particular, the company enjoys a monopoly on
exploration activities in China's very prospective offshore region
in addition to having a growing presence in the country's natural
gas and liquefied natural gas (LNG) infrastructure. The impending
acquisition of Canadian energy producer
) will further improve CNOOC's growth profile by augmenting proven
reserves by 30%, while helping it to vastly expand its holdings in
Finally, despite the depressing natural gas fundamentals and the
understandable reluctance on the investors' part to dip their feet
into these stocks, we would advocate to opt for
Cabot Oil & Gas Corp.
). The company's recent results have been driven by its exposure to
the high-return Marcellus and Eagle Ford Shale plays, as well as
its above-average production growth. A relatively low-risk profile
and longer reserve lives are other positives in the Cabot story.
We recommend avoiding
Weatherford International Ltd.
), a major oilfield services provider. Of late, the company has
been pegged back by certain tax accounting and goodwill impairment
issues, forcing it to defer its income tax reporting. Further,
Weatherford expects poor-margin Iraqi contracts to hurt operations
and shrink its near-term average output. Low gas prices also remain
a concern. Given these headwinds, we expect shares of Weatherford
to be under pressure.
We are bearish on Brazil 's state-run energy giant
Petroleo Brasileiro S.A.
), or Petrobras S.A. The Rio de Janeiro-headquartered company has
been suffering on the back of lower production, rising costs and
heavy fuel imports. We also remain concerned by Petrobras' huge
investment requirements, the possibility of heightened state
interference and caps on local fuel prices.
We are also skeptical on Canadian energy explorer
Talisman Energy Inc.
). Taking a cautious view of gas prices, Talisman's capital program
specifically focuses on the promising North American liquids-rich
areas, which is a major shift away from dry natural gas
development. While subscribing to management's outlook, we believe
the realignment of Talisman will take some time to bear results.
Questions about the company's sustainable operational efficiency
and execution abilities also remain key areas of concern, in our
Based upon the number of near-term challenges, we remain
pessimistic on the near-term prospects of
Nabors Industries Ltd.
). The land drilling contractor is facing headwinds in the pressure
pumping market on the back of collapsing prices and lower
utilization. The recent weakness in the North American onshore rig
count has also been a negative. As usual, we remain concerned about
weak natural gas fundamentals, which are likely to limit the
company's ability to generate positive earnings surprises. Nabors'
fairly debt-heavy balance sheet also remains an issue.
Chinese refining giant
China Petroleum and Chemical Corporation
) -- also known as
-- is another company we would like to avoid for the time being,
mainly due to slower domestic growth. Moreover, increases in the
price of international crude oil -- amid government caps on fuel
prices -- has been preventing the company from fully passing on
spiraling costs to consumers, and thereby hurting refining margins.
Lastly, we expect ADRs of another Chinese heavyweight,
PetroChina Co. Ltd.
), to be under pressure in the near future. The Beijing-based
integrated outfit recently posted weak quarterly results on the
back of a challenging operating environment and persistent refining
losses. We also remain concerned by PetroChina's oil production
growth prospects, considering its heavy exposure to significantly
mature-producing areas. Other near-term headwinds include
high-priced gas imports amid low domestic gas sale prices, policy
uncertainty and an ambitious investment program.
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