Oil & Gas Stock Outlook - Jan 2013 - Zacks Analyst Interviews

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OUTLOOK

Crude Oil

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 future.

Natural Gas

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.

OPPORTUNITIES

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 Chevron Corp. ( CVX ). 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. ( HP ). 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 solutions.

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 Tesoro Corp. ( TSO ), Valero Energy Corp. ( VLO ) and Marathon Petroleum Corp. ( MPC ).

China's CNOOC Ltd. ( CEO ) 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 Nexen Inc. ( NXY ) will further improve CNOOC's growth profile by augmenting proven reserves by 30%, while helping it to vastly expand its holdings in Canada.

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. ( COG ). 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.

WEAKNESSES

We recommend avoiding Weatherford International Ltd. ( WFT ), 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. ( PBR ), 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. ( TLM ). 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 view.

Based upon the number of near-term challenges, we remain pessimistic on the near-term prospects of Nabors Industries Ltd. ( NBR ). 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 ( SNP ) -- also known as Sinopec -- 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. ( PTR ), 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.

BP PLC (BP): Free Stock Analysis Report

CONOCOPHILLIPS (COP): Free Stock Analysis Report

CHEVRON CORP (CVX): Free Stock Analysis Report

EOG RES INC (EOG): Free Stock Analysis Report

NABORS IND (NBR): Free Stock Analysis Report

NATL OILWELL VR (NOV): Free Stock Analysis Report

PETROBRAS-ADR C (PBR): Free Stock Analysis Report

PHILLIPS 66 (PSX): Free Stock Analysis Report

ROBBINS & MYERS (RBN): Free Stock Analysis Report

SCHLUMBERGER LT (SLB): Free Stock Analysis Report

CHINA PETRO&CHM (SNP): Free Stock Analysis Report

SASOL LTD -ADR (SSL): Free Stock Analysis Report

TESORO CORP (TSO): Free Stock Analysis Report

WILLIAMS COS (WMB): Free Stock Analysis Report

WESTERN REFING (WNR): Free Stock Analysis Report

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Stocks

Referenced Stocks: BP , COP , CVX , EIA , LNG

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