Record-high U.S. crude stocks, a struggling European economy,
worries about China's growth outlook, and the strong dollar have
weakened oil prices to around mid-$90s a barrel. Partly offsetting
this unfavorable view has been the improvement in domestic labor
market conditions that points towards an improving economic growth
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, Angola, Brazil and Colombia. 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 0.7 million barrel per day
in 2012 to a record-high level of 89.0 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 1.2 million barrels per day in
2014. Importantly, EIA's latest report assumes that world supply is
likely to go up by 0.6 million barrels per day this year and by 1.8
million barrels per day in 2014.
In our view, crude oil prices in the second 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 hit an all-time high of 3.929 trillion cubic
feet (Tcf) in 2012. The oversupply of natural gas pushed down
prices to a 10-year low of $1.82 per million Btu (MMBtu) during
late April 2012 (referring to spot prices at the Henry Hub, the
benchmark supply point in Louisiana).
However, things have started to look up in recent times. This year,
cold winter weather across most parts of the country boosted
natural gas demand for space heating by residential/commercial
consumers. This, coupled with flat production volumes, meant that
the inventory overhang has now gone, thereby driving commodity
prices to $4.38 per MMBtu - the highest since Sep 2011.
This, in turn, is expected to buoy natural gas producers. With the
financial incentive to produce the commodity and the subsequent
improvement in the companies' ability to generate positive earnings
surprises, the stocks are likely to move higher.
But as the weather continues to turn milder and temperatures reach
higher-than-normal levels, natural gas demand may suffer in the
near future on account of above-average builds, thereby pulling
down prices again.
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 domestic exploration and production (E&P) group, we
SM Energy Co.
EPL Oil & Gas Inc.
). Supported by attractive oil and gas investments, balanced and
diverse portfolio of proved reserves, together with development
drilling opportunities, we expect the companies to sustain their
production growth and profitability over the foreseeable future.
Further, we remain optimistic on the near-term prospects of
). The oilfield services behemoth -- among the top three players in
each of its product/service categories -- is enjoying strong demand
for its services in international markets and expects the trend to
continue in the coming years. Additionally, the company remains in
excellent financial health and has recently announced a 39%
increase in its quarterly dividend.
) 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 recent
acquisition of Canadian energy producer Nexen Inc. 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 uncertain natural gas fundamentals and the
understandable reluctance on the investors' part to dip their feet
into these stocks, we would advocate to opt for Canada 's biggest
natural gas producer
). Encana has one of the largest natural gas resource portfolios in
North America, which provides a diverse/high quality inventory of
reserves. We see a solid long-term future for the company as demand
for natural gas soars, spurred by its cost effectiveness and
abundant supply in North America.
We are bearish on Italian energy company
). The integrated player -- with a large presence in Libya -- has
seen its total production fluctuate in recent times, primarily due
to operational disturbances at several fields in the North African
Additionally, Eni's upstream portfolio carries greater political
risk than its peers, since it has the highest exposure to the OPEC
countries. The Rome-based company has also been mitigated by a weak
macroeconomic scenario in Italy and Europe that is likely to affect
its performances going forward.
Based upon the number of near-term challenges, we remain
pessimistic on the near-term prospects of
National Oilwell Varco Inc.
). With markets remaining competitive and pricing likely to be
soft, the energy equipment maker's margins are expected to suffer
in the next few quarters. Recent weakness in the North American
onshore drilling environment has also been a negative. Furthermore,
we expect shares to remain depressed until it increases its sub-par
Energy-focused engineering and construction firm
McDermott International Inc.
) is another company we would like to avoid for the time being,
mainly due to its erratic earnings trend over the last few quarters
and a disappointing outlook for 2013. Apart from having to deal
with steeper operating costs, McDermott has already hinted that its
top line will suffer next year due to uncertainty regarding the
timing of big awards.
Near-term bookings also remain lumpy, as the current uncertain
environment has hurt the economics of building new oil and gas
infrastructure. Additionally, the transfer of the power generation
and government operations has left McDermott with a less
diversified business, thereby heightening its risk profile.
We are also skeptical on independent energy exploration firms
Cabot Oil and Gas Corp
Range Resources Corp.
). Both of them have been among the better performing S&P
stocks since the start of 2013, gaining 40% and 20% during the
period, respectively. Most of the gains have been driven by their
exposure to the high-return Marcellus Shale play, as well as their
above-average production growth.
But given natural gas' volatile fundamentals and the duo's high
exposure to the commodity, we do not believe that the stocks will
be able to sustain the momentum in the near future. The companies'
steep valuations as well as miniscule payouts also worry us.
CNOOC LTD ADR (CEO): Free Stock Analysis Report
CABOT OIL & GAS (COG): Free Stock Analysis
CHEVRON CORP (CVX): Free Stock Analysis Report
ENI SPA-ADR (E): Free Stock Analysis Report
ENCANA CORP (ECA): Free Stock Analysis Report
EPL OIL&GAS INC (EPL): Free Stock Analysis
HALLIBURTON CO (HAL): Free Stock Analysis
MDC HLDGS (MDC): Free Stock Analysis Report
MCDERMOTT INTL (MDR): Free Stock Analysis
NATL OILWELL VR (NOV): Free Stock Analysis
SM ENERGY CO (SM): Free Stock Analysis Report
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