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The Federal Reserve's pledge towards a new round of economic
stimulus, a tightening global supply picture in view of the ongoing
unrest in the resource-rich Middle East and a German court's green
light to the Eurozone bailout fund have strengthened oil prices to
around mid- to upper $90s a barrel. Partly offsetting this
favorable view has been high U.S. crude stocks and worries about
China's growth outlook.
The long-term outlook for oil, however, remains favorable given the
commodity's fairly positive demand picture. In particular, while
the Western economies exhibit sluggish growth prospects, global oil
consumption is expected to get a boost from sustained strength in
the non-OECD (Organization for Economic Cooperation and
Development) countries that continue to expand at a healthy rate.
According to the Energy Information Administration (EIA), which
provides official energy statistics from the U.S. Government, world
crude consumption grew by an estimated 1.0 million barrel per day
in 2011 to a record-high level of 88.3 million barrels per day. In
2010, oil demand increased by over 2 million barrels per day to
87.3 million barrels per day, which more than made up for the
losses of the previous 2 years, and surpassed the 2007 level of
86.3 million barrels per day (reached prior to the economic
One might note that global demand for 2009 was below the 2008
level, which itself was below the 2007 level -- the first time
since the early 1980's of two back-to-back negative growth years.
The agency, in its most recent Short-Term Energy Outlook, said that
it expects global oil demand growth of 0.8 million barrels per day
in 2012 and 1.0 million barrels per day in 2013. EIA's latest
forecasts assumes that demand will be lackluster in U.S., Europe
and Japan but this will be more than made up by impressive
consumption surge coming from Russia, the Middle East and Brazil.
Separately, the Organization of the Petroleum Exporting Countries
(OPEC) -- which supplies around 40% of the world's crude --
predicts that global oil demand will increase by 0.8 million
barrels per day annually, reaching 88.7 million barrels a day in
2012 from last year's 87.9 million barrels a day. In 2013, OPEC
expects world liquid fuels consumption to grow by another 0.8
million barrels per day to average 89.5 million barrels per day.
Lastly, the third major energy consultative body, the Paris-based
International Energy Agency (IEA), the energy-monitoring agency of
28 industrialized countries, also said that it expects world oil
consumption to grow by 0.8 million barrels per day during both 2012
and 2013 to average 89.8 million barrels per day and 90.6 million
barrels per day, respectively.
In our view, crude oil prices in the remainder of 2012 are likely
to exhibit a sideways-to-bullish trend. While domestic demand is
relatively soft and the global economy still showing signs of
weakness, the fact that demand is outpacing supply appears to be
As long as growth from developing nations continues and the global
output is unable to keep up with that, we are likely to experience
a surge in the price of a barrel of oil. With a world population of
7 billion people and all the easy oil being already discovered and
expended, we assume that crude will trade in the $90-$100 per
barrel range for the near future.
Over the last few years, a quiet revolution has been reshaping the
energy business in the U.S. Known as 'shale gas' -- natural gas
trapped within dense sedimentary rock formations or shale
formations -- it is being seen as a game-changer, set to usher in
an era of energy independence for the country. The success of this
unconventional fuel source 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, gas stocks -- currently some 10%
above the benchmark levels -- are at their highest level for this
time of the year, reflecting robust onshore output.
To make matters worse, near-record mild winter weather across most
of the country curbed natural gas demand for heating, leading to an
early beginning for the stock-building season. The grossly
oversupplied market continued to pressure commodity prices in the
backdrop of sustained strong production.
This prompted natural gas prices to dive approximately 63% from the
2011 peak of $4.92 per million Btu (MMBtu) in June 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 ).
However, in the recent past, repeated smaller-than-average storage
builds have rallied back prices toward $3.00 per MMBtu. As hot
summer weather prevailed across the country, homes and businesses
were prompted to increase electricity draws to run air
But with temperatures falling from their summer highs and
consequent cooling demand set to wane, bigger storage builds are
likely to prevail in the near future. In fact, the EIA foresees
natural gas storage at all-time highs of around 4.0 trillion cubic
feet by October's end.
Moreover, there are apprehensions that should natural gas breach
and stay above the $3.00 per MMBtu barrier, utilities that took
advantage of the beaten down prices to switch to the commodity from
the more costly coal, could revert back to the latter. This demand
loss may further inflate natural gas inventories.
Therefore we do not expect much upside in gas prices in coming
weeks. In other words, there appears no reason to believe that the
supply overhang will subside and natural gas will be out of the
dumps in 2012.
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 oilfield services group, we like
National Oilwell Varco Inc.
). We are a fan of National Oilwell's healthy backlog, solid
balance sheet and strength in international operations,
particularly in the Middle East and Brazil. The impending
Robbins & Myers Inc.
) acquisition will further boost National Oilwell's earnings
visibility by expanding its blowout preventer product line; a
critical safety machine for a well. The recent influx of offshore
rig awards adds to the positive sentiment.
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 higher fuel demand in the U.S. are likely to push
2012 industry margins higher than last year's levels. Against this
backdrop, we are particularly bullish on
Western Refining Inc.
Tesoro's decision to resume dividend payout and the announcement of
a $500 million share buyback program make us optimistic about the
company. Our positive stance also revolves around Tesoro's proposed
acquisition of British energy giant
) Southern California refinery, which, apart from boosting refinery
capacity, will also improve the company's operational efficiency.
An uptick in crack spreads and Tesoro's scale and diversification
benefits afforded by its portfolio of seven refineries add to the
On the other hand, we believe Western Refining's strategic actions
-- to improve its performance and competitiveness in a
cost-effective manner -- will drive growth in the company's profits
and boost its stock valuation. Western Refining's strong retail and
wholesale operations, along with exposure to the profitable
Southwest refining assets, are some other catalysts.
), the world's largest oil services firm, is also a top pick. We
believe Schlumberger's combination of balance sheet strength;
technological leadership and management depth will be beneficial in
the long term. We also believe the company is favorably positioned
to benefit from current trends in oilfield services, given
improving activity levels and greater need for stimulation and
completion of services in North America.
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
EOG Resources Inc.
), a former natural gas exploration and production (E&P)
company that has made significant headway into the more profitable
oil space with the introduction of the commercial viability of
We recommend avoiding
), one of the six supermajor oil companies. Following the recent
spin-off of its refining/sales business into a separate,
independent and publicly traded company
), ConocoPhillips is now totally dependent on its upstream
portfolio that offers lackluster volume growth prospects. Moreover,
the transfer of the downstream operations (post-split) has left the
Houston, Texas-based firm with a less diversified business.
We are bearish on Brazil's state-run energy giant
Petroleo Brasileiro S.A.
), or Petrobras S.A. Following the company's dismal second quarter
showing, we see little reason for investors to own the stock. The
Rio de Janeiro-headquartered group recently posted its first
quarterly loss in 13 years on the back of a weak domestic currency,
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 leading North American energy firm
Williams Companies Inc.
). In particular, we remain wary of low natural gas prices, which
are likely to restrict near-term growth prospects at Williams.
Additionally, we believe that transfer of the upstream assets
(post-split) has left Williams with a less diversified business.
As a result, the business risk profile of the reorganized Williams
is weaker than that of the pre-spin-off company. Lastly, we remain
concerned about Williams Companies' high debt levels, which leave
it vulnerable to an extended drop in commodity prices. As of June
30, 2012, Williams had debt of over $9 billion, representing a
debt-to-capitalization ratio of more than 60%.
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. Considering these factors, we see
Nabors as a risky bet from which ordinary investors should exit.
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 South African petrochemicals group
) to be under pressure in the near future. While approximately 60%
of Sasol's operations are based in South Africa , about 90% of its
sales are either denominated in dollars or are influenced by the
global commodity and benchmark prices, which are quoted in dollars.
As such, the group is exposed to risks associated with an
unfavorable rand-dollar exchange rate.
Moreover, Sasol's quest for its flagship coal-to-liquids (CTL) and
gas-to-liquids (GTL) projects are expected to stretch its
medium-term returns significantly, as the company would have to
employ a considerable amount of nonperforming capital on its
balance sheet until start up.