Crude Oil
The improving economic scene, both here in the U.S. as well as worldwide, had been the main driver of the oil rally that saw the commodity zoom past the $85 per barrel level earlier this year.
However, growing doubts about the strength of the U.S. economy this summer and host of other issues renewed apprehensions about the global growth and energy demand outlook. This weakened oil prices. Another headwind for the commodity has been high levels of product inventories (gasoline and distillate stocks remain above the upper boundary of the average range for this time of year), along with soaring commercial oil supplies.
But far too many factors weigh on oil prices -- from OPEC decisions and geostrategic tensions to the value of the U.S. dollar and seasonal variables -- to definitively size up each one of them for their respective impact on prices.
In its latest release, the Energy Information Administration (EIA) reported an unexpected increase in crude stockpiles, which rose by 970,000 barrels for the week ending September 17. At 358.3 million barrels, crude supplies are 22.7 million barrels above the year-earlier level and remain over the upper limit of the average for this time of the year. Additionally, we remain concerned in light of the high gasoline and distillate inventory builds, both of which remain significantly above their five-year averages.
In fact, a supply overhang has weighed on the market for several months, with U.S. stockpiles of oil and fuel products rising to their highest levels since the EIA began collecting weekly crude inventory data in 1990. As such, crude oil's near-term fundamentals remain weak, to say the least.
According to the EIA, world crude 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.
However, the agency also provided some positive news in this otherwise bleak supply-demand picture. According to the EIA, the decline in oil demand bottomed out in the middle of 2009, as the world economy began to rebound in the latter half of the year. The agency, in its Short-Term Energy Outlook, said that it expects this recovery to continue in 2010 and 2011, contributing to global oil demand growth of 1.6 million barrels per day and 1.4 million barrels per day, respectively.
Recently, the Paris-based International Energy Agency (IEA), the energy-monitoring body of 28 industrialized countries, also raised its global oil demand forecast for 2010, citing higher-than-expected demand in North America and advanced countries in Asia. IEA predicts that oil demand will average 86.6 million barrels a day in 2010 (or 1.9 million barrels a day increase from 2009) and 87.9 million barrels a day in 2011 (or 1.3 million barrels a day increase from 2010).
However, the third major energy consultative organization, the Organization of the Petroleum Exporting Countries (OPEC), an intergovernmental organization that supplies around 35% of the world's crude, forecasted global oil demand to be lower than expected this year and next on the back of a slowing economic recovery and higher supplies from non-member countries. In its latest monthly oil report, OPEC said it expects world oil demand to grow by 1.05 million barrels per day in 2010 and by the same amount in 2011.
We expect crude oil to trade in the $75 – $85 per barrel range in the near future, supported by the rising consumption in emerging and developing economies, led by Asia. But this does not mean that we will not see any short-term pullbacks. On the whole, we expect oil prices in 2010 to be higher than 2009 levels, but remain significantly below 2008 peak levels.
Natural Gas
Though the favorable weather this summer erased a hefty surplus over last year's inventory level, following a high of 101 billion cubic feet (Bcf) for the week ending April 23, the specter of a continued glut in domestic gas supplies still exists, with storage levels remaining 6% above their five-year average. In fact, the latest build, though lower than market expectations, has send natural gas inventories to their highest level since December 18, 2009.
Further pressurizing the commodity is the rapid rise in the number of drilling rigs working in the U.S. (the natural gas rig count has climbed 45% from the seven-year low reached last July) that signals a supply glut later this year in the face of consumer worries regarding high unemployment and economic recovery.
More importantly, production from dense rock formations (shale) through novel techniques of horizontal drilling and hydraulic fracturing remain robust. In fact, the share of shale gas in the country's natural gas production has shot up from zero to 8% in the last decade. This has created a massive oversupply, compelling natural gas prices to slash from $13 per million Btu (MMBtu) four years ago to sub-$4.0 per MMBtu today (referring to Henry Hub spot prices). As there are more technological breakthroughs, shale gas has become viable in some cases at just $3 per MMBtu.
There are concerns among traders that the market will be oversupplied in the short to medium term, with rig counts going up and onshore production increasing. The lack of tropical storm activity in the Gulf of Mexico (an energy-rich region representing about 11% of domestic gas output) is also expected to hold back natural gas price increase.
As per the U.S. Energy Department, domestic gas production will average 61.2 Bcf per day in 2010, up 2.1% from last year. The agency further added that gas inventories are expected to reach 3.69 Tcf at the end of the injection season (by October 31), just 3% shy of the record level reached at the end of the injection season last year.
We believe the weak fundamentals are going to continue to weigh on natural gas prices in the near-to-medium term, translating into limited upside for natural gas-weighted companies and related support plays.
OPPORTUNITIES
Despite the ongoing weakness, the current oil price environment should benefit producers, particularly those international players having attractive growth opportunities in their home markets. One such standout name is Brazil's Petroleo Brasileiro S.A., or Petrobras (PBR), which remains well-placed to benefit from stands to benefit from the country's economic growth and massive pre-salt oil reserves. Additionally, we expect Petrobras' expertise in deep-water operations, huge recent discoveries, and the growing domestic refined products market to fuel its medium-term earnings outlook.
Within the oilfield services group, we are positive on London-based Acergy S.A. (ACGY). With a healthy backlog, significant cash balances and no near-term refinancing requirements, Acergy should weather the challenging business environment better than many of its peers.
Our continued Outperform recommendation on Acergy ADRs also reflects the company's high-quality client base, which mostly includes well-capitalized oil majors or national oil companies. We believe Acergy's impending merger with Subsea 7 will create a stronger, more diverse seabed-to-surface engineering and construction player, enabling it to provide a broader array of services.
Another service provider we are a fan of is Core Laboratories N.V. (CLB). We like Core Labs' leadership position in the reservoir optimization niche, along with its global footprint and deep portfolio of proprietary products and services. Furthermore, the company's low asset intensive operations and limited capex needs allow it to generate substantial free cash flows.
Halliburton Co. (HAL), the world's second-largest oil services firm after Schlumberger Ltd. (SLB), is also a top pick. We like Halliburton's leading position in the global oilfield services market, its broad and technologically-complex product and service offerings, and its robust financial profile. The company's recent results have been driven by increased activity in the unconventional oil and gas shale plays in North America, seasonal recovery of markets in the eastern hemisphere and improved activity in Latin America.
Among the onshore contract drillers, we are positive on Patterson-UTI Energy (PTEN). The Texas-based company, which had heavy spot market exposure, was hit badly by the financial crisis with operators tending to release land rigs to preserve cash. However, Patterson-UTI has recovered almost all its lost market share and its long-term outlook seems compelling on the back of recent acquisition of certain assets of onshore well service rig provider Key Energy Services.
WEAKNESSES
The first name we would avoid is BP plc (BP). The Gulf of Mexico (“GoM”) oil spill has definitely ruptured the basic fundamentals of BP. We believe that most of the negative sentiment currently associated with the company stems from the lack of clarity on the ultimate amount of liabilities. This will remain a major headwind over the next few quarters, in our view.
We have recently downgraded energy-focused engineering and construction firm McDermott International (MDR) shares to Underperform from Neutral due to the tentative commodity price scenario and the company's clouded post-split outlook. Near-term bookings remain lumpy at McDermott, as the current uncertain environment has adversely affected 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 also maintain our cautious view on oil refiners. We believe that refinery run rates are likely to hover around the high 80's/low 90's during the near-to-medium term, which will ensure the continuation of robust light end product output (like gasoline, heating oil, diesel and jet fuel) from the domestic source.
Though refining margins have rebounded from the troughs of the fourth quarter, they remain way off the levels achieved a few years ago. We believe that the imbalance between supply and demand will remain in place for the next 6 - 12 months and negatively impact the bottom line.
As such, we have a cautious stance on major independent refiners like Tesoro Corp. (TSO) and Valero Energy Corp. (VLO), given that the overall environment for refining margins is likely to remain poor. We believe upside for these firms will be limited over the next few months.
Lastly, we continue to be skeptical on offshore drillers, given the fallout from the Macondo incident and the high number of rigs available to the market. We take a bearish stance on Transocean Inc (RIG), Diamond Offshore (DO) and Pride International (PDE).
ACERGY SA (ACGY): Free Stock Analysis Report
BP PLC (BP): Free Stock Analysis Report
CORE LABS NV (CLB): Free Stock Analysis Report
DIAMOND OFFSHOR (DO): Free Stock Analysis Report
HALLIBURTON CO (HAL): Free Stock Analysis Report
MCDERMOTT INTL (MDR): Free Stock Analysis Report
PETROBRAS-ADR C (PBR): Free Stock Analysis Report
PRIDE INTL INC (PDE): Free Stock Analysis Report
PATTERSON-UTI (PTEN): Free Stock Analysis Report
TRANSOCEAN LTD (RIG): Free Stock Analysis Report
SCHLUMBERGER LT (SLB): Free Stock Analysis Report
TESORO CORP (TSO): Free Stock Analysis Report
VALERO ENERGY (VLO): Free Stock Analysis Report
Zacks Investment Research
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However, growing doubts about the strength of the U.S. economy this summer and host of other issues renewed apprehensions about the global growth and energy demand outlook. This weakened oil prices. Another headwind for the commodity has been high levels of product inventories (gasoline and distillate stocks remain above the upper boundary of the average range for this time of year), along with soaring commercial oil supplies.
But far too many factors weigh on oil prices -- from OPEC decisions and geostrategic tensions to the value of the U.S. dollar and seasonal variables -- to definitively size up each one of them for their respective impact on prices.
In its latest release, the Energy Information Administration (EIA) reported an unexpected increase in crude stockpiles, which rose by 970,000 barrels for the week ending September 17. At 358.3 million barrels, crude supplies are 22.7 million barrels above the year-earlier level and remain over the upper limit of the average for this time of the year. Additionally, we remain concerned in light of the high gasoline and distillate inventory builds, both of which remain significantly above their five-year averages.
In fact, a supply overhang has weighed on the market for several months, with U.S. stockpiles of oil and fuel products rising to their highest levels since the EIA began collecting weekly crude inventory data in 1990. As such, crude oil's near-term fundamentals remain weak, to say the least.
According to the EIA, world crude 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.
However, the agency also provided some positive news in this otherwise bleak supply-demand picture. According to the EIA, the decline in oil demand bottomed out in the middle of 2009, as the world economy began to rebound in the latter half of the year. The agency, in its Short-Term Energy Outlook, said that it expects this recovery to continue in 2010 and 2011, contributing to global oil demand growth of 1.6 million barrels per day and 1.4 million barrels per day, respectively.
Recently, the Paris-based International Energy Agency (IEA), the energy-monitoring body of 28 industrialized countries, also raised its global oil demand forecast for 2010, citing higher-than-expected demand in North America and advanced countries in Asia. IEA predicts that oil demand will average 86.6 million barrels a day in 2010 (or 1.9 million barrels a day increase from 2009) and 87.9 million barrels a day in 2011 (or 1.3 million barrels a day increase from 2010).
However, the third major energy consultative organization, the Organization of the Petroleum Exporting Countries (OPEC), an intergovernmental organization that supplies around 35% of the world's crude, forecasted global oil demand to be lower than expected this year and next on the back of a slowing economic recovery and higher supplies from non-member countries. In its latest monthly oil report, OPEC said it expects world oil demand to grow by 1.05 million barrels per day in 2010 and by the same amount in 2011.
We expect crude oil to trade in the $75 – $85 per barrel range in the near future, supported by the rising consumption in emerging and developing economies, led by Asia. But this does not mean that we will not see any short-term pullbacks. On the whole, we expect oil prices in 2010 to be higher than 2009 levels, but remain significantly below 2008 peak levels.
Natural Gas
Though the favorable weather this summer erased a hefty surplus over last year's inventory level, following a high of 101 billion cubic feet (Bcf) for the week ending April 23, the specter of a continued glut in domestic gas supplies still exists, with storage levels remaining 6% above their five-year average. In fact, the latest build, though lower than market expectations, has send natural gas inventories to their highest level since December 18, 2009.
Further pressurizing the commodity is the rapid rise in the number of drilling rigs working in the U.S. (the natural gas rig count has climbed 45% from the seven-year low reached last July) that signals a supply glut later this year in the face of consumer worries regarding high unemployment and economic recovery.
More importantly, production from dense rock formations (shale) through novel techniques of horizontal drilling and hydraulic fracturing remain robust. In fact, the share of shale gas in the country's natural gas production has shot up from zero to 8% in the last decade. This has created a massive oversupply, compelling natural gas prices to slash from $13 per million Btu (MMBtu) four years ago to sub-$4.0 per MMBtu today (referring to Henry Hub spot prices). As there are more technological breakthroughs, shale gas has become viable in some cases at just $3 per MMBtu.
There are concerns among traders that the market will be oversupplied in the short to medium term, with rig counts going up and onshore production increasing. The lack of tropical storm activity in the Gulf of Mexico (an energy-rich region representing about 11% of domestic gas output) is also expected to hold back natural gas price increase.
As per the U.S. Energy Department, domestic gas production will average 61.2 Bcf per day in 2010, up 2.1% from last year. The agency further added that gas inventories are expected to reach 3.69 Tcf at the end of the injection season (by October 31), just 3% shy of the record level reached at the end of the injection season last year.
We believe the weak fundamentals are going to continue to weigh on natural gas prices in the near-to-medium term, translating into limited upside for natural gas-weighted companies and related support plays.
OPPORTUNITIES
Despite the ongoing weakness, the current oil price environment should benefit producers, particularly those international players having attractive growth opportunities in their home markets. One such standout name is Brazil's Petroleo Brasileiro S.A., or Petrobras (PBR), which remains well-placed to benefit from stands to benefit from the country's economic growth and massive pre-salt oil reserves. Additionally, we expect Petrobras' expertise in deep-water operations, huge recent discoveries, and the growing domestic refined products market to fuel its medium-term earnings outlook.
Within the oilfield services group, we are positive on London-based Acergy S.A. (ACGY). With a healthy backlog, significant cash balances and no near-term refinancing requirements, Acergy should weather the challenging business environment better than many of its peers.
Our continued Outperform recommendation on Acergy ADRs also reflects the company's high-quality client base, which mostly includes well-capitalized oil majors or national oil companies. We believe Acergy's impending merger with Subsea 7 will create a stronger, more diverse seabed-to-surface engineering and construction player, enabling it to provide a broader array of services.
Another service provider we are a fan of is Core Laboratories N.V. (CLB). We like Core Labs' leadership position in the reservoir optimization niche, along with its global footprint and deep portfolio of proprietary products and services. Furthermore, the company's low asset intensive operations and limited capex needs allow it to generate substantial free cash flows.
Halliburton Co. (HAL), the world's second-largest oil services firm after Schlumberger Ltd. (SLB), is also a top pick. We like Halliburton's leading position in the global oilfield services market, its broad and technologically-complex product and service offerings, and its robust financial profile. The company's recent results have been driven by increased activity in the unconventional oil and gas shale plays in North America, seasonal recovery of markets in the eastern hemisphere and improved activity in Latin America.
Among the onshore contract drillers, we are positive on Patterson-UTI Energy (PTEN). The Texas-based company, which had heavy spot market exposure, was hit badly by the financial crisis with operators tending to release land rigs to preserve cash. However, Patterson-UTI has recovered almost all its lost market share and its long-term outlook seems compelling on the back of recent acquisition of certain assets of onshore well service rig provider Key Energy Services.
WEAKNESSES
The first name we would avoid is BP plc (BP). The Gulf of Mexico (“GoM”) oil spill has definitely ruptured the basic fundamentals of BP. We believe that most of the negative sentiment currently associated with the company stems from the lack of clarity on the ultimate amount of liabilities. This will remain a major headwind over the next few quarters, in our view.
We have recently downgraded energy-focused engineering and construction firm McDermott International (MDR) shares to Underperform from Neutral due to the tentative commodity price scenario and the company's clouded post-split outlook. Near-term bookings remain lumpy at McDermott, as the current uncertain environment has adversely affected 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 also maintain our cautious view on oil refiners. We believe that refinery run rates are likely to hover around the high 80's/low 90's during the near-to-medium term, which will ensure the continuation of robust light end product output (like gasoline, heating oil, diesel and jet fuel) from the domestic source.
Though refining margins have rebounded from the troughs of the fourth quarter, they remain way off the levels achieved a few years ago. We believe that the imbalance between supply and demand will remain in place for the next 6 - 12 months and negatively impact the bottom line.
As such, we have a cautious stance on major independent refiners like Tesoro Corp. (TSO) and Valero Energy Corp. (VLO), given that the overall environment for refining margins is likely to remain poor. We believe upside for these firms will be limited over the next few months.
Lastly, we continue to be skeptical on offshore drillers, given the fallout from the Macondo incident and the high number of rigs available to the market. We take a bearish stance on Transocean Inc (RIG), Diamond Offshore (DO) and Pride International (PDE).
ACERGY SA (ACGY): Free Stock Analysis Report
BP PLC (BP): Free Stock Analysis Report
CORE LABS NV (CLB): Free Stock Analysis Report
DIAMOND OFFSHOR (DO): Free Stock Analysis Report
HALLIBURTON CO (HAL): Free Stock Analysis Report
MCDERMOTT INTL (MDR): Free Stock Analysis Report
PETROBRAS-ADR C (PBR): Free Stock Analysis Report
PRIDE INTL INC (PDE): Free Stock Analysis Report
PATTERSON-UTI (PTEN): Free Stock Analysis Report
TRANSOCEAN LTD (RIG): Free Stock Analysis Report
SCHLUMBERGER LT (SLB): Free Stock Analysis Report
TESORO CORP (TSO): Free Stock Analysis Report
VALERO ENERGY (VLO): Free Stock Analysis Report
Zacks Investment Research
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