The sector could be years away from a full recovery, even though there are positive signs in the short term.
The worst might be over for oil, if a series of recent and closely connected developments are a guide.
But whether it’s time for most investors to make a return to a thoroughly trashed sector is less clear, with what’s happening in the iron ore market a guide to how quickly optimism can revert to pessimism.
First clue that conditions for petroleum producers are improving can be found in the price of oil which hit a 13 year low of $US27 a barrel in late January and is now trading at around $US38/bbl, a 40 per cent increase over two months – though that percentage rise is misleading, coming off a very low base.
Iron ore enjoyed a similar sharp upward move two weeks ago only to see most of a rise above $US60 a tonne wiped out this week as the price fell to $US52.88/t.
Whether the oil price bounces around over the rest of the year doesn’t worry the International Energy Agency, the western world’s official oil-sector watchdog, which has flipped from pessimism to optimism in its latest industry analysis which found that:
“For prices there might be light at the end of what has been a long, dark, tunnel”.
BHP Billiton appears to share the IEA’s confidence that the future trend for oil is more likely to be up than down, lifting it to the top of its growth targets, initially by accelerating exploration and possibly through future asset acquisitions.
Capping off this overdue run of confidence is news from the US that investors have rushed to buy bonds issued by leading oil companies such as Anadarko Petroleum which this week saw an offer of $US3 billion in bonds oversubscribed by a factor of 6.6 when it received $US20bn in applications.
The trend can also be seen in the prices of most ASX-listed oil stocks with Santos, Beach and AWE leading the way.
Santos is up 57 per cent from its 12 month low of $2.46 reached on January 20 to recent sales at $3.86. Beach has doubled from 35c to 70c over the same time, and AWE has led the way with a 106 per cent rise since January 21 from a low of 31c to 64c.
Bigger stocks have done less well. Oil Search is up 25 per cent to $6.95 and Woodside has barely moved with a 3 per cent rise to $25.72, a modest recovery which probably reflects the disappointment of investors who preferred to see Woodside as a dividend-yield play – which it no longer is after a hefty cutback in its annual payout.
The improved IEA outlook was incorporated in the monthly report of the Paris-based energy organisation, which cautiously welcomed what it saw as a move in the “correct” direction though “there is a long way to go”.
That qualification about the time it will take for oil to recover has been echoed by investment banks concerned that the rise might be self-defeating because it will encourage high cost producers to stay in business in the hope that they can survive.
Goldman Sachs said the oil-price rally could reverse promising supply cuts which are essential for a long-term price recovery.
BHP Billiton appears to have no doubt about the long-term trend with oil nominated as its preferred area of investment thanks to a combination of the rising price of the commodity itself and the falling cost of exploration.
In dollar terms, BHP Billiton is not spending more in its search for conventional oil with its annual budget held steady at $US600m, but for that outlay it expects to be able to secure the services of extra drilling rigs for work on a range of deep-water projects.
In effect, BHP Billiton is aiming get more bang for its oil exploration bucks which is one important aspect of what’s happening. Another is that oil (and copper) have replaced iron ore as the company’s preferred internal growth options – a point which underlines the strength of a diversified portfolio of resource assets.
Other hints that life is returning to the oil sector can be found in attempts by some of the world’s biggest oil-producing countries such as Saudi Arabia and Russia to orchestrate a production freeze as a way of lifting the price.
Whether cartel-like behavior will work seems unlikely with a more potent force being the natural (and sometimes) rapid decline in the rate of production in most oilfields with the collapse in the oil price from more than $US100/bbl over the past 20 months forcing a sharp contraction in essential field development and exploration.
BHP Billiton is in a unique position among Australian oil producers in that it has cash flow from other business units to direct into what it sees as the commodity offering the best prospects for recovery.
US investors share BHP Billiton’s expectation of a sustainable rise in the oil price given their stampede into bonds issued by a number of leading producers.
The rush for Anadarko bonds follows similar strong interest in bonds issued by ExxonMobil and ConocoPhillips – though Tuesday’s surge in demand for Anadarko paper took everyone by surprise.
Originally priced at 412.5 basis points above U.S. Treasury bonds the Anadarko issue had such strong demand that the price was cut to 362.5 basis points, trimming the yield on 10-year paper to 5.6 per cent -- which is still a generous return at a time of low interest rates.
For Australian investors the key message is that oil appears to have started its inevitable recovery.
How long it will take for a full recovery, or even whether oil can reclaim the high ground of a price above $US80/bbl, is unknown – and will probably remain a risk for several years.
But for the oil industry, it’s the trend which is its friend.