Oil - here comes the turn!

There’s some bumps ahead, but some major analyst calls on the oil sector indicate we may have reached the bottom.

Summary: Analyst consensus is that oil prices have bottomed and that investors should watch for a rebound in 2016, as investment banks appear to be responding to oil company writedown announcements positively. The latest round of oil calls includes nine buy calls, 10 holds and one sell.

Key take out: There looks to be volatility ahead before oil prices stabilise in the second half of this year as oil supply declines – investors should consider current trends in the oil market and read these in conjunction with analyst calls on oil.

Key beneficiaries: General investors. Category: Shares.

A string of developments in the oil industry over the last week signals a turning point is close, with brokers forecasting potentially huge gains for key stocks later this year.

Fresh asset value write-downs totalling at least $15 billion by leading Australian oil and gas producers courtesy of the oil-price crash make good headlines, but if the picture is so grim today why are financial analysts optimistic about oil tomorrow?

The answer lies in a growing belief that the oil price has hit the bottom, or is so close to it, and that the next significant move is more likely to be up than down.

Volatile daily price fluctuations are another sign that traders are looking for an excuse to get back into oil in the belief that the sector has been oversold.

Last week’s blizzard which blanketed New York with snow was a pointer to investor interest, because while the storm had no real effect on oil supply or demand, it helped lift the oil price by 20 per cent over three days, from around $US26 a barrel to $US32/bbl.

This week’s price correction, which has seen oil slip back to around $US30/bbl, was a reminder that oil is very much a trader’s market buffeted by reports of excess supply and slack demand – a trend that is likely to dominate discussion about oil over the next six months.

However, the second half of the year is likely to see the first effects of supply declining, even with Iran returning to the business of oil exports, which was the central argument in my last oil story (see The number one hunting ground in 2016, January 13).

A simple test of that theory is to check what analysts in the big investment banks have been telling their clients about oil stocks since that report and after the local oil leaders revealed the likely size of their write-downs.

The write-down casualty list has been severe:

• BHP Billiton said on January 15 that it was likely to book an impairment charge of $US7.2bn on its US shale gas assets.

• Woodside said on January 21 that it was likely to incur an impairment charge of up to $US1.2bn.

• Beach has warned of a $650 million charge against profits and

• Santos has warned of fresh write-downs of up $3bn.

• Oil Search has flagged a modest writedown on assets based in Iraq of about $US400m.

Those impairment charges, which will be progressively revealed over the next three weeks during the annual (and half-year) reporting season mean, in theory, the market is fully-informed about the extent of the likely losses from what’s happened over the past 12 months.

So where to from here?

Woodside Petroleum, for example, has seen at least seven recent reports from leading investment banks such as Citi, UBS, Credit Suisse and J.P. Morgan since it revealed its likely $US1.2bn charge against profits, with none tipping the stock as a sell. Six have said hold and one, Citi, has said buy.

A similar pattern can be seen in testing analyst views of Santos, Beach and Oil Search, with only one sell recommendation (on Santos from Morgans), a view offset with buy calls from Macquarie, Citi, UBS and Credit Suisse. All have been since the latest asset-value write-down announcement and at a time when the oil price was struggling to get back over $US30/bbl.

Analysts do not always get it right, but the latest crop of oil-sector reports produces a count of nine buy calls, 10 holds and that one sell on Santos.

This week’s market reaction to an asset sale by one of Australia’s mid-tier oil producers, AWE Ltd, is a guide to the growing interest in oil as a recovery situation.

By selling its US shale assets for $271m in cash, AWE will be able to repay all debts, have $60m in the bank and be able to push ahead with a planned gas project in WA. This was news that lifted the stock in early trade Wednesday January 27 by 10c (27.8 per cent) to 46c.

Another pointer to growing interest in an oil recovery is the expanding exposure to oil by Berkshire Hathaway, the company run by Warren Buffett, one of the world’s most successful investors.

Over the past few weeks, Berkshire Hathaway has spent $US450m to acquire an additional six million shares in Phillips 66, the former refining arm of US oil major ConocoPhillips.

Whether Buffett’s interest in Phillips is about an oil-price recovery is not clear, because Phillips 66 – an oil refiner and transporter – is more of a beneficiary of low oil prices, and a future potential beneficiary from the widespread oil refinery closures over the past decade.

It is a bet by Buffett on oil, but one with his traditional approach of finding long-term value that other people can’t see.

The bigger oil picture, and the one which most investors follow, is the trend in the oil price and that’s where a global battle of wills is underway, with major producers refusing to cut production despite the potential for some of them to fail.

Recent events of note for oil sector followers include a warning from Saudi Arabia that it will not cut output unless other countries do, something Russia said it would consider if there was a consensus to cut.

In Canada, production cuts loom over the hugely expensive oil sands industry with investment starting to decline thanks to producers requiring an oil price of $US80/bbl to be profitable.

Daily moves in the oil price are important for traders while long-term investors will be looking at forecasts such as the latest from Citi which is for the price to reach a low point in the June quarter, perhaps below $US30/bbl, and to then rebound to around $US52/bbl in the December quarter.

It’s that sort of optimism which explains why Citi told clients on Monday January 25 that Santos, the most harshly treated of Australia’s top oil stocks, is a buy with a 12 month price target of $7.28 (more than double its current price of $2.88), and that Beach is a buy with a target price of 68c, (74 per cent higher than the current 39c).

Citi’s forecasts are optimistic, but they gain credibility because they are echoed by other banks with Credit Suisse forecasting a 20 per cent rise in the Woodside share price to $32. Deutsche Bank is forecasting a 16 per cent rise by Oil Search to $7.20.

Like all share price forecasts, the latest crop of oil sector calls should be treated as a guide and read in conjunction with other events in the oil market where the trend seems to be for more volatility before stability breaks out in the second half of the year.