Oil is firing up Australian producers

What happens between now and the next OPEC meeting is critical to the oil market.

Summary: Woodside Petroleum’s share price has risen 11 per cent since September 28, the day of the OPEC meeting in Algeria, while Santos is now 17 per cent higher. 

Key take-out: Australian investors will have plenty to think about over the next two weeks as the energy sector releases third-quarter production reports, ahead of OPEC's November meet in Vienna.

Key beneficiaries: General investors. Category: Energy sector shares.

Oil is up, but that’s not the important signal for investors from a market which has been down for more than two years.

The significance of oil closing above $US50 a barrel in the US last night is that it points to an end to the glut which has flooded the global oil market and killed the price.

BHP Billiton has been quick to seize on the changing tone in the oil market with the head of its oil and gas division, Steve Pastor, telling analysts in a well-timed briefing yesterday that the market was expected to move back into balance next year.

“While currently well supplied, underlying fundamentals suggest both the oil and gas markets are improving more quickly than our mineral commodities,” Pastor said.

Easy as it might be to dismiss the optimism for oil from the man in charge of BHP’s oil operations there is a greater probability of him being right than wrong, and that’s not something that could have been said at any time since the oil floodgates were opened in mid-2014.

What’s changed – and the reason investors should dust off the files on opportunities in a down-trodden sector – is that an experiment in free market economics conducted by 14 of the world’s biggest oil producing countries appears to have failed.

Chart: Oil price (West Texas Intermediate crude), past 18 months

Source: Bloomberg, Eureka Report

Led by Saudi Arabia, the Organisation of Petroleum Exporting Countries (OPEC), launched an attack on rival producers in non-OPEC countries, with the high-cost oil extracted from shale-rock formations in the US the primary target.

As an exercise in economics the OPEC approach was simple and brutal. In theory, low-cost oil from traditional producers would force the newcomers with higher costs out of business.

It worked, but only partially, with the real victims of the oil flood being OPEC members themselves with national budgets decimated by the oil-price collapse to less than $US40/bbl.

Saudi Arabia, which created the crisis, is the country which blinked first in a multi-trillion dollar game of chicken with the US shale-oil industry, agreeing at an unofficial meeting of OPEC members in Algeria late last month that it would agree to modest production cuts to achieve a higher price.

What happens between now and November 30, the date of the next official meeting of OPEC, is critical to the oil market because most past attempts to coordinate production levels by the fractious members of the oil club have failed.

This time, however, there are signs that a modest cut in output by OPEC members of between 250,000 and 750,000 barrels a day might be achievable, with Saudi Arabia taking the biggest haircut while arch-enemy Iran is permitted to lift production after years of economic sanctions.

How high the oil price can rise during the latest attempt at “market management” by OPEC is the question every investor is asking and, while any answer is a guess, there does seem to be a short-term target price band emerging of between $US50 and $US60/bbl.

A lot can go wrong in what’s happening in oil but the incentive for producers (OPEC and non-OPEC) is to achieve a price which generates reasonable profits and encourages some fresh investment in exploration and production.

Hints of the improving trend can be seen in the share prices of Australia’s leading oil and gas stocks.

Woodside Petroleum’s share price rose by 5 per cent on September 29, the day after the unofficial OPEC meeting in Algeria, and has kept rising to trade around $29.44, 11 per cent above its pre-Algerian price.

Santos enjoyed a similar boost, adding 7.8 per cent after the Algerian meeting and at $4 it is now 17 per cent higher. Oil Search and Beach have also enjoyed an upward re-rating as investors return to the oil sector.

While the next OPEC meeting in Vienna at the end of November is a key event in the wider oil market Australian investors will have plenty to think about over the next two weeks as third-quarter production reports are released.

First cab off the oil-rank is Oil Search which is scheduled to report on October 18, follow by Woodside on October 20, Santos on October 21, Beach on October 27 and Origin on October 31.

Deutsche Bank, in its latest analysis of the sector, said it expected the oil price to be around $US50/bbl for the rest of 2016, rising modestly to around $US55/bbl next year.

Goldman Sachs has raised its oil-price forecast for the final quarter of 2016 from $US43/bbl to $US51/bbl.

Citi is even more cautious because the oil-price recovery to more than $US50/bbl is largely dependent on the draft OPEC deal in Algeria being agreed at the formal meeting at the end of next month.

“It’s a long way from Algiers to Vienna,” Citi noted.

“Until last week the market was operating under an assumption that OPEC had effectively ceased to be.

“Last week it showed some signs of life. This is not a game-changer in our view given the uncertainties and scepticism around any actual cuts to production, but it probably raises the floor for the trading range from the low-$US40s/bbl to the mid-$US40s/bbl.

“It is less clear that it has raised the top of the range much above $US50/bbl.”

In other words, Citi believes that best of the price recovery is in the market, at least for this year.

A more sustainable recovery is unlikely before the middle of next year.

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