Oil revival rolls on

Any doom and gloom still surrounding the oil market since the 2014 price crash is on the way out.

Summary: The oil market could have escaped from the post-2014 price crash slump, with some analysts saying the price will stabilise at $US70 or even a little higher.

Key take-out: Higher oil and gas prices have boosted the share prices of Australia's local industry leaders and might have even contributed to the growing strength of the Australian dollar.

 

Not many investors would nominate oil as the top performing commodity of the past six months. Until mid-2017, oil and gas had struggled to shake off the effects of a 2014 price crash, but with the price up 54 per cent since July, oil has been the resource-sector star.

The rise from around $US45 a barrel for oil in Europe (Brent crude) to the current $US69.20/bbl (as of Friday), and from $US43/bbl to $US64/bbl for the US marker crude (West Texas Intermediate) has started to change opinions about oil and gas.

Chart: Oil price (Brent crude), past 12 months

Source: Bloomberg

Some observers believe the glut of oil, caused by over-production in the Middle East and the return of the US as one of the world's top producers, thanks to its use of technology to unlock previously impervious reservoirs, is passing and $US70/bbl could be the new benchmark, with higher future prices more likely than lower prices.

Other oil watchers are not convinced that the industry has fully repaired itself and the rise to around $US70/bbl will encourage the re-start of mothballed oilfields and fresh investment in undeveloped discoveries.

On balance, the more likely trend is for oil to retain its new-found high and possibly edge higher. This is because idled fields, especially those in Saudi Arabia and Russia, can be quickly turned on, but it will take years for new projects to start production.

Chart: Oil price (West Texas Intermediate), past 12 months

Source: Bloomberg

Rather than being seen as the sick man of the commodity sector, oil and gas has become the revival story. It's one that will not be a straight line up, but a series of steps that will depend on producer discipline being maintained and costs kept low.

The next few years, theoretically, could be very good for investors with an appetite for the risks always associated with oil and gas.

Local leaders of the industry are starting to reflect the improving mood.

  • Woodside, despite being more exposed to gas and long-term contracts, has risen around 15 per cent over the past three months to $33.35 (Friday close), close to a 12-month high.
  • Santos is up around 25 per cent to $5.14 (Friday close), aided by takeover speculation; and
  • Beach Energy has led the way with a 50 per cent rise to $1.285 (Friday close), thanks to the acquisition of Lattice Energy and support for the stock's biggest shareholder, the industrial equipment and media billionaire, Kerry Stokes.

Investment Banks Take Note of Oil

Investment banks have ignored oil for several years because of its uncertain price outlook. Now, they are warming to the idea that the worst is over and a sustainable recovery has started, reflecting a combination of limits on supply and strong demand from a buoyant global economy.

If the oil industry could be explained in a single word it would be rebalanced, a description which encompasses supply and demand issues, as well as the significant cost cuts that have enabled producers to survive the three-year downturn.

Deutsche Bank said in its latest oil sector forecast that it entered 2018 feeling “considerable enthusiasm” about the potential for the oil sector.

“No doubt our confidence is helped by the much better feel to commodity markets and a price structure that in our opinion affords risk to the upside,” Deutsche Bank said.

Macquarie Bank effectively echoed that positive sentiment, saying last week that when it came to oil and gas it was “risk on!”.

“We see the sector rallying hard off strong oil and liquefied natural gas (LNG) prices, and believe investors are now willing to pay for what they have avoided since the oil-price crash in 2014, risk,” Macquarie said.

UBS, a third investment bank with a recent view on oil, was more cautious, asking a question about the 2018 outlook: “Have oil and spot LNG prices recovered too quickly?”

“Our 2018 Brent forecast of $US60/bbl may yet prove correct if Middle East concerns abate and U.S. shale (oil) activity accelerates,” UBS said.

Tipping the oil price is almost as difficult as trying to tip the price of gold (or bitcoin) because there are multiple factors influencing the market, with supply and demand matched by geopolitical considerations. Further influence comes from the pace of technological change, which continues to unlock previously impermeable but oil-rich geological structures.

Implications for Australia

For Australia the oil-price recovery is important, because the country is a major energy exporter and oil remains the yardstick against which all other forms of energy are priced.

It is possible that the recent strength of the Australian dollar, which is putting pressure on exporters, can be traced to the oil-price recovery and an even more impressive recovery in the price of LNG.

Until recently, LNG was a commodity which appeared to have entered a prolonged period of oversupply thanks to new projects in Australia, the Middle East, Russia and the US.

In fact, the expected glut never arrived, with LNG now in short supply thanks to soaring Chinese demand. This is a result of a massive environmental clean-up underway in China, focused on switching from coal-burning power to generate electricity to gas-fired power stations.

Short-term, or spot-market cargoes of LNG, which had fallen to $US4 per million British thermal units in 2015, averaged $US8/mbtu last year and have recently been trading at $US11/mbtu.

“We see an improved demand for LNG emerging in the Pacific Basin,” Deutsche Bank said.

“This is, in part, driven by seasonal factors due to winter (heating) demand in the northern hemisphere … but we also believe this reflects wider structural changes emerging in the region, particularly China.”

Credit Suisse, which also acknowledges the improved outlook for oil and gas, introduced another theme which is likely to recur -  a lack of new projects on the drawing boards of Australia's leading oil and gas companies. Credit Suisse said that the four years from 2007 to 2011 had seen a frenzy of project approvals and development, but since then there had been a six-year project-approvals drought.

Investors will be hoping that the drought does not break too quickly and oil and gas producers take time to enjoy the higher prices (and lower costs) and consider returning some of their rising cash flows to shareholders.

 

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