Robust Demand Pushes Oil, Gas Prices
Summary: The decision by OPEC and allies to continue limiting production until the end of 2018 has provoked a review of the outlook for oil and, by association, Australian gas prices.....
As widely expected, OPEC and allies have extended their current crude oil output agreement to the end of 2018. Morgan Stanley considers this a positive step forward as it reduces the risk of upside surprises to production, given the inclusion of both Libya and Nigeria in the quota.
The broker forecasts very little growth from OPEC next year with production in Venezuela, Angola and Algeria also likely to decline independent of OPEC policy. The decision comes against a backdrop where the oil market is already rebalancing and inventories have been drawn down rapidly.
With globally synchronous economic growth and oil prices well below historical highs, Morgan Stanley expects demand will continue to power ahead in 2018, and forecasts another year of 1.5mb/d growth. In the absence of an uptick in investment, the broker expects global production decline to continue, modelling a further contraction of 0.1mb/d in 2018.
This leaves an opportunity for the US to fill the gap but for this to happen, US shale will need to contribute at least 1.1mb/d of global growth in 2018, almost a 20% increase. Even so, this will leave the oil market under-supplied by an amount similar to 2017.
Oil prices have risen faster than National Australia Bank analysts expected, with Brent now above US$63/bbl. This should present upside to domestic prices, compounded by forecasts for a lower Australian dollar. Meanwhile, the performance of Queensland coal seam gas has been patchy and new development is likely to be relatively high cost.
The analysts suspect that even if the Commonwealth can create a surplus in the domestic market and keep prices lower than export benchmarks until 2019, it is likely that 2020 is will mean renewed international integration and gas prices will continue to equal export prices, minus transport costs. The key factor may well be the speed with which the US gears up for LNG exports.
The analysts suggest if east Asian prices move away from oil and towards Henry Hub, then there may be downward pressure on Australian export prices.
UBS presents a base case that OECD inventories will reach five-year averages by the September quarter of 2018 after which there will be have a tapering of producer quotas. The broker retains a longer-term view of Brent at US$70/bbl, a level which is estimated to incentivise new production.
The broker increases estimates for 2018 Brent by US$5/bbl to US$60/bbl, which has material implications for company earnings in that year. Higher oil prices also flow into higher contracted LNG pricing. Companies with higher-than-optimal debt levels such as Santos ((STO)), Origin Energy ((ORG)) and to a lesser degree Oil Search ((OSH)), should be able to accelerate a reduction in debt. No acceleration in growth activities is expected.
Shaw and Partners also revises oil estimates higher, in line with current moves in the market, and considers the recent easing of gas prices a temporary reprieve. Corporate activity is on the ascendancy which means industry appetite for gas is heightened. Oil markets, if OPEC adheres to its cuts, are expected to continue rebalancing through 2018 and gather momentum in 2019.
The broker also notes recent drawdowns in the US and OECD are counter-seasonal and, if sustained, would be quite bullish for oil prices in 2018. The broker revises earnings and valuations for oil stocks across the board and prefers the lower cost, lower-geared stocks which offer the least risk through the cycle.
Supply, rather than demand, is considered the key driver of the rebalancing story. Traders are keenly watching US supply and data shows the US rig count plateauing. US production is now at a record high and benefiting from the diversion of capital to short-cycle onshore US production.
Yet, despite rising domestic supply, US inventories are falling at greater than historical rates, which can only be explained by exports. This suggests that US volumes are displacing supply from other regions where depletion rates are rising.
The question Shaw and Partners asks is: when will debt and equity providers exhaust the funds for this negative investment in US production? A lot of onshore companies remain in negative cash flow and can only continue growing if there is capital to feed on.