Crude Shock Awaits the Commodity We Love to Hate

By Mark Story | More Articles by Mark Story

Despite all expectations that it would do the exact opposite, the Saudi and Russian-led OPEC group recently approved the continuation of current production levels.

If that wasn’t enough to shock the market, Saudi Arabia went one step further by announcing plans to extend its voluntary 1mb/d cut beyond the planned two-month period (of February-March) to at least the end of April.Unsurprisingly, OPEC’s missive saw the price of Brent and Crude oil advance by around 6% in as many days, with both now up over 30% year-to-date (YTD).

Given the recent freeze in Texas, which took 2.5mn barrels a day out of commission, plus an estimated 1 million in other states, OPEC’s decision not to scale-back production cuts suggests it isn’t fazed by concerns over a looming supply shock.

Don’t drill baby, don’t drill no more

OPEC members clearly are not being kept awake by US shale operators, with US production currently at 10 million bpd – 3.1 million bpd below where it was a year ago – nor do they see any threat from rising output elsewhere. Prince Abdul Aziz gave what was tantamount to ‘two fingers to the bush’, when he was quoted as saying “the US mantra, drill baby drill is gone forever”.

Bottom line is, if a lack of capital spending (in the US) inhibits growth this year, ANZ Bank analysts tend to agree with the Prince’s conclusions.

While OPEC plans to meet again on 1 April to review the supply agreement, ANZ analysts suspect the likelihood of them increasing output looks low, with the focus clearly on overtightening the market, rather than removing support too early. Based on its outlook for global synchronised growth in the second half of the year, ANZ expects the recovery in crude oil demand to accelerate, and is forecasting growth in the second half of 2021 of 7mb/d (from the first half).

However, the bank doesn’t expect demand to exceed pre-pandemic levels until early 2022, and has upgraded its short term (0-3mth) target, with Brent crude likely to break its next resistance level of USD70/bbl. Analysts at influential investment bank Goldman Sachs, went one better in response to OPEC’s decision by lifting its second-quarter and third-quarter forecasts for Brent by $5 each to $75 and $80 a barrel, respectively.

Not all analysts are as bullish. In line with its Global team, and following OPEC’s announcement to keep oil production steady, JP Morgan increased its Brent price forecast increases from US$53/bbl to US$60/bbl and its calendar year 2022-CY2023 forecast also increases to US$60/bbl, while its long-run price from CY2026 is unchanged at US$60/bbl.

Acute shortage looming

Ironically, OPEC’s decision to opt for the status quo by maintaining its production cuts has provided some badly needed support in the face of the commodity’s ubiquitous fall from grace, as the world moves to cut carbon emissions. While that decision bodes well for producers, some of which have been re-rated on the back of this news, over the longer term there’s growing concern that today’s shortage will only become more acute.

Adding to that concern, big oil majors are planning to continue reducing their production despite signals demand is not declining as fast as energy transition advocates would have us believe.

Given the industry’s dwindling appetite for exploration, coupled with an unprecedented demand collapse during Covid, French Total speculates that, in little more than five years, the world will need 10 million bpd more oil than it has. Echoing similar, albeit more acute concerns, the American Petroleum Institute expects underinvestment and natural depletion to deliver an oil shortage as soon as next year.

Net winners

As a result of the lift in oil price estimates and reflective of OPEC’s decision to maintain its production cuts, analysts at Ord Minnett have upgraded Woodside Petroleum (ASX: WPL) to a Buy rating with an improved price target of $29.05. The broker notes that with OPEC’s decision likely to keep oil prices higher for longer, some producers like Woodside appear to be well placed to benefit from upcoming offtake agreements, and potential asset sales.

While offset somewhat by a higher weighted average cost of capital (WACC) on update of the Risk-Free Rate, Macquarie expects earnings per share (EPS) changes for full year 2021 based on higher oil price (for the oil majors it covers) to range between nil for Carnarvon Petroleum (ASX: CVN) and 100.3% for Karoon Energy (ASX: KAR).

With energy stocks looking attractive on value, JP Morgan remains positive on the sector, and believe a broad sector exposure can deliver returns over the long run. As a result, the broker now has an Overweight rating on all stocks (other than Carnarvon, where there are potential balance sheet constraints).

It maintains a cautious view, however, and favours stocks with strong financials. With a strong balance sheet to provide capacity to fund growth capex and exposure to domestic markets, the broker’s favoured stock is Santos. But given that it is the most expensive of the large caps under its coverage, the broker does not see additional opportunity for earnings upgrades for Santos (target price $9.95); same goes for Cooper (ASX: COE target price $0.45) and Woodside (target price $29.05).

After STO, JP Morgan favours Oil Search (ASX: OSH; target price $5.35), which has the greatest leverage to Brent and good growth from Tier 1 assets, and then Beach (ASX: BPT; target price $2.20), which has a strong balance sheet, growth optionality and leverage to east coast gas prices with an attractive valuation. In line with its market estimates, JP Morgan continues to see the biggest potential upside relative to consensus for Oil Search and Beach of 18% and 14% respectively.

Keep transportation on your watch-list

Beyond energy stocks, research tends to suggest little direct correlation between oil prices and the broader share market. But one sector that’s strongly linked with the spot price of oil is transport. Given that the dominant input cost for transportation firms is fuel, investors might want to pay close attention to how the transport stocks they own might be affected, even if those impacts don’t appear evident right now.

While there are no fewer than 18 companies in the transportation industry group listed on the ASX, those mostly directly exposed to higher fuel costs to keep an eye on include:

Freight

  • K&S Corporation (ASX: KSC)
  • Lindsay Australia (ASX: LAU)
  • CTI Logistics (ASX: CLX), and
  • Wiseway Ltd (ASX: WWG).

Airlines

  • Regional Express Holdings (ASX: REX)
  • Air NZ (ASX: AIZ)
  • Alliance Aviation (ASX: AQZ), and
  • Qantas (ASX: QAN).

 

Qantas’s share price has kicked up over 9% in the last month – versus a 2.09% drop in the ASX200 (as of 11 March) – with investors returning to deep value Covid-recovery stocks on the back of an emerging economy story as vaccine rollouts occur around the globe.

What’s also been driving Qantas’s share price are the airline’s plans to return to international travel by as early as October, plus government plans will to support the domestic tourism market. It is only early days, however, and investors need to keep recovery story stocks on their radar, especially in light of the market’s single biggest risk: the re-emergence of Covid.

Mark Story

About Mark Story

A former editor, columnist, and chief reporter on business and financial publications across NZ, Australia, Hong Kong and the US, Mark operates Prime Strategy Media. He divides his time between share market commentary and analysis, B2B, financial, mainstream media, and high level content and strategy for financial institutions.

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