Oil & Gas – Stable trends
In 2016, the production cuts announced by OPEC and 11 non-OPEC members led to a rally in crude oil prices. To understand oil price development in 2017 and the resultant performance of energy stocks, investors need to focus on: a) the oil production rebound in the US and b) the OPEC’s production cut compliance, and a potential extension of the cut from June 2017.
The US Energy Information Administration (EIA) published its Short-Term Energy Outlook on January 10. As per its estimates: a) US production will increase from 8.9 mn barrels per day (mbd) in 2016 to 9.0 mbd in 2017, b) production began increasing in 4Q16 itself, averaging 8.9 mbd vs. 8.7 mbd in 3Q16 and c) shale production declines have stopped at the Lower 48 region.
The EIA expects onshore crude oil production at the Lower 48 to average 6.8 mbd in 2017, an increase by almost 0.2 mbd over 2016. Interestingly, EIA has changed its previous forecast of a production decline in the region to an increase instead. This change reflects a rise in crude oil prices, which has allowed producers to increase active rigs at a faster pace than expected.
Consensus expects incremental rig commitment from oil majors leading to ~800 rigs by FY17 in the US from the bottom of ~300 in May 2016. However, their E&P capex trend still remain mixed, while oil-service majors expect E&P investments to improve post OPEC’s production cut. The recent earnings of the big four US oil-services companies highlight continued US land recovery. Rig count is up ~15% YoY to 712 as of 27 January. We believe that the increased North American activity and its improving demand-supply fundamentals should lead to service price inflation.
The Vienna meeting held on January 21–22 gave initial reports of OPEC’s production cut compliance, indicating that members have already cut production by 1.5 mn barrels per day (mbd). This implies ~80% compliance of the initial 1.7–1.8 mbd cut, which is a positive given the historical precedents of unsatisfactory compliance.
Oil-services companies also expect international markets to remain pressurised and not to bottom out until 2H17. We share a similar view given the weak demand for offshore drilling markets, low activity levels, continued pricing pressure and subdued bidding activity. Further, the international rig count’s decline by 166 to 929 in December 2016 depicts the continued oversupply situation.
However, in case oil prices stay around the current levels, we take a more constructive stance and expect slow recovery of international land rig activity. Consensus expects low- to mid-single-digit growth potential post 1Q17, which should act as a catalyst for companies with high international exposure. OPEC has increased its 2017 world oil demand by 1.16 mbd YoY to average 95.60 mbd. At the same time, it expects non-OPEC supply to grow by only 0.12 mbd in 2017 vs. an OPEC supply decline in 1H16.
Given this demand–supply backdrop, we present a basket of stocks that are most likely to benefit from firmer oil prices and a more stable energy market. These are Royal Dutch Shell, Chevron, Schlumberger and Halliburton.
Abhishek Iyer & Saurabh Lohariwala
Data & recommendations as of February 06th, 2017 close
This document is an objective and independent explanation of the content of the recommendation and cannot be considered as adapted to a person or based on the analysis of the situation of a person.