Oil and Gas: Turn in oil market starting to materialise

About the author:

Adrian Prendergast
Author name:
By Adrian Prendergast
Job title:
Senior Analyst
Date posted:
25 November 2020, 12:00 PM
Sectors Covered:
Mining, Energy

  • An eventual Covid-19 recovery, building supply response, and the prospect of a weakening US dollar have combined to leave us bullish on our oil & gas coverage.
  • The oil market has suffered two once-in-a-decade downturns in the last ~5 years which has eroded investor sentiment.
  • Oil has proven more correlated to a falling US dollar than other major commodities.
  • We have made short- and medium-term upgrades to our oil price forecasts.

Peak negativity already behind us

Covid-19 has been responsible for ~9.8mb/d in lost oil consumption globally in 2020. This has only been partly offset by OPEC+ supply cuts (3.5mb/d) and natural industry supply response (~1.7mb/d). Meanwhile some early positive indicators are starting to emerge:

  1. Recent US dollar weakness
  2. Q4 decline in global oil inventories (first time this year)
  3. Upgrades to global oil consensus (first time this year)

The major missing piece for a full-fledged recovery in oil remains the bulk of demand impacted by Covid-19, but we believe we are seeing signs that support our view that oil equities/markets have already past peak negativity and a recovery is unfolding.

Big winner from USD weakness

Supporting the view of our chief economist and strategy team, who expect further US dollar weakness heading into 2021, we have identified oil as a major beneficiary. Over the last decade, the oil price has proven significantly more correlated to the US dollar when compared to other physical markets (gold, copper and iron ore). We see this as likely to continue as investors seek to gain leverage to a falling US dollar given:

  1. Oil prices are near the low of the cycle
  2. Oil is by far the largest and most liquid commodity market
  3. Oil has the most fragmented/spread supply/demand market.

We view these points as reducing secondary factors that risk diluting leverage to a falling USD.

Supply scenarios

We see long-term global oil demand growth rates ranging between -1% pa and +1% pa through a range of tested scenarios, meanwhile existing supply has been steadily declining at c3% pa.

While the oil market remains well supplied with ~9.8mb/d of temporarily lost demand, we expect the 2-4% pa supply gap (between demand and supply growth) will inevitably result in rising future oil prices.

There are complicating factors that could accelerate the recovery in oil prices, such as a major loss of access to capital for the heavily-indebted US oil industry, which has been the key swing producer of oil over the last decade.

The lack of available capital, combined with a decimated service industry, could see US oil supply unable to rebound at the pace expected even if oil prices are buoyant.

Changes to oil price deck / key picks

We have upgraded our short- and medium-term oil price forecasts, summarized further in this report (login to view). This has led to sector-wide upgrades to earnings/valuations.

Highest leverage to rising oil prices in our coverage is Karoon Energy (ASX:KAR), other top sector picks are Santos (ASX:STO), Beach Energy (ASX:BPT), and Senex Energy (ASX:SXY).

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Disclaimer: Analyst may own shares. The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents ("Morgans") do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.

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