Analysts are generally of the view that the first half will contain the highs in the oil price for the year and there will be a deterioration later in 2019, but uncertainty is heightened as policies are driven by geopolitics.
Commonwealth Bank analysts lower the oil price outlook for the next 18 months and now expect Brent to peak at US$72/bbl mid year. Ongoing compliance with the OPEC- led deal is expected to be the primary driver of higher oil prices through the first half. The analysts downgraded the oil price outlook in November, subsequent to a US decision to grant waivers to countries importing crude oil from Iran. This meant more was available to the market.
The downward revision to estimates was also underpinned by constraints on US oil infrastructure. However, Canada’s oil sector has revealed that producers only lower output as a last resort and US shale oil producers are expected to behave in a similar fashion.
The analysts expect oil prices will ease later in the year as US infrastructure constraints are reduced. Expiry of the OPEC-led supply agreement will also add downward pressure. The three main producers, the US, Russia and Saudi Arabia, each have their own targets for the oil price, setting the scene for ongoing tension.
Citi suspects OPEC assurances about stabilising markets may actually be creating more volatility. OPEC et al have moved from a rapid surge in supply mid 2018 to calls for another production cut, after Brent fell to US$50/bbl at the end of December from US$86/bbl in early October.
The debate is seen centring on whether a supply gap is emerging. Saudi Arabia and the IEA (International Energy Agency) envisage a supply gap will emerge in the next few years, although Citi doubts this will be insurmountable at prices of US$45-60/bbl for West Texas Intermediate (WTI). The key meetings for OPEC energy ministers are in Vienna over March and April.
Morgan Stanley believes the market is likely to be broadly balanced in 2019, which supports a partial recovery in the oil price. Still, the broker expects this will be capped at US$65/bbl, while the sharp fall in Brent has arguably overshot a deterioration in fundamentals.
Oil Price Trajectory
After reviewing the potential trajectories for oil inventory, Citi revises forecasts slightly higher, expecting Brent to average US$62/bbl in 2019, mainly because of the potential for a tight moment at the end of the year from new lows in observed inventory. Stock is expected to then build in 2020, even if OPEC et al maintain production cuts to the end of 2020.
Morgan Stanley, on the other hand, believes the market is likely to be broadly balanced in 2019, which supports a partial recovery in the oil price. Still, Morgan Stanley analysts expect this will be capped at US$65/bbl. As said, the sharp fall in Brent is seen as an overshoot to a deterioration in fundamentals.
As OPEC reduces output, non-OPEC output is unlikely to slow down. Balancing the market would require OPEC’s discipline to continue well into 2020. OPEC’s market share is falling and, Morgan Stanley points out, oil prices rarely rise strongly when this happens.
Downside risks for the market in the short term, the broker suggests, include elevated Chinese imports and a high percentage of oil in transit and floating storage. Morgan Stanley points out this is reminiscent of late 2016 when several countries increased production sharply in October of that year and it took several months for this increase to make its way through the system.
While OPEC cut production in early 2017 the draw down in inventory failed to materialise for several months. In 2019, this is likely to keep the oil market well supplied, at least in the first half. Further out the broker suspects supply cuts and a boost in demand should restore the balance and support a partial price recovery, but only to the mid US$60/bbl region for Brent.
Australian Energy Stocks
Morgan Stanley considers US$65/bbl an attractive price for the Australian oil producing sector, as significant work has been done on cost structures and balance sheets over the last two years
The broker retains Overweight positions on Santos ((STO)), Beach Energy ((BPT)), and Woodside Petroleum ((WPL)). Progress on LNG developments, including PNG LNG, Scarborough, Browse and Darwin LNG are themes to watch in 2019. Meanwhile, the broker believes stability in oil prices will be good for service companies and that the recent pull back in WorleyParsons ((WOR)) shares is overdone.
Further reserve upgrades are expected in the Cooper Basin and there is potential for incremental capital management. Morgan Stanley also queries whether Woodside may lift its dividend above the 80% pay-out ratio, and whether Beach Energy can start to pay a more meaningful dividend.
Citi advises investors should look at the latter’s net debt position to determine how fast the business is de-gearing and whether there is any FY20 hedging in the upcoming results.
Progress on growth projects will be the focus for UBS in 2019. Woodside has made significant progress with all three of its key growth projects and catalysts include a FID (final investment decision) in Senegal and Scarborough and Browse entering FEED (Front End Engineering Design).
The focus for Oil Search ((OSH)) will be FEED for PNG expansion and the business in Alaska. Brownfield asset growth is expected for Santos as well as FID for Barossa. Origin Energy ((ORG)) is expected to focus on APLNG and sales volumes from energy markets. Citi will be on the look-out for the sale of Ironbark.
Citi believes investors should check for whether a fully termed Browse-NWS tolling agreement has been signed when Woodside reports in February, as well as results of flow testing in Myanmar.
Updates on the construction of gas processing for Senex Energy ((SXY)) will also be sought. East Coast gas production continues to decline, Citi observes, and supply from LNG exporters is likely to remain muted for a time as the focus turns to the international markets and the uptick in demand in the northern hemisphere.
The broker notes LNG project contribution to the domestic market during peak winter showed this were functioning well, with pricing relatively flat and indicating no shortfall in supply. The broker believes Australian gas prices of $8-9/GJ are here to stay, which is positive for both Beach Energy and Senex Energy.
Lastly, sector analysts at Credit Suisse upgraded their recommendation for Beach Energy to Outperform from Neutral this morning on the expectation of further consolidation in east coast gas supply with Beach expected to play a leading role in the process. Two potential targets put forward by Credit Suisse are Cooper Energy ((COE)) and Bass Oil ((BAS)).
