Download US Energy and Commodity Price Outlook

U.S. Energy and Commodity Price Outlook
ENERGY SECTOR REPORT
26 June 2017
ANALYST(S)
Brian M Youngberg, CFA
Buy-rated energy stocks:
Integrated Energy:
Chevron (CVX - $104.45)
Royal Dutch Shell (RDS.A - 52.61)
Total SA (TOT - $49.33)
Exploration & Production:
Apache (APA - $45.63)
Canadian Natural Res. (CNQ - $28.46)
ConocoPhillips (COP - $44.81)
Devon (DVN - $30.01)
EnCana (ECA - $8.24)
EOG Resources (EOG - $87.69)
Marathon Oil (MRO - $11.59)
Newfield Exploration (NFX- $27.56)
Pioneer Natural Resources (PXD $154.75)
Midstream:
Enbridge (ENB - $39.02)
Oil Services:
Halliburton (HAL - $41.90)
National Oilwell Varco (NOV - $31.84)
Prices and opinion ratings as of market close on
06/22/17; subject to change. Source: Reuters.
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OIL AND NATURAL GAS PRICE OUTLOOK
Our long-term expectation is for oil prices to typically be in a
range of $55 to $70 per barrel, although it will be above and
below that at times. Prices have lately drifted downward of
concerns of oversupply and limited demand growth. While OPEC
(Organization of Petroleum Exporting Countries) and other
countries have reduced output, it has been offset enough by
rising U.S. shale production and elsewhere to delay the expected
improvement in excess global inventories.
We see oil markets gradually improving, but daily volatility will
continue, driven by new data and headlines. We see prices rising
as we move through the second half of the year and into 2018
as global markets begin to show improving balance between
supply and demand. Prices will continue to be driven by numerous
factors, including global supply (including OPEC actions and U.S.
shale activity), global demand (most notably India, China and the
developing world), geopolitics, alternative energy sources, global
economic conditions, and investor sentiment on oil prices.
We see natural gas prices mostly being in the range of $3.25 to
$4.00 per thousand cubic feet (mcf) over the longer term, although
they will be above and below that at times while remaining volatile.
Prices have been below this range for a while, but have recently
risen with supply declining and demand remaining solid. However,
inventories remain above seasonal averages. Growing usage for
power generation and eventually exports will increase demand,
but higher prices will likely result in supply rising again and putting
a cap on prices. Key drivers in natural gas prices include drilling
activity, the U.S. economy and weather.
GUIDANCE
We believe it is an opportune time for investors to consider
investing in energy stocks if they are not currently overweight
energy in their portfolio. However, we believe investors will need
to be diversified within the sector, be patient and remain focused
on the longer term. In addition, investors should expect continued
volatility for both oil and natural gas prices. However, we see
prices of both commodities higher most of the time in the longer
term relative to today's levels.
While we are positive on the energy sector, we also emphasize
diversification. Our recommended weighting for energy is 9%. If
you are currently below this level, we would recommend adding
appropriate energy stocks based on suitability. For those investors
in excess of our recommended weighting, we suggest reducing
your position to improve diversification.
Please see important disclosures and certification on page 4 of the report.
Page 1 of 4
26 June 2017
What Is Our Outlook for Oil Prices?
Our long-term expectation is for oil prices to typically
be in a range of $55 to $70 per barrel (see Figure
1), although it will be above and below that at times.
Prices have generally been below this range since
the start of 2015. Prices have lately drifted downward
on concerns on oversupply and limited demand
growth. While OPEC (Organization of Petroleum
Exporting Countries) and other countries have
reduced output, it has been offset enough by rising
U.S. shale production and a surprising increase
from some troubled countries, most notably Libya,
to delay the expected improvement in excess global
inventories. We see prices rising in the second half of
the year and into 2018 as global supply and demand
become better balanced.
Figure 1
Where output goes from there will heavily depend on
oil prices because that is the key driver in spending.
Internationally, we believe there is little upside for
incremental supply because we see OPEC and
Russia sustaining their cuts, there is limited new
capacity in Iran and Iraq, and declines will continue
in Venezuela, China and Mexico. Some pockets of
higher output may include Canada and Brazil.
Global Demand Growth Improving, But More
Needed - Global demand growth has historically
averaged around 1.5% per year, but averaged
1.3% for several years following the financial crisis
as Asian and European economies struggled.
Asian demand, most notably China and India, has
generated most global oil-demand growth in recent
years. While this change does not sound like much,
oil prices tend to be quite sensitive to such changes
(see Figure 4 on page 3). Demand growth improved
in 2016 and needs to continue to improve in 2017 to
support oil prices rising. So far, U.S. demand in 2017
has been weaker than expected, with international
demand difficult to estimate quite yet. It will need to
accelerate to reach the EIA estimate of 1.7% for the
full year.
Figure 2
Past performance does not assure future results.
Why Are Oil Prices Down in 2017?
Plentiful Supply - Supply growth in recent years
has been strong, much faster than the rate of growth
in demand (see Figure 2), resulting in rising global
inventories and weak prices. Early in 2017, supply
declined with the OPEC cuts and the recurring impact
from reduced investment around the world due to
low prices. However, the OPEC cuts have been
partially offset, more than expected, by higher U.S.
output (see Figure 3 on page 3) from oil shale and
the Gulf of Mexico as investment budgets were
raised this year by most producers. In addition,
we have seen unexpected supply from Libya and
Nigeria. Essentially, supply has been stronger than
anticipated recently.
We expect U.S. production to continue to rise in
coming months and likely exceed the previous peak.
Page 2 of 4
OPEC Agreement Positive, but Impact on
Inventories Muted So Far - Beginning in 2014,
OPEC changed course and protected its market
share rather than protect market prices. In late
2016, OPEC decided to reduce production to help
push prices higher. Certain non-OPEC countries
also agreed to cut. These cuts took effect at the
start of 2017 for a six-month period and have now
been extended through the first quarter of 2018. We
believe this will have a material impact on markets
in the coming months but for now is being partially
offset by rising U.S. production and the surprising
rise out of Libya and Nigeria. We believe the greater
26 June 2017
impact will be seen later this year and as we move
into 2018.
Figure 3
5), but have recently risen with supply declining (see
Figure 6) and demand remaining solid. However,
inventories remain above seasonal averages.
Growing usage for power generation and eventually
exports will increase demand, but higher prices will
likely result in supply rising again and putting a cap
on prices. Key drivers in natural gas prices include
drilling activity, the U.S. economy and weather.
Figure 5
What Factors Will Influence Oil Prices in the
Future?
What makes forecasting oil prices so difficult is the
numerous factors that impact them. Prices are quite
sensitive to any change in any of these factors.
Since most are out of an investor's control, we do not
recommend investing based on guessing what will
happen to any of them. These drivers include global
supply and demand; geopolitics, including terrorism;
alternative energy sources; the global economy;
and investor sentiment. The U.S. dollar is normally a
driver, but has not been lately.
Figure 4
How do Energy Stocks Fit Into a Diversified
Portfolio?
Our recommended weighting for energy is 9%.
If short of this figure, consider the stocks we rate
with a Buy opinion (listed on page 1). If currently
in excess of this guidance, we would recommend
improving your portfolio's diversification by reducing
your exposure to the sector.
Figure 6
Past performance does not assure future results.
What About Natural Gas Prices?
We see natural gas prices mostly being in the range
of $3.25 to $4.00 per thousand cubic feet (mcf) over
the longer term, although they will be above and
below that at times while remaining volatile. Prices
have been below this range for a while (see Figure
Page 3 of 4
26 June 2017
What Should an Investor Do Today If They Need
to Add Energy Stocks to Their Portfolio?
As to where to start, it depends on an investor's
risk appetite and need for income. If an investor
needs income or is risk averse, focus on those with
higher yields we rate a Buy. If not risk averse and
wanting growth rather than a higher dividend, we
would encourage looking at those stocks with less
of a yield (or no yield) we rate a Buy. These stocks
can also help more conservative investors broaden
their exposure in the sector. See the list on page 1
for stocks that we recommend with a Buy rating. The
investment category and price movement is noted in
the research opinion for each stock.
Valuation -- We believe the current valuation of
the energy stocks that we recommend with a Buy
opinion remain attractive relative to our longerterm commodity-price expectations. Nearer-term
figures are skewed by low commodity prices. We
use midcycle prices to value energy stocks. Methods
used to evaluate the attractiveness of energy stocks
include traditional measurements, such as price-toearnings (P/E) ratios; P/E relative to the summation
of our earnings growth outlook and the dividend yield
(PEGY ratios); price-to-operating cash flow (PCF);
enterprise value to earnings before interest, taxes,
depreciation and amortization (EV/EBITDA); and net
asset value (NAV).
Risks -- Some of the primary risks of the energy
sector: declining commodity prices, which are cyclical
and will affect earnings and the stock price; reduced
company growth expectations; cash liquidity; demand
being difficult to predict and which could change at
unexpected rates; foreign operations being affected
by political uncertainties and currency fluctuations;
regulatory changes affecting company operations;
and adverse legal decisions.
Please see the full opinions of the individual
companies mentioned in this report for additional
information, including valuation and risks.
Required Research Disclosures
Analyst Certification
I certify that the views expressed in this research report
accurately reflect my personal views about the subject
securities and issuers; and no part of my compensation
was, is, or will be directly or indirectly related to the specific
recommendations or views contained in the research report.
Brian M Youngberg, CFA
Page 4 of 4
Analysts receive compensation that is derived from revenues of the firm
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revenue.
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