Oil & Gas: Still warning against falling swords
About the author:
- Author name:
- By Adrian Prendergast
- Job title:
- Senior Analyst
- Date posted:
- 23 March 2020, 2:15 PM
- Sectors Covered:
- Mining, Energy
- We continue to recommend caution investing in oil & gas, with weak demand/supply fundamentals having some way to play out.
- Despite recent downgrades, global consensus on oil still sits 63% above the spot Brent oil price for the next 12 months – highlighting the downgrade cycle could keep rolling in the near term.
- We have changed our investment methodology – prioritising resilience over value by applying a gearing discount to our valuations to reach our target prices.
- We have downgraded CY20/CY21/CY22 oil forecasts by 39%/27%/2%.
- The shift in our investment methodology, combined with lower oil price forecasts, has seen broad downgrades across our coverage universe.
- Woodside Petroleum (WPL) remains our preferred large cap exposure, with Beach Energy (BPT) our top pick amongst the mid and small-caps.
Prioritising resilience over value
With current oil prices now below the breakeven levels for almost the entire global oil supply chain, after plunging 55% in the space of 3 weeks, we have shifted our target price methodology in the oil & gas sector away from seeking value to now prioritise resilience. We have sought to do this by introducing a Gearing Discount to our DCF valuations, allowing our target prices to better accommodate varying debt loads across the sector. We see this methodology as robust given the magnitude of uncertainty facing our/consensus forecasts.
Short and medium-term oil price downgrades
The speed at which the weak supply and demand fundamentals has emerged is unprecedented. This is a unique scenario with no previous examples of similar conditions. Responding to the changing landscape, we have made heavy cuts to our oil forecasts for CY20/CY21/CY22 of 39%/27%/2% respectively. While volatility may remain elevated, ultimately the lower oil prices go, the greater damage it will deal to the global oil supply chain which in the future will mean a higher required oil price to induce new supply. As a result, while the picture for at least the next three years has changed, we have not made any adjustments to our long-term oil price forecasts.
Downgrade cycle to keep rolling
Commodity forecasters continue to scramble to downgrade oil price expectations in response to the sudden plunge in prices. However it seems this still has some way to play out with global consensus forecasts for oil over the next 12 months still sitting 63% above the current spot Brent price.
Don’t try to catch a falling sword
We continue to recommend caution towards investments in the oil and gas sector, with demand conditions still deteriorating as the coronavirus spread in key oil consuming regions accelerates and the price war between Saudi Arabia and Russia continues. On a 2-3 year investment horizon we see deep value on offer across our coverage (with WPL and BPT our key picks), while near-term volatility is likely to remain a feature.
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