Commodities: OPEC paves way for continuing recovery
About the author:
- Author name:
- By Adrian Prendergast
- Job title:
- Senior Analyst
- Date posted:
- 22 March 2021, 2:49 PM
- Sectors Covered:
- Mining, Energy
- Volatility is inevitable, but we view it as likely to generate opportunities to increase exposure to the continuing oil/energy recovery.
- The oil recovery is a fairly simple story, with supply poorly positioned to absorb ‘lost barrels’ due to the damage dealt by two once in a decade oil price downturns in the last five years (2015/16 and 2020), a focused OPEC+ supply strategy, and a rapid recovery in global demand from COVID on accelerating vaccine rollout.
- US oil industry is severely damaged, but we expect a lagged supply recovery to start to become evident during April/May.
- We deliver oil price upgrades to 2021-23 following the OPEC decision and ongoing recovery of oil market fundamentals.
- Our key picks are STO, KAR and SXY, each with attractive value and strategies.
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OPEC change material for oil expectations
Moves from OPEC+ to maintain supply cuts in April surprised the oil market, but does make logical sense. The main agenda of OPEC, as a cartel of oil producing countries, is to protect oil market fundamentals and price stability.
The decision to keep 500,000 bopd of OPEC supply offline, in addition to a further 1 million bopd of supply from Saudi Arabia, will therefore help to drain some of these excess inventories. This is also important given the ongoing global demand decrease from COVID-19.
Measuring the impact on global oil demand-supply balance estimates from the OPEC+ move has increased the tightness we expect over 2021-23 and resulted in upgrades to our oil price forecasts.
Consensus too bullish on initial US oil reaction
We continue to talk about the disconnect between bullish consensus forecasts for US oil supply and the dire health of balance sheets and lack of investor support for US oil producers.
We have long held the view that a lack of capital in the US would limit the speed in which the industry would be able to grow supply. This view has been confirmed by the lack of US supply growth in recent months despite an impressive recovery in oil prices.
However with Brent now trading up in the US$60-$70/bbl range we see it as likely that US producers will finally be in a position to start to add new production.
What’s happening on the ground in US oil?
In recent years US investors have been 'off' energy, unimpressed with the lack of FCF generation and reliance on external capital. The notable change since COVID has been that US banks have now also joined in on wanting to reduce their oil exposure.
To survive the problem of negative cash flow and limited access to capital (no debt or equity), US oil producers have been forced into consolidating, entering Chapter 11, and/or relinquishing acres as they fail to meet lease obligations.
This pressure has been further complicated by a moratorium on federal lands from the new US administration, and a broader cultural shift towards ESG from the investment community. All of the above, combined with an intention to exit oil from a group of supermajors, has left the US oil industry as a group poorly positioned to source the capital needed to increase production.
How to play energy recovery
In the short term there is further upside risk, with potential for a supply squeeze that could push oil prices through U$80/bbl, as global stockpiles decline, fiscal stimulus continues and recovering US oil activity takes time to translate into added barrels.
Volatility is unavoidable, but the fundamentals supporting oil increase our confidence in any weakness generating opportunities to add to sector exposures.
As a result we have upgraded: 2021 to US$63/bbl (was $56), 2022 US$60 (was $55), and 2023 US$60 (was $56). Looking at the medium term, eventually OPEC+ supply cuts and lagging US oil production will reverse/catch-up, while the improving oil price environment will encourage production from other supply sources, albeit offset by returning demand. We leave our long-term Brent oil forecast unchanged at US$62/bbl (2025, real).
We see our preferred sector picks as well positioned to benefit from the upcycle, and maintain our key picks as Santos (STO), Karoon Energy (KAR) and Senex Energy (SXY).
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Disclaimer: 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.