Oil and Gas: It’s a matter of floor not ceiling
About the author:
- Author name:
- By Adrian Prendergast
- Job title:
- Senior Analyst
- Date posted:
- 19 October 2021, 8:00 AM
- Sectors Covered:
- Mining, Energy
- As expected the oil & gas sector is now enjoying a ‘catch up’ rally, as a delayed re-rating to rising oil and gas prices starts to kick in.
- We see real upside risk to current oil price assumptions, but see increased market confidence in oil’s floor as the greater positive likely to drive a lasting re-rating for sector valuations.
- ESG remains a key issue impacting supply and supporting commodity prices.
- We maintain our bullish view on the sector, with Woodside Petroleum (ASX:WPL), Santos Limited (ASX:STO), & Karoon Gas Australia (ASX:KAR) our preferred sector exposures. While also confident in long-term value in Beach Energy (ASX:BPT).
Catch-up rally now unfolding
For the majority of the year oil & gas stocks have underperformed rising oil and gas prices, with a couple of notable de-rating periods. This unnerved investors who were questioning whether a sunset discount had appeared.
We saw the de-rating as more a lack of conviction from local investors rather than any material ESG impact. Oil & gas stocks in more ESG-conscious markets (US/Europe) outperformed our Aussie oil & gas stocks during the same period which supported our view.
What we expect is playing out now is the new multi-year record prices for oil and LNG is starting to penetrate that pessimism and resulting in a ‘catch up’ rally across Australian oil & gas stocks.
Over the last month, WPL share price is +27% (vs oil +13%), STO share price +18% (vs oil +13%) and OSH share price +20% (vs oil +13%). No longer limited by sentiment, and with oil and gas prices still rising, we see a strong outlook for the sector.
Confidence in floor will improve
We think this oil cycle has a long way to go. As expected demand is rushing back while supply has been caught flatfooted.
We attribute this primarily to issues stemming from ESG pressures, namely: 1) increased government interference in some key producing countries, 2) reduced access to capital pushing WACC’s higher, and 3) several global majors looking to exit oil (so poorly positioned to reinvest in supply growth).
While we see the potential for oil prices to rally through US$100/bbl, more important will be the market’s restored confidence in what a typical oil cycle looks like. Which we expect will see Australian oil & gas stocks gradually re-rated.
Oil/LNG forecast upgrade
We have upgraded our forecasts to mark-to-market the recent strength. The biggest changes are coming in spot LNG prices, with JKM pushing north of US$32/mmbtu. We have also upgraded our oil forecasts (summary later in report).
The changes have resulted in sector wide upgrades to our target prices and earnings, to varying degrees depending on market exposures.
Amongst the large-caps we maintain our top equal preference for WPL and STO. We view both companies as well positioned as both pursue their own transformative mergers. WPL holds much larger exposure to spot oil and gas prices, while STO boasts a strong diversified earnings mix and investor support.
We maintain an Add rating on both WPL (login to view target price) and STO (login to view target price).
Amongst the small/mid-caps our top pick is KAR, which we maintain an Add rating and (login to view target price). KAR is in the favourable position of being the lone pure oil producer of any scale on the ASX. We think the high-margin barrels it produces will help fund a more than doubling of production as KAR works to rejuvenate the Bauna field.
We pull back our rating on Senex Energy Limited (ASX:SXY) to Hold (from Add), a long-time top sector pick for us but now trading close to fair value after receiving a proposal over a possible takeover offer. SXY’s share price has risen 64% over the last 12 months. Its formidable management and board have done a good job creating and protecting value for shareholders, this remains a confident hold.
We also remain confident on value being on offer in BPT (Add - login to view target price) and COE (Add - login to view target price). Both less exposed to current spot commodity prices, but both still looking oversold in long-term value terms with attractive upside.
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