Energy stocks are by no means the ‘safe-haven’ they once were, and the lowering of long-term (WTI) oil price assumptions from US$85/bbl to US$65/bbl will see the sector struggle to significantly outperform the S&P/ASX200 again this year. But despite the current cyclical downturn, curious market dynamics are giving the sector a welcomed kicker.
Higher oil prices, courtesy of both the recent global bear-market rally and revelations that OPEC will cut production levels, delivered share price gains to local energy stocks. But the other longer-term driver, says David Wall resources analyst with Hartleys is unprecented global interest in LNG as a large and predictable alternative source of energy to oil.
While the market has traditionally wired the worth of oil & gas companies to the spot price, Wall says a significant portion now willingly factor-in the long-term upside based on the supply and demand crunch into the future. And best estimates now suggest the market could become short LNG again around 2015.
Unsurprisingly, coal seam gas (CSG) assets – comprising over 13 percent of Australia’s gas supply – currently dominate the M&A stakes within the sector. The changing structure of LNG pricing, which has correlated gas more to the oil price, and the search for large volume alternative fuel supplies – has seen the petrochemical ‘super majors’ start entering this market.
And recent acquisitions by foreign playmakers within Australia’s CSG sector, notably Petronos of Malaysia, UK oil and gas group, British Gas (BG) and US-based ConocoPhillips has created a fertile market for future M&A activity.
Now that the big players – with pockets deep enough to bring proven reserves to fruition – have finally arrived, Roger Leaning head of research with ABN Amro Morgans expects a lot more deals to be done. He expects greater rationalistion of Queensland’s CSG assets well before the costly infrastructure investment (at Gladstone) necessary to convert it into LNG. But given that these large players collaborate in similar joint-ventures offshore, he doesn’t believe the final outcome has to be an and/or scenario where one winner takes all. And with five projects still proposed for Gladstone, he says there are potential synergies from further industry consolidation.
But with much of the CSG consolidation having aready occured, Leaning says the risk for investors is having to gain exposure through smaller stocks, like Eastern Star Gas (ESG), Bow Energy (BOW), and Molopo Australia (MPO) with limited access to funding. And with so much M&A acticity yet to play out, he says the biggest danger is backing a horse that doesn’t end up being taken out.
While there’s no certainty the bigger players (upstream) will get necessary ‘heads of agreement’ with the supply of gas, Wall says the other real risk for investors is simply ongoing oil price uncertainty.
And while Wall expects some energy stocks in the sector to outperform, he says the cyclical downturn doesn’t bode well for the sector at-large. Until the steep decline in oil prices is matched by an equal decline in the cost of stgeloping new projects, he says investors who like the ‘CSG story’ may be waiting a long time for projects like Gladstone to come to fruition.
Given these dynamics, Leaning recommends investors looking for CSG exposure gain access via Origin Energy (ORG). He says despite a challenging year for wholesale energy, Origin used its diversity (encompassing natural gas, oil exploration and production, electricity generation, an energy retailing) to deliver an excellent result.
And while Wall agrees that Orgin, Arrow Energy (AOE) and Santos (STO) are premier companies within the CGS space, his standouts for share price apprectaion this year include: Bow Energy (due to a 30 percent upside for takeover potential, and for having acerage in the right location) and Eastern Star Gas. “Located in NSW, Eastern Star is a different play (to its Qld counterparts) and as it’s not using feedstock for an LNG plant, has to move supply into the domestic market,” says Wall.
For investors looking for more traditional oil & gas exposure, Leaning recommends Oil Search (OSH) with Santos a close second. In addition to stgelopment and resource upgrades, he also expects Santos to have strong corporate appeal, especially due to the strength of the long-term LNG market. “While it doesn’t have the events that Oil Search and Santos will capitalise on this year, our favoured traditional oil & gas stock is Woodside Petroleum (WPL) due to its defensive characteristics (ROE, low net debt-to-equity and moderate P:E) and long-term exposure.”
In addition to Woodside and Oil Search, the other traditional oil & gas stock Wall favours is Carnarvon Petroleum (CVN) due to key assets in Thailand, strong production and business model, plus its robust balance sheet.
Citi Smith Barney also favours the larger explorers and producers within the sector. Due to the defensive nature of its stgeloped and in-construction LNG portfolio, and with equity risk having significantly diminished, plus exploration upside – Woodside is also the broker’s number one (energy sector) pick. Given the current volatile nature of commodity prices, Citi favours the stability and potential price catalysts of Woodside.
The broker also favours Oil Search due to its leverage to PNG LNG, and the potential for lower Capex which may provide further catalysts in the coming months. “We still like Santos due to its corporate appeal and CSG position, but acknowledge that CSG to LNG is a higher risk proposition in the current market. However,
consolidation and the associated synergies could alleviate some of these CSG concerns.”
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