The price of oil began its descent about a year ago, plunging to just under US$55 in six months. Since then the price has fluctuated but remained above that low. Events over the last week or so have led to another drop. Here is a one year price chart for Brent Crude.
What happened? Four issues are likely catalysts:
• The Chinese have been stockpiling oil at these lower prices with that country’s economic issues suggesting reduced demand for oil in the near future.
• Iran may begin shipping oil in the aftermath of a nuclear deal, adding to the global supply glut.
• The state of the European Union following a resolution of the Greek debt crisis is uncertain.
• The US EIA (Energy Information Agency) reported a surprising increase in US oil inventories.
Some analysts are already cutting year end 2015 forecasts for Brent Crude. Despite the latest dip and the uncertainty of where oil is headed from here, as of 9 July 2015 analysts have yet to recommend selling any of the four top ASX Oil & Gas stocks. The following table summarizes analyst recommendations posted on the Reuters financial website.
Oil Search Ltd
Analyst opinion alone should never be the major reason to buy a stock. Few, if any, analysts or market experts accurately predicted the dramatic fall in the price of oil. In June an IEA (International Energy Agency) report forecasted higher than expected oil demand through 2015 but not enough to absorb the current over supply. The falling price has led to cutbacks, perhaps the most significant being Brazil’s Petrobas reducing its five year oil production forecast by 1.4 billion barrels per day (bpd) and Iraq’s decision to renegotiate current contracts.
Analysts at Citi and Deutsche Bank are now claiming these cut backs and project cancellations could lead to “tighter” oil markets by 2017. The perplexing truth is investors can find evidence to support both a bull and a bear case for major oil producing companies.
How attractive are the ASX top Oil & Gas producers right now? Let’s look at some numbers.
52 Week % Change
6 Month % Change
2 Year Earnings Growth Forecast
2 Year Dividend Growth Forecast
Woodside Petroleum (WPL)
Oil Search Ltd
Woodside Petroleum (WPL) has the least amount of analyst support of any stock in the table and the only negative earnings growth forecast. The company also has the greatest exposure to what could be a major growth driver in the future – Liquefied Natural Gas (LNG). In truth, the potential of all these stocks rests not with oil but with LNG.
All have invested heavily in LNG projects and all have suffered through numerous construction delays and massive cost overruns. Woodfield was the first to ship LNG from its Pluto operation back in October 2012, driving the stock price and subsequently the dividend payments up substantially. Here is a five year price performance chart for WPL.
LNG was supposed to usher in the Golden Age of Gas but prior to the commencement of shipping from Pluto, Woodfield was plagued by a myriad of delays and cost overruns. The company and its shareholders prospered from the early long term LNG contracts, which are linked to the price of oil. The price negotiation is backward looking, with a range from 6 to nine months. This meant Woodside’s LNG contracts were priced based on a much higher oil price than we see today.
Consequently Woodside has paid special dividends to shareholders and has the lowest gearing of any of the stocks in the table – 15.52% as of the most recent quarter (MRQ). The company has $3.27 billion in total cash against $2.59 billion in debt, both MRQ.
Woodside produces oil in Australia and has exploration permits around the world, but the company is clearly focusing on expanding its LNG footprint. Cost concerns prompted the company to shift its Browse LNG project to a “floating” operation but that undertaking is now on hold.
In June of this year Woodside announced a joint venture with a US based producer to build an LNG export plant in the US. This followed a May deal with US LNG producer Cheniere Energy to buy 20 years of LNG from a Cheniere facility. Natural gas supplies are substantially cheaper in the US, allowing Woodside a hedge against losing business for its higher cost LNG from Australia. In the US, LNG pricing is generally linked to natural gas prices, not oil prices.
Origin Energy (ORG) is more diversified than the others with operations in power generation and electricity retailing. The company’s primary focus is gas exploration and production, with only a small presence in oil. In addition, Origin has interests in wind and solar power generation.
The company has invested heavily in its joint venture Australia Pacific LNG (APLNG) project and got a credit downgrade recently due to its precarious debt position. Total cash on hand (MRQ) was $562 million against total debts of about $12 billion. Origin Management has announced the possible sale of its New Zealand oil interests. To add to its trouble, APLNG has a contract with China’s Sinopec, one of the joint venture partners, to purchase LNG once the operation begins shipping, with “sustained production” expected in Q2 of FY 2016. Weakening demand in China has raised concerns about the contract, with Origin management issuing a statement that the flexibility built into the contract would not impact the deal, which called for delivery of 7.6 million tonnes of LNG a year.
Given the fact the company will not see any revenue from APLNG until the end of calendar year 2015 at the earliest, potential Origin investors can take heart in Origin’s recent investor presentation at which cost cutting measures and capital expenditures were outlined and the announcement the company’s conventional gas assets were seeing rising prices and increasing demand in all markets. Note that Origin has the highest two year earnings growth forecast of any share in our table at 19.2%. Over ten years the Origin share price has outperformed the ASX XEJ Energy Index. Here is the chart.
With 5 Buy and 9 Outperform recommendations, Oil Search Limited (OSH) appears to be the top analyst pick. The company has a 29% interest in the Papua New Guinea LNG project (PNG LNG) which began shipping in May of 2014. Santos Limited (STO) holds a 13.5% interest, with Exxon Mobil the largest stakeholder and the operator of the project.
There are many who doubt the long term viability of LNG. At least in the short term, LNG is paying off for Oil Search shareholders in a big way. The company released Full Year Financial Results in February, with a 110% revenue increase; a 72% profit increase; and a 171% increase in operating cash flow. In addition, OSH management announced it was “reprioritizing” its work for FY 2015 to focus on its LNG efforts in response to the falling price of oil.
With two new LNG ventures in focus, management assured investors the company’s balance sheet was strong enough to support new projects. However, a closer look reveals the “strength” lies in what Oil Search can borrow. As of the end of Fiscal Year 2014 the company’s gearing was 88% with $960 million in cash against $4.41 billion in debt. Oil Search reported its liquidity at $1.56 billion, including about $600 million in financing capability along with the cash on hand.
Along with its interest in PNG LNG Santos Limited (STO) holds a majority interest (30%) in the Gladstone KNG project (GLNG) which will begin shipping later this year. However, operating at full capacity could take two to three years, putting Santos in the unenviable position of negotiating contracts at a low oil price. Gladstone development began back in 2011 with an estimated price tag of $16 billion. By April of this year that cost estimate had risen to $18.5 billion. Shareholders have suffered along the way, with the stock price down close to 50% over five years. Here is the chart.
Santos currently derives about 46% of its revenue from oil production, which could account for its share price dropping more than any of the other majors in our table. The company’s Full Year 2014 results showed a 12% revenue increase along with a 6% rise in underlying profit; figures which included its share of PNG LNG operations.
Whether any of these stocks represent a buying opportunity lays in the future growth of LNG. Being late to the game puts Santos at a disadvantage. In addition, there are market experts who question LNG growth projections. Oil & Gas analyst firm Woods Mackenzie is not among them. Their forecast calls for current and contracted supply to meet LNG demand until 2020, after which the game changes. The following graph is from a Santos Investor Presentation. It suggests investors with a long term view and a tolerance for risk might see any of the shares in our table as buying opportunities.
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