For weeks both bulls and the bears have been drooling over the prospect of big swings in the price of oil following the meeting of oil producers in Doha, Qatar on Sunday, 17 April. Indeed, Bloomberg news was reporting a range of analyst post-meeting predictions from $30 to $50 per barrel pending the outcome of the meeting.
On the one hand there were those certain an agreement to freeze production at current levels would be reached. On the other hand there were those citing Saudi Arabia’s insistence they would only agree to a deal if Iran went along with the program, which the Iranian oil minister said they would not do. In fact some news outlets quote the Iranian minister as referring to the proposed production freeze as “a joke.”
In the midst of this “will they or won’t they” speculation, the price of oil has been bouncing around, depending on which side of the argument held sway on each trading day.
Now you know the results of the meeting as you enjoy your morning coffee. If the price of Brent crude has fallen back to $30, is it time to consider buying some of the beaten down oil and gas producers on the ASX? If the price hit $50, is it too late?
For those investors waiting to buy until “the bottom is in”, even the return to the $30 level might not be enough. For those investors waiting to confirm an upward trend, even the upswing to $50 might not be enough. In either case very few investors rely solely on their own judgment to make investment decisions. They research a sector and stocks within it and look for the opinions of those with purportedly more expertise than they as retail investors possess.
The analyst community often is a place to go for informed opinions and forecasts. In the case of the oil and gas sector, the vast majority of analysts have been dead wrong since the price of oil stood at around $115 per barrel in mid-year 2014. Why look to them for advice and counsel now?
There are other informed sources to consider. One is industry insiders. These are individuals working within the oil and gas sector with reputations bordering on the legendary. In the US Harold Hamm has earned the right to have investors heed his opinions.
Hamm is the CEO and founder of Oklahoma based Continental Resources (NYSE:CLR) with a market cap of US$12 billion. Hamm began his career repairing cars and pumping petrol before going on to start his own oil company, which grew into Continental. Hamm’s efforts were instrumental in the shale oil revolution that began in the Bakken Oil Field in the US states of Montana and North Dakota. Continental was the first US oil producer to combine horizontal drilling with hydraulic fracturing to open the first commercially successful shale oil find back in 2004.
Hamm has gone on record saying the price of oil will double to $60 by the end of 2016. He bases his prediction on the declines in production already beginning in the US and his expectation of declining production elsewhere around the world, correcting the current demand/supply imbalance far sooner than many others are anticipating.
Harold Hamm is not exactly a household word, even in the US, but another legendary oil and gas pioneer comes closer to that status – Texas oilman T. Boone Pickens. Pickens was a “wildcatter” – a US term for bold oilmen willing to drill in areas having no known oil reserves – and went on to form his own oil company. In early February of 2016 Pickens predicted the price of oil would double to $52 per barrel by year end, up from the $26 price at that time. Pickens had made the same prediction one year ago and stated he got it wrong due to the timing of the drawdown of excess oil inventory. This time he predicted the drawdown is coming.
Another source of confidence for retail investors is following the “smart money.” For that we turn to the US Hedge Fund community – arguably the largest and most influential in the world. Hedge Funds throughout 2015 were betting against rising oil prices. In the last few months Bloomberg, Reuters, the Wall Street Journal, and the Financial Times have all run articles highlighting a trend reversal. US hedge funds, according to these sources, have gone bullish on the price of oil.
Finally, we have the short sellers, some of whom appear to be getting nervous about the price of oil. To some investors, short sellers are “the smartest guys in the room” because the high risk that goes along with shorting requires painstaking research. If you buy 100 shares of a stock for $5 the most you can lose is $500 should the company go into receivership. Shorting at $5 means “borrowing” shares that must be paid back in time. The potential loss is infinite as a stubborn short seller who refuses to buy back the shares at $6 or $7 may eventually have to buy back at $30, $40, or even higher.
The collapse of US energy giant Enron is considered one of the top financial scandals of all time. Analysts missed it but the short sellers got it right. In the US the Financial Industry Regulatory Authority (FINRA) requires short interest to be reported twice a month. The following table shows the change in short interest over the most recent two week period for some of the top oil and gas stocks on the New York Stock Exchange (NYSE).
So there you have it. Regardless of where the price of oil is as you are reading this, we have some industry whales, hedge funds, and short sellers all of the opinion by the end of 2016 the price could be somewhere in the neighborhood of $60 per barrel.
As of 14 April our largest oil and gas producer, Woodside Petroleum (WPL) could be had for a share price not seen since 2005. Despite the calamitous price drop that began towards the end of 2014, Woodside actually posted a profit for the Full Year 2015, although the fall-off from FY 2014 was dramatic – a decrease of 98%.
Woodside was beleaguered by delays and cost overruns in its flagship LNG project at Pluto, but once the site began shipping in April of 2012, the stock price gradually rose until the oil price collapse in 2014. The company began trading on the ASX in 1988 and is up 2000% since then. That gain is more than twice that of the Dow Jones Industrial Average (DJIA), one of the most influential indices in the world.
Oil Search Limited (OSH), the second largest producer on the ASX fared better in terms of share price. Following the success of Woodside’s Pluto, investor appetites for other companies pursuing LNG opportunities initially increased. Oil Search is a partner in the Papua New Guinea LNG (PNG LNG) which began shipping in May of 2014, driving up the OSH share price until the following fall when the bottom began to drop out of the oil price.
Here is a five year chart for Oil Search.
Our third largest oil and gas producer, Santos Limited (STO) also has interests in an LNG project at Gladstone – GLNG, as well as a smaller interest in the PNG LNG operation. Gladstone began shipping in October of 2015 and investors welcomed the news, at least for a moment. Here is the chart:
You would have to go back in time to June of the year 2000 to be able to buy shares of Santos at the share price around $4.00.
All three of these companies will benefit when the price of oil goes up. If you believe in the basic laws of supply and demand, it is not a question of “if” the price goes up, but rather a question of “when” and by how much.
The short term future of LNG is in question as demand in Asia from China, Japan, and South Korea fell this year. However, the Department of Industry, Innovation and Science recently released its Gas Market Report 2015. The report claims the long term outlook for Australian LNG exports is positive, with an anticipated doubling of LNG use in India by 2020 among the reasons for the optimism. The International Energy Agency predicts global gas demand will increase by 50% by the year 2040.
LNG pricing is linked to the price of a barrel of oil so all three companies will see benefit to their LNG revenue if the price goes up and stays up. Woodside’s operations have been in place the longest and the company has abandoned plans to develop another LNG operation called Browse.
Santos has less than one year’s LNG revenue and is now free of the crushing capex costs associated with the construction of the Gladstone LNG project. As a result, however, the company is laboring under a heavy debt burden with gearing at 72% and close to 7.5 billion in total debt.
Woodside’s gearing is about 29% with close to $4.5 billion in debt. Oil Search has $4 billion in debt with 91% gearing, all as of the most recent quarter.
Despite the depressed share prices and the horrible operating environment, analysts covering these three stocks see all returning to positive earnings in the near future. The following table shows share price information along with earnings per share for 2015 and the average analyst estimates for earnings in 2016 and 2017. The estimates are from Reuters, with the figures for Santos adjusted to reflect $US dollars.
Analysts have been wrong before and they will be wrong again, but if they are right here, retail investors sitting on the fence should take note. Following a return to reasonably positive earnings in 2016, Woodside is expected to increase earnings by 49%; Oil Search by 217%; and Santos by 1,350%.