Energy: Don't Expect a Quick Recovery for Crude Prices
Markets have rebounded recently, but much uncertainty remains, meaning near-term prices could remain ugly or deteriorate further.
Energy investors are still grappling with the critical question: How long will it take for the oil industry to work through the current period of oversupply and rebalance itself? U.S. output is likely to decline this year due to heavily reduced capital spending. Consequently, while global demand is expected to grow by around 1.2 mmbl/d in 2016, global supply is expected to remain fairly flat (and it won't grow in 2017 either if oil prices average less than $50 per barrel this year as expected). However, the magnitude of the current oversupply is such that global stockpiles will continue growing through mid-2017 in all but the most optimistic scenarios.
What does that mean for crude prices? U.S. producer commentary indicates that many will start completing backlogs of deferred wells and even adding rigs if WTI oil goes north of $45. Therefore, near-term rallies above that level probably aren't sustainable. But the likelihood of strong declines this year is also waning. We expect production outside of OPEC and the U.S. to surprise to the downside, with the recent lowered output targets from Mexico and Colombia being the start of a trend, rather than one-off events. Therefore, we expect WTI prices to hold steady in the $35-$45/bbl range for the next 12-18 months (with the caveat that the scaling back of economic forecasts in consumer countries, especially China, is a key risk that could trigger further weakness). Beyond that we anticipate a gradual rebound to the midcycle levels outlined above, which are consistent with long-run marginal costs.
Continental Resources (CLR)
Continental is our top pick in the U.S. oil-focused exploration and production group. Continental played a key role in the early development of the Bakken Shale and now holds 1.2 million net acres prospective in this prolific oil play. The company has added a second string to its bow with the ongoing delineation of the South Central Oklahoma Oil Play. Even at today's prices, wells drilled in these areas offer attractive returns, and Continental's positions will take at least 20 years to work through. The firm has a strong liquidity reserve and is still expected to be free cash flow neutral in 2016.
We view ExxonMobil as offering the best combination of value, quality, and defensiveness. Exxon will see its portfolio mix shift to liquids pricing as gas volumes decline and as new oil and liquefied natural gas projects start production. The company historically set itself apart from the other majors as a superior capital allocator and operator, delivering higher returns on capital than its peers as a result.
Cabot Oil & Gas (COG)
On the gas side, Cabot controls more than a decade of highly productive, low-cost drilling inventory targeting the dry gas Marcellus Shale in Pennsylvania. Fully loaded cash break-even costs are less than $2.50 per mcf, which should allow the firm to remain on strong financial footing over the next several years.
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Dave Meats does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.