12 May 2009

Is energy back with a vengeance? (Part 1)

Not yet!


It is worth noticing a few items:
  • Global oil supply fell to 83.4 mb/d in March to match diminishing demand; this corresponds to IEA 2009 demand forecast, 2.8 md/d less than in 2008 (see chart).
  • OECD industry stocks rose by 7.5 mb in February to 2,743 mb (7.2% above a year ago) i.e. 61.6 days consumption at the end of February (7.9 days above last year).
  • Investors have started to anticipate the the world economy has reached its trough hence anticipating higher demand along the road.
  • Oil companies have drastically cut into their exploration and development investments.
  • Prices recently have tracked expectations for the global economy, seeking signs of demand recovery. However, pervasively weak market fundamentals could limit further gains until the summer.

  • May 12, oil passed the $60/b mark, the first time since mid-November (oil prices were down awhopping 70% in 2008) to consolidate at $57 today. It is moving towards its 200 day Moving Average (MA) which may check its progression, at least temporarily.
  • After reaching a low of $37.12/b on Feb 19, prices have strongly rebounded with a gain of over 60%. Whilst bearable for consumers (particularly for the non $ based with the current weakness of the $), further advances would act as an additional tax on consumers.

I however believe that the second half of the year will see oil prices strengthening:
  • North Sea, Mexican and the US production is declining.
  • Russian production which represents 75-80% of non-OPEC' growth is expected to remain flat or even fall due to the lack of investments.
  • Most tar sands production in Canada is marginally profitable (only one project has not been shelved). Remember that oil extracted from tar sands/oil sands represent the largest reserve of oil in the world but is very costly to produce and not environmental friendly.
  • Brazil offshore discoveries will not come on stream for a considerable period of time
  • Venezuela with Chavez at the helm of the country is finding it difficult to finance its oil industry.
  • Mature fields are declining faster than expected.
  • According to the IEA, $26 trillion need to be spent by 2030 to meet demand. As of today, there is no way that this amount of money can be found in the coming 20 years.
  • Investec calculated that $70-80 minimum is needed to justify the development of new, marginal projects
  • OPEC has +/- 5 mb/d of spare capacity
Any pick-up, or perceived pick-up, in the world economy, particularly in China, will boost oil prices well beyond the current levels. OPEC spare capacity coupled with industry stocks will limit a decisive break above the 200 day MA, hence my moderate view for oil prices until the summer.

The aggressive investors can however selectively position itself with oil stocks now, which, in addition, are also paying 4-6% dividend yields. Oil stocks underperformed oil and are due to a catch-up. We are in a situation not dissimilar to the early 80's when it was cheaper to buy oil by taking over a competitor than invest in exploration and development; this should therefore lead to strong a M&A activity not dissimilar to the early 80's. I however would personally feel more comfortable when oil is back in the low $50/b.