Matein Khalid: Energy Upturn

Brent crude has fallen to $110. This is due to a stronger US dollar, the US-Iran nuclear deal in Geneva, the reopening of Libya’s Shahara oilfield, the end of the Federal Reserve’s balance sheet expansion and Saudi Arabia’s unwillingness to cut the 30 million barrel output limit in the last OPEC meeting.

Libya produced 1.5 million barrels a day (MBD) in the twilight of the Colonel Gaddafi era. However, conflicts between the Tripoli government and tribal militias/ militant oil workers unions had paralysed Libya’s oil ports/loading terminals on the Mediterranean. This added a $10 geopolitical risk premium on oil prices that has been unwound since November as a deal between Tripoli and the militias enabled oil output to triple to 650,000 barrels since November 2013. Iraq’s daily production has also risen above three million, despite the recent escalation in its sectarian civil war.

However, as long as supply shock exists in Libya, Iraq, Sudan, Yemen, and Nigeria at a time when the world economy experiences the first synchronised recovery since 2007, it is difficult to envisage a sustained fall in crude oil prices. A $95 to 115 trading range for Brent crude is credible, a range preferred by Saudi Arabia, OPEC’s swing producer and the central bank of black gold.

This means opportunities exist to accumulate value ideas in the US, Europe and emerging markets energy shares. Energy has been a laggard in the parabolic bull run in European and American equities since late 2012. I believe there is a compelling opportunity to accumulate shares of megacap US oil services firms, particularly Schlumberger and Halliburton. Both benefit from the growth in US shale oil production, deepwater Brazil/West Africa, Mexico’s historic reforms, the return of Iraq, Iran and Libya to global markets and the Kremlin’s planned $500 billion capex to explore the Russian Arctic. Halliburton has shed its low margin, politically toxic contracting business Brown and Root and is now a candidate for a valuation rerating as it scales up its business outside North America and restructures via its “Frac of the Future” corporate strategy.

International, integrated supermajors (the Seven Sisters) have not boosted their reserve replacement ratios and mediocre earnings growth. The North Sea and Venezuela have also been the Achilles heel of mediocre or even declining production growth while downstream in Europe has not exactly been a money gusher. However, the Seven Sisters are totally different businesses with a varied global product mix and corporate strategies. For instance, Chevron has boosted its reserves and delivered significant cash flow.

The real money making opportunities lie in high margin, domestic US shale oil and gas production companies because the Seven Sisters are exposed to governments in Russia, Africa and the Gulf that tax oil price windfalls at the same time as legacy oilfields in Alaska and the North Sea decline.

Moreover, several multibillion dollar LNG and deepwater projects have had huge cost overruns at the same time as storage/trading costs have risen. Above all, the Seven Sisters desperately need to add long life reserves in low tax, low political risk zones. This means US shale oil and gas, the reason Exxon Mobil shares have outperformed since last summer.

I am not bullish on BP, given the Macondo tragedy litigation risk. Shell is overexposed to cost inflation in gas to liquids and LNG projects. Total is vulnerable to France Inc’s industrial relations woes. The winner? Occidental Petroleum, which plans to shed its chemicals, midstream and Middle East assets and invest in its California Elk Hills and Parmian Basin in Texas acreage, where it is the leading US shale oil and gas producer. After all, Texas now produces 2.6 million barrels a day (MBD), in the same league as Kuwait and Abu Dhabi and higher than Oman and Qatar!