Oil bull has further to run
Thursday, March 28, 2002
Wilf Gobert (L) & Brian Prokop (R)
CALGARY (GlobeinvestorGOLD) -- In the past month, the Toronto Stock Exchange’s index of oil and gas stocks rose to an all-time high of 10,633, which is a 34-per-cent gain from the bear market low, set in late September. A bull market rally for sure. Like the broader stock market and economic indicators in North America, energy investors are looking beyond current bad news and commodity price risk.
And the pressure is building for analysts with below-consensus estimates to raise their forecasts.
The futures contracts for light crude oil traded on the New York Mercantile Exchange have a twelve-month average, called the strip, of about $25 (U.S.) per barrel. The consensus estimate in First Call for 2002 is $21, with a range of $17 to $25.80. It was only January when crude oil was trading below $20, with rampant fear that a market-share war between OPEC and Russia would result in a 1998-style collapse in world oil prices. For the first quarter, crude oil has averaged $21.28, in line with estimates of $21 for the year, if the futures prices fail to hold current levels as economic events unfold.
Since January, OPEC members have agreed to extend production cuts beyond March 31 to at least June 30, with some talk of maintaining the choke on supply through the entire year. Russia has paid lip service to maintaining its share of production cutbacks. What Russia says is not necessarily what Russia will do, but OPEC is exercising a suspension of disbelief of Russia's true intentions in order to maintain price stability.
With production cutbacks by OPEC and selected other oil-exporting countries like Russia, oil commodity analysts, on average, are looking past the currently weak economic activity and adequate inventories of crude oil and refined products. Their supply/demand models say economic growth recovery, weak capital spending in the oil industry, and production cutbacks, will result in a supply shortfall and declining inventories in the second half of the year.
Natural gas prices in North America are another topic with widely varying views. The First Call consensus estimate for the benchmark U.S. gas contract is $2.69 (U.S.) per thousand cubic feet, but the range of estimates is between $2.45 and $3.25. The NYMEX futures contract for May delivery is trading at $3.38 and the 12-month strip is $3.60. The first quarter has averaged $2.47. Why the wide spread in estimates? It goes back to the same supply/demand and economic issues affecting crude oil prices or GDP growth forecasts.
With natural gas, the debate is centered more narrowly in the United States and Canada compared with worldwide considerations for crude oil. That's because the trade of natural gas outside of the two countries, is fairly minor at this time.
Natural gas analysts focus a remarkable amount of time and effort in analyzing natural gas storage in the United States. In an average winter, storage supplies about two trillion cubic feet or 2,000 Bcf (billion cubic feet) of U.S. natural gas consumption, which is between 16 per cent and 18 per cent of total supply. However weekly storage withdrawals in the winter, and injections in the summer, represent a valuable indicator of the supply and demand balance.
During the winter of 2000-2001, some analysts were projecting that storage withdrawals would end at zero by March 31, the contractual end of the withdrawal season. However the collapse in consumer demand caused by high natural gas and electricity prices resulted in storage ending the season at 742 Bcf. With the economic slowdown and consumer conservation in 2001, the end of the 2001 injection season saw storage rise to a near-record level of 3,144 Bcf. With the mild winter of 2001-2002, storage is expected to end this season at about 1,500 Bcf, nearly double the prior-year level. And that statistic has natural gas producers worried about a price collapse when injections (essentially an element of demand for gas) begin in April.
The commodity price bulls say forget the high storage levels. With capital spending in the oil patch in decline and with economic growth accelerating in the second half of the year, natural gas will be in tight supply by next winter, they say.
So what is an energy investor to do? First, it's a bull market, so unless you are a trader you should be over-weighted. Secondly, for large-cap portfolio managers and analysts, there are only a few stocks to consider, thanks to the deluge of takeovers during the past few years. During the 1998-2001 period, the TSE saw 142 energy stocks delisted (compared to 81 new listings) and the oil and gas index saw its name count drop by 16 to 38. And of those 38, just nine stocks represent over 80 per cent of the value of the index.
For our money, our large-cap selections include Suncor Energy Inc., Petro-Canada, Canadian Natural Resources Ltd., Nexen Inc. and Talisman Energy Inc. (we are restricted on the merger that will form Encana Corp.).
Most important for energy investors, however, is the trading volatility of the index. Over the past twenty years, the annual decline in the index from its high one year to its low the next year is 25 per cent. And the average increase in the index from its low in one year to its high the next year is a gain of more than 50 per cent. And finally, the average bull market in Canadian energy stocks has been a gain of 80 per cent.
This bull could run a long distance from here -- but beware of trading volatility in the short run.
Wilf Gobert is a managing Director and Brian Prokop specializes in the oil and |
