Energy: Super spike period may be upon us - Sector a buy Goldman - Sachs March 30, 2005
We believe oil markets may have entered the early stages of what we have referred to as a super spike period - a multi-year trading band of oil prices high enough to meaningfully reduce energy consumption and recreate a spare capacity cushion only after which will lower energy prices return. Resilient demand has caused us to revise up our super-spike range to $50- $105 per bbl up from $50-$80 per bbl previously. We see as much as 80% total return upside to super-spike-adjusted peak values and are comfortable recommending that investors add to positions in the sector at current prices, on a pull-back, or even after rallies. Top picks remain XOM, AHC, BBG, DVN, ECA MUR, NFX, PXD, PCO, STR, and SU (all OP/A). The key risk to our Attractive coverage view would be a sharp slowdown in economic growth in China and other emerging Asian economies.
Please see our detailed 32-page report, "Super spike period may be upon us: Sector a buy." If you are on our e-mail distribution list, a .pdf will be sent today. If you are an institutional investor client of Goldman Sachs and not on our email distribution list, please call 1-212-357-0931 or send an e-mail to arjun.murti@gs.com to receive a .pdf of this report.
CONFERENCE CALL 3/31 AT 11:00 AM (NY time).
Arjun Murti and Terry Darling will be hosting a conference call on Thursday, March 31, 2005 at 11:00 AM (New York time) to provide updated views on the integrated oil, E&P, R&M, and oil services/drilling sectors. The dial-in numbers are as follows: 1- 877-208-2954 (Domestic), 1-973-528-0056 (Int'l), Conference Entry Code: 12442. Replay will run for two weeks starting two hours after the call. The replay numbers are as follows: 1-800-332-6854 (Domestic), 1-973-528-0005 (Int'l), Replay Code: 12442.
RAISING 2005/2006 WTI OIL PRICE FORECASTS TO $50/$55 FROM $41/$40
We have increased our 2005 and 2006 forecasts for WTI spot oil to $50 per bbl and $55 per bbl, respectively, up from $41 per bbl and $40 per bbl before (see Exhibit 1 in our report). Our higher forecasts are driven by the combination of resilient oil demand growth, a growing premium for "light-sweet" crude like WTI relative to "heavy-sour" grades, and further sharp increases to the industry cost structure.
Consistent with our WTI oil price increase, we have also raised our forecast for Henry Hub spot natural gas for 2005 and 2006 to $6.75 per MMBtu and $7.00 per MMBtu, up from $6 per MMBtu in both years, respectively. Note, our Henry Hub forecast does not rise as much as our WTI estimate due to relative weakness in residual fuel oil pricing-a key alternative fuel to natural gas.
We have made no change to our Gulf Coast 3:2:1 refining margin forecast of $6.25 per bbl for 2005 and adjusted 2006 only slightly to $6.50 per bbl from $6.25 per bbl. However, we have significantly widened our estimated spread between WTI oil and Maya crude (i.e., the spread between light-sweet crude and heavy-sour crude) to $18 per bbl and $20 per bbl in 2005 and 2006, respectively, up from $13 per bbl for both years previously. High (and rising) OPEC production volumes, limited complex refining capacity, and increasingly strict sulfur specifications in the United States and Europe are driving the widening differentials, in our view.
RAISING "SUPER SPIKE" RANGE TO $50-$105 PER BBL FROM $50-$80 PER BBL
We have raised our estimated "super spike" range for WTI oil prices to $50-$105 per bbl from $50-$80 per bbl previously. The strength in oil demand and economic growth, especially in the United States and China, following a year of $40-$50 per bbl WTI oil has surprised us. Looking back at the late 1970s and early 1980s, we see that gasoline spending was a much higher percentage of the economy and consumer spending than it is today, likely explaining the lack of impact we have seen thus far from what otherwise appear to be high crude oil and gasoline prices. Our new "super spike" range assumes a level of gasoline spending relative to the economy and consumer spending that is still below the heights reached in 1979-1981, suggesting our new range could prove conservative, especially if there is a supply disruption in a major oil exporting country.
Note, our new range is now driven slightly more by the oil price we think is needed to cause a multi-year reduction in energy consumption and slightly less so by the potential for political disruption in a major oil exporting country. The reason for this adjustment in view is that persistent high prices are improving the financial position of key oil exporting countries and could serve to keep potential revolution at bay. Note, the pressure on these governments still very much exists and would be exacerbated by an unexpected sharp fall in oil prices. If future political crises are to be averted, we believe it is critical that oil exporting countries reinvest cash inflows into building a diversified economic base that can allow the majority of their growing populations to have economic hope.
2006 EPS ESTIMATES FOR COVERAGE UNIVERSE NOW 53% ABOVE FIRST CALL CONSENSUS
We believe the Street's need to further revise up its EPS projections for the sector will drive further share price outperformance versus the broader stock market and we reiterate our Attractive coverage view. Our 2005 and 2006 EPS estimates for our coverage universe have increased by 21% and 35%, respectively, from previous forecasts and stand 19% and 53% above the corresponding First Call consensus forecasts. Our new EPS estimates correspond to an assumption of 30% EPS growth in 2005 and 28% EPS growth in 2006. By way of comparison, the First Call consensus is looking for only 11% EPS growth in 2005 followed by a 3% decline in 2006. Please refer to Exhibit 1 at the end of this note for 2005 - 2007 EPS changes for a universe of companies.
NO CHANGE TO "30-YEAR" NORMALIZED VIEW FOR COST OF CAPITAL RETURNS FOR INDUSTRY
Though we remain very bullish on the outlook for commodity prices and the sector over the next few years, there is no change to our view that over the very long-term, which one may think of as the 30-year view of the sector, that oil, natural gas, and refining remain commodity businesses where excess returns ultimately get competed away. Our "normalized" forecasts continue to assume a long-term cost of capital-like level of returns for industry. Note, we nominally incorporate our normalized assumptions into the years 2007-2010 in our models, even though we believe on a "spot" forecasted basis that such years could remain well above the 30-year normalized view. We believe this modeling discipline is critical to remembering that over a generation, oil is a commodity business. We prefer instead to treat the potential for continued above normal returns as an option value as reflected in our super-spike-adjusted valuations.
REITERATE ATTRACTIVE COVERAGE VIEW: 80% UPSIDE POTENTIAL TO SUPER-SPIKE PEAK
We believe the sector has as much as 80% total return potential upside to super-spike-adjusted peak values that correspond to a scenario that assumes a 100% probability of a super spike (see Exhibits 3 and 4 in our report). A 50% probability of a super-spike to the $75-$105 per bbl level would still show 50% upside potential for the sector. For investors that do not believe we are entering a super spike phase, we see the sector offering 20% upside to peak valuations like those seen during the 1990s oil price cycles. Our view is that this cycle is already much better than the 1990s cycles, leaving aside our view that oil prices are poised to continue to rise meaningfully from here. In addition to commodity strength, we also see M&A and increasing shareholder activism as other drivers for the sector.
There is no change to our top picks, which include Exxon Mobil among the super-cap oils; Amerada Hess, Murphy Oil, and Suncor in the domestic oil group; Devon Energy and EnCana among the large-cap E&Ps; Newfield Exploration, Pioneer Natural Resources, and Questar in mid-cap E&P; Bill Barrett Corp. in small-cap E&P; and Premcor among the R&Ms (all Outperform rated) (see Exhibit 2 in our report). Note, we believe the sector call is more important at this time than relative stock calls for our coverage universe. Similarly, increasing shareholder activism and the potential for M&A has reduced our confidence that Underperform-rated stocks like Marathon Oil, Petro-Canada, Unocal, Western Gas Resources, and Ashland will necessarily lag in the near term.
REG AC CERTIFICATION Each of the analysts named below hereby certifies that, with respect to each subject company and its securities for which the analyst is responsible in this report, (1) all of the views expressed in this report accurately reflect his or her personal views about the subject companies and securities, and (2) no part of his or her compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this report: Arjun Murti, Brian Singer. Each of the analysts named below hereby certifies that, with respect to each subject company and its securities for which the analyst is responsible in this report, (1) all of the views expressed in this report accurately reflect his or her personal views about the subject companies and securities, and (2) no part of his or her compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this report: Arjun Murti, Brian Singer.
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Goldman increased earnings estimates on 53 Oil, Gas, and Service Companies. Too numerious to list. Basiclyo every Oil and Gas related company that they cover. |
