Integrated oil, E&P, R&M trading update -- Ignore 'demand destruction' fear mongering; sector risk/reward remains favorable - Goldman Sachs - December 04, 2005
We believe investors should ignore relentless "demand destruction" fear mongering by some and take advantage of what appears to be a very favorable risk/reward for Energy equities to add to positions. Recent strong GDP reports in the US, China, and India coupled with a continued above-trend outlook for 2006 in each of those areas we think bodes well for 2006 energy demand. A recovery in US gasoline demand from post-hurricane lows as well as a return of more seasonal weather patterns should boost short-term demand and as importantly investor psychology. We think we are early in the second phase of a three phase energy bull market, with the conditions for favorable equity performance for the sector likely to remain in place through much of this decade. Top high-beta picks remain BBG, CNQ, ECA, MUR, NFX, SWN, SU, VLO, and XTO, with XOM our preferred low-beta super major (all OP/A).
IGNORE "DEMAND DESTRUCTION FEAR MONGERING
We believe energy demand remains solidly on-trend with past patterns of economic activity and that no observable "demand destruction" has occurred beyond that which was required by supply disruptions following the catastrophic hurricanes in the US Gulf Coast. We believe that drawing conclusions during shoulder month periods following devastating hurricanes and a warm start to winter has the risk of leading to incorrect assessments about the relative state of industry. Guilt by anecdote is dangerous and we caution investors from jumping to unnecessarily bearish conclusions about desired energy demand growth. An up-tick in Goldman Sachs's Global Leading Indicators (GLI) coupled with a continued above-trend GDP outlook for key oil consuming countries like the US, China, and India point to a coming recovery in oil demand growth rates following a natural slowing that occurred in 2005. Similarly, we believe underlying natural gas demand (i.e., ex-weather) is about as strong as can be expected in light of the significant production shut-ins following the hurricanes. In our view, current high natural gas prices largely exist in order to destroy demand; we think investors should differentiate between necessary demand destruction due to inadequate supply availability and a true price-driven demand fall-off the latter of which we do not see at this time. The recent return to more seasonal weather patterns in northern US and Europe will also boost short-term oil and natural gas demand and probably as importantly investor psychology.
WE THINK WE ARE IN EARLY STAGES OF PHASE 2 OF A 3 PHASE ENERGY BULL MARKET
With West Texas Intermediate (WTI) spot oil prices set to average around $57/bbl in 2005 and having reached as high as $70/bbl, we believe the past year will be remembered as the first of what we think could be a 3-5 year period of "super spike" energy prices (see our March 30, 2005 report, "Super-spike period may be upon us; sector Attractive" Message 21185072 ). Though we do not know how high energy prices ultimately need to go before a sustained curtailment in demand occurs, we increasingly believe the lower end of our unchanged $50-$105/bbl WTI oil equivalent band has not been detrimental to energy demand or the outlook for key economies like the United States or the so-called "BRICs" countries (i.e., China, India, Russia, and Brazil-in reverse order of the acronym due to importance to world oil markets).
SECTOR RISK/REWARD LOOKS FAVORABLE, EVEN WITH RECENT BOUNCE
We see 25% upside to traditional peak valuations for the sector versus just 7% downside risk to traditional mid-cycle valuations. Given the sharp correction in our energy coverage universe during the first three weeks of October, the risk/reward appears favorable even after the recent 11% bounce in absolute terms (4% relative to the S&P 500, which has also been strong). Given our view that the cyclical bull market for energy commodities is likely to last for several more years, we think energy equities can trade to if not through traditional peak valuations. The occasional fears about weather, a soft patch in the economy, or other Street noise can drive oil equities back toward conservative mid-cycle valuations as we saw in October. However, during the current bullish period, we see traditional mid-cycle as representing a floor on energy equity valuations and offering an excellent buying opportunity.
RISK OF NEGATIVE 4Q 2005 EPS REVISIONS ALREADY REFLECTED IN VALUATIONS
We believe the risk of negative revisions to 4Q 2005 EPS given lower-than-expected oil prices during the first half of the fourth quarter is already discounted in energy equity valuations. We note that strong natural gas prices and refining margins suggest negative EPS revision risk is greatest for oil-leveraged companies. However, oil-leveraged stocks have for the most part been among the weakest in recent months, suggesting the risk of lower 4Q 2005 EPS is already well known.
(Investment funds affiliated with The Goldman Sachs Group, Inc. have a principal investment in Bill Barrett Corp. (BBG). As a result of its position in BBG securities, The Goldman Sachs Group, Inc. may be deemed an affiliate of BBG.)
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. |
