Integrated oil, E&P, R&M sector update -- Oil bull market in early part of its middle phase; report published - Goldman Sachs - December 12, 2005
We believe 2006 will be another strong year for energy equities on the heels of our continued cyclically bullish view of energy commodities. We believe we are only one year into a 4-5 year "super-spike" phase for energy commodities, with energy equities likely to perform well through much of this period. A warm winter or a soft patch in the economy present short-term trading risks. However, risk/reward appears favorable. Energy equities are trading only 10% above traditional mid-cycle valuations that we think will continue to act as a support level, with 20% upside to traditional peak and 60% upside to super-spike-adjusted peak valuations. Top picks include MUR, CNQ, and SU among oil-leveraged companies; XTO, NFX, ECA, SWN, and BBG of the US natural gas-leveraged E&Ps; VLO for refining; and XOM among the lower-beta super-cap integrated oils (all listed companies are OP/A rated).
Please see our detailed report, "Oil bull market in early part of its middle phase." If you are on our e-mail distribution list, a .pdf will be sent today.
CURRENT "SUPER-SPIKE" PHASE UNDERPINS BULLISH SECTOR VIEW
Resilient energy demand, lackluster supply growth, and non-existent spare capacity continue to underpin our view that we are in the early stages of a multi-year "super-spike" phase. With WTI oil prices on-track to average about $57/bbl in 2005, we think the past year will be remembered as the first of what could be a four- to five-year "super-spike" phase. Our base-case view for energy commodities in 2006 remains $68/bbl for West Texas Intermediate (WTI) spot oil, $10/MMBtu for Henry Hub spot natural gas, and $10/bbl for Gulf Coast refining margins, all of which we think are above the consensus view. Our base-case view is well within our unchanged $50-$105/bbl oil equivalent "super-spike" range. We disagree with what appears to be a growing consensus that crude oil prices reached their peak levels earlier in 2005.
POSITIVE EPS REVISION CYCLE EXPECTED TO RESUME IN 2006
Hurricane volatility, a warm start to winter, and additional assumed cost inflation have caused us to modestly revise down 4Q2005, 2006, and 2007 EPS by an average 2%-4% for the companies we cover. Even with that done, our EPS forecasts for our coverage universe are an average of 20% above the corresponding First Call consensus estimates and represent a strong 50% EPS growth for the sector in 2006. As such, we believe the cycle of positive EPS revisions will resume in 2006.
E&P VERSUS OIL SERVICE: WE FAVOR BOTH, NOT ONE OVER THE OTHER
Since the October 2005 sector correction, oil service stocks have been outperforming other high-beta energy sub-sectors after having lagged for much of the up-turn that began in 2002. Investors increasingly appear to believe that the risk/reward for oil service/drilling stocks in 2006 is more favorable than that for the E&P, domestic integrated oil, or R&M companies-all of which are high-beta ways to invest in expected energy commodity price strength. We agree that the "sweet spot" for oil service/drilling companies would be a flattish energy commodity environment consistent with $50-$60 per barrel of oil equivalent pricing. However, this is not our view. We think energy commodity prices will continue to escalate cyclically during the "super-spike" phase, to the benefit of all of the high-beta sub-sectors.
SECTOR RISK/REWARD FAVORABLE
We see 20% total return upside to traditional peak values for the sector and as much as 60% upside to super-spike-adjusted peak values. This contrasts with only 10% downside risk to traditional mid-cycle valuations. Given our view that energy commodity prices are likely to remain at levels that support returns on capital well in excess of the 8%-10% "cost of capital"-like returns we assume under mid-cycle conditions, we believe mid-cycle valuations will continue to serve as a support level for the sector.
Our preference remains for high-beta E&P, domestic integrated oil, and R&M companies. For E&P-oriented companies, most of our favorites are well-exposed to key E&P "win zones", which we also think are best positioned for increasing M&A activity we expect in 2006.
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. |
