From: Bigenergybull
Goldman Sachs FWIW
>Overview: Gaining confidence that the end of the correction is
nearing
We see increasing visibility that the sharp correction in energy equities over the past 4-6 weeks
will abate, and we expect a sharp winter rebound for the sector. We believe a “perfect storm” of
technical and seasonal factors coupled with legitimate fundamental fears of a slowing US economy
have driven the sharper-than-expected pullback. The key seasonal and technical drivers have
included: (1) normal “shoulder months” seasonality post the summer driving peak and prior to winter
weather; (2) ongoing gasoline de-weighting by major commodity funds; (3) weakness in near-term
natural gas prices due to very high storage levels as the end of the refill season approaches; (4) a very
mild hurricane season thus far; and (5) a perceived lessening of geopolitical turmoil.
In our view, the seasonal and technical factors are on-track to bottom out in October, suggesting,
at a minimum, that a trading rebound will occur over the remainder of the fourth quarter and we
think into the first quarter of 2007 depending on the severity of winter weather. In addition to
winter weather, the health of the US and global economies is the key to the outlook for energy
equities over the next 12 months. Beyond cyclical economic uncertainty, we see little change to the
positive secular fundamentals that have underpinned the energy bull market this decade and expect
the strong secular fundamentals to persist at least through to the end of this decade. The economic
uncertainty, however, likely warrants much more of a trading approach to the sector over the next 12
months than has been the case for most of the energy bull market to date.
We reiterate our Attractive coverage view and now see 27% upside on average for our coverage
universe to 12-month target prices (based on DCF and EV/DACF analyses with key downside risk
being sharply lower commodity prices). In terms of timing, we believe investors should begin to reestablish
or add to oil equity positions over the next 1-4 weeks. Trying to perfectly time a trading
bottom is always difficult and not our area of greatest strength. With that said, we believe risk/reward
has become quite compelling and with a looming reversal or end to the seasonal and technical
trading issues, a sharp rebound in the fourth quarter appears likely.
From a sub-sector perspective, we believe “higher beta” sub-sectors like E&P (both natural gas
and crude oil leveraged) as well as oil service/drilling stocks (covered by Daniel Henriques and
team) will rebound most meaningfully, with the super majors naturally lagging. For the R&Ms we
see less fundamental upside, but expect a trading rebound. Ethanol producers look oversold to us and
we think can bounce meaningfully higher than R&Ms. Of our Buy-rated stocks, our very top picks at
this time include ConocoPhillips among integrated oils; Canadian Natural Resources among oilleveraged
E&Ps; XTO Energy among large-cap natural gas E&Ps; Mariner Energy among small-cap
E&Ps; and Aventine Renewable Energy among biofuels and R&M equities.
Per our normal practice of updating company EPS estimates toward the end of a given quarter
for actual commodity prices experienced during the quarter as well as any other needed
company specific adjustments, our EPS estimates and target prices are under review for our
coverage universe. With that said, we are leaving unchanged our $68/bbl WTI spot oil and $9/MMBtu
Henry hub spot natural gas price forecasts for 2007-2009 as well as our respective $45/bbl and
$6/MMBtu normalized assumptions. However, our refining margin forecasts for 2007-2009 are likely to
be slightly lower than our previous estimates, as some of the trading liquidity issues that we think is
contributing to excessive recent margin weakness (discussed below) likely also resulted in higherthan-
normal price gains during the summer.
Gasoline de-weighting overhang set to end by mid-October
We believe investors should not underestimate the meaningful negative impact that the ongoing
de-weighting of gasoline by the major commodity funds is exerting on gasoline prices. The deSeptember
24, 2006 Americas: Energy: Oil
Goldman Sachs Global Investment Research 3
weighting is a result of diminishing trading liquidity in the NYMEX reformulated gasoline contract
(RFG), which is scheduled to be de-listed in January 2007, and the fact that the replacement RBOB
(reformulated gasoline blendstock for oxygenate blending) contract has not gained sufficient trading
liquidity to merit a corresponding inclusion in the commodity funds. The fact that the de-weighting is
occurring during a period of seasonally declining demand post the summer driving season peak has,
in our view, meaningfully exacerbated the downside trading pressure.
Importantly, the de-weighting is scheduled to run its course by mid-October, which we believe
will remove excessive selling pressure on headline gasoline prices. Moreover, weakness in
gasoline prices we think has negatively impacted the price of West Texas Intermediate (WTI) spot
crude oil given the co-relationship between the two. While gasoline prices are typically strongest
during 2Q and 3Q, we believe removal of the selling overhang will spark a rebound from current
depressed levels in coming months.
In terms of gasoline supply/demand fundamentals, we note that gasoline demand has been
remarkably healthy in light of what had been circa $3/gallon US retail pump prices. In addition,
inventories relative to demand remain low. The only bearish data point has been a noticeable pick-up
in finished gasoline production in recent months, which, when combined with future planned ethanol
capacity growth, could diminish the need for higher gasoline imports in coming years. Note, a high
level of imports is still expected to be needed, but growth in imports may be able to moderate relative
to the sharp required growth in recent years. With that said, gasoline markets remain highly
susceptible to either faster-than-expected demand growth or unplanned refinery downtime. While the
former may be less likely over the next 12 months if the US economy slows further, the latter appears
inevitable given the still limited spare capacity in the refining business and the natural propensity of
refineries to run into operating issues.
Natural gas storage refill season will also conclude in October
Understandable concerns exist that as US natural gas inventories approach or reach “full” levels in
coming weeks, the potential exists for further weakness in spot natural gas prices and forced shut-ins
by producers. Where significant debate does exist is the outlook for the next 6-12 months. There is no
change to our view that with normal winter weather, natural gas inventories will move back into
the normal historical range by the end of 1Q2007, in our view sparking a sharp rebound in spot
natural gas prices (see our September 1, 2006 report, “Gas E&Ps: Winter power surge expected”).
Almost irrespective of the outlook for winter, we think the end of the storage refill season will serve as
a relief to investors as confidence we think will grow that whatever low price natural gas price falls to
will in fact be the near-term bottom.
Energy pricing is impacted by weather, for better or worse
The biggest challenge in forecasting energy commodity prices is the significant influence of
weather, be it the severity of winter, hurricane season, or summer heat. A fundamentally sound
bullish view can go awry in the short-term if weather does not cooperate as can a bearish view if
severe weather occurs. The weather impact is most pronounced in winter, in particular for natural gas.
The problem with assuming “normal” weather is that it is rarely normal but rather “cold” or “warm”.
As usual, winter weather forecasts are all over the map. Even the likely impact of a continuation of a
weak El Nino is not certain, as historical winter weather during a weak event has been both cold and
warm. Given the sharply bearish trend of the past 4-6 weeks for energy equities and the fact that the
last two winter periods were mild, we see risk/reward as being biased to the upside and think fear of a
warm winter is more on the minds of investors than the upside from normal or cold weather. With
that said, the weather will be whatever it is going to be and the stocks will react accordingly.
September 24, 2006 Americas: Energy: Oil
Goldman Sachs Global Investment Research 4
Secular view remains bullish, with US/global economic outlook key
to cyclical view of energy in 2007
We see little change to the bullish secular fundamentals that have underpinned the energy bull
market this decade to date. In terms of crude oil, we believe OPEC spare capacity remains limited to
around 1 million b/d, almost all of which is in Saudi Arabia, and non-OPEC supply growth lackluster.
In our view, the seemingly annual concerns about an acceleration in non-OPEC supply growth over
the next 12 months will again prove off base. Our forecasts continue to call for around 0.9 million b/d
of non-OPEC supply growth in 2007, which we think will be less than global oil demand growth of 1.0-
1.4 million b/d resulting in ongoing tightness in OPEC spare capacity. Most importantly, we see little
evidence of so-called “demand destruction”, in particular in the key oil demand centers of the United
States and China.
However, we fully recognize that within a bullish secular period, cyclical weakness can exist. If
the US economy slows further and possibly falls into recession, we believe weaker energy prices
would be likely unless a meaningful supply disruption occurred or weather is particularly extreme.
Importantly, Goldman Sachs Economics Research continues to call for around trend global economic
growth, as US weakness is forecast to be offset by strength in the rest of the world including most
importantly China. While a decoupling of global growth from the US economy does not have much
precedence, as our economists recognize, recent evidence seems to support their view that the
specific nature of the US slowdown (consumer driven) and domestic demand strength in foreign
economies is supportive of their base-case global economics forecast.
Greater trading volatility likely here to stay, with energy now a
higher-beta sector
The days of energy being a low-beta defensive sector are long gone. Strong secular fundamentals,
geopolitical turmoil, and normal weather uncertainty have all combined to increase trading volatility.
Over the course of this decade, the volatility has been mostly to the upside. Economic uncertainty
over the next 6-12 months we think will serve to balance upside and downside volatility to a greater
degree than has been the case for most of the energy bull market. As such, we expect to move to a
more trading oriented approach to both our coverage view and individual company
recommendations than we have in recent years. While we are most comfortable in evaluating
longer-term secular trends and have long favored a “buy-and-hold” approach to investments in
general, current market dynamics we think favor a greater trading approach.< |
