Integrated oil, E&P, R&M trading update -- A likely limited impact from Hurricane Rita enhances longer-term bullish outlook for oil equities - Goldman Sachs - September 25, 2005
First and foremost, our sympathies remain with those impacted by Hurricanes Katrina and Rita. While it is still early days in the damage assessment process, it appears that incremental refinery outages from Hurricane Rita will not be material, though there is still uncertainty in terms of Rita?s (and Katrina?s) effect on natural gas production. To be sure, energy supply/demand balances remain fragile, with price risk skewed to the upside. It may seem counter-intuitive, but we believe the longer-term energy bull market is enhanced by the absence of a traditional supply shock. As such, while the seemingly limited incremental impact of Rita may cause the pull-back in oil equities that started last Thursday to continue, we would be buyers of the dip and reiterate our Attractive coverage view. No change to top picks, with XTO and MUR (both OP/A rate) looking particularly attractive today.
HURRICANE RITA PASSING WITHOUT MAJOR INCIDENT ENHANCES CONFIDENCE IN LONGER-TERM CYCLE
We reiterate our view that the traditional supply shock-driven commodity price gains ala the 1970s is NOT bullish for oil equities long term. As such, our confidence in our bullish longer-term outlook for energy equities is enhanced by the seeming limited impact Hurricane Rita has had on energy infrastructure. To be sure, already tight supply/demand balances have been tightened further by Rita; we now expect both US gasoline and distillate inventories to be at or near the bottom of historic ranges by December.
Note, in our view, bottom of historic inventory ranges signify even tighter conditions today than it historically did, given that the limits of spare capacity have been reached. In the past, inventories could reach so-called minimum operating levels and market participants could still have confidence that new capacity could be started up relatively quickly if needed. This is no longer the case suggesting the much higher commodity trading band we are seeing today for the same level of inventories is logical. Put another way, we think inventory levels relative to demand will need to be higher in the future compared with years past, until new spare capacity is built, which in our view is years away.
DEMAND DESTRUCTION WORRIES UNDERSTANDABLE, BUT WE THINK WILL PROVE PREMATURE
Perhaps the number one question on investors' minds these days is whether we are at the inflection point for energy demand growth. It has been our view that a multi-year reduction in energy demand is needed in order for lower energy prices to return (and a bear market for oil equities to begin). Recent weekly gasoline statistics in the US and conflicting signals from Asia have sparked investor concerns. While we are sympathetic to the notion that it is not going to be easy to forecast demand destruction ahead of time such that an investor that waits for it to be clear may have suffered significant underperformance, we continue to believe that overall energy demand is on-track to continue its upward march.
Some market participants have cited the negative year-over-year comparisons in implied US gasoline demand post-Hurricane Katrina as evidence that US consumers are finally feeling the pinch of higher retail gasoline prices. It remains our view that so long as the sharp jump in retail gasoline prices post-Katrina turns out to be temporary, as increasingly appears the case, gasoline demand growth will continue. Furthermore, weekly US implied gasoline demand statistics are highly uncertain in the best of times let alone following a catastrophic event like Hurricane Katrina. Looking back, we note there have been a number of periods where weekly year-over-year growth in implied gasoline demand has dipped into negative territory only to bounce back in subsequent periods. The current dip looks no different. In fact, when one considers the catastrophic nature of Katrina, one could even argue that recent implied gasoline demand numbers actually look rather healthy, especially outside of the Gulf Coast region that bore the brunt of the storm.
With wholesale and retail gasoline prices retreating from highs seen in the immediate aftermath of Katrina, we expect US gasoline demand growth to remain resilient. We note Goldman Sachs Economics Research similarly expects US GDP to return to a relatively strong 3.5% growth rate in 2006. The combination of a near-term pull-back in gasoline prices and rebounding economic activity we think is supportive of our bullish longer-term cyclical view for energy.
WINTER HEATING MARKETS THE NEXT HOT SPOT
The ultimate impact of Hurricanes Katrina and Rita on US natural gas production remains unknown, though risk, in our view, is skewed toward having a tighter market via greater and longer-lasting production shut-ins than is currently known. Assessing production and pipeline infrastructure is not as quick or easy a process as some may wish. This can be seen in what was a still high shut-in production figure following Katrina and just prior to Rita shut-ins, with only a few company announcements as to the long-term fate of production facilities or other infrastructure.
The combination of tighter heating oil supplies following refinery downtime coupled with tighter natural gas markets given Gulf of Mexico production shut-ins point to winter energy commodity price risk as being skewed decidedly to the upside, even considering already high heating oil and natural gas prices. While it still likely takes a normal or colder-than-normal winter for large price spikes to occur, moderate winter weather may not result in a magnitude of price declines as seen historically. Moreover, the market remains highly susceptible to any further supply disruptions later this fall or winter.
BULLISH OIL EQUITY OUTLOOK IN TACT; WE WOULD BUY THE DIP
Given our base-case outlook that the longer-term underpinnings of the energy bull market remain in tact-i.e., resilient demand growth, limited spare capacity, and moderate-to-non-existent supply growth-we would be buyers of oil equities on pull-backs. Note, energy markets have entered the traditional fall "should months" period between peak summer and winter demand, which can often be a rather lackluster time for energy commodity prices and equities. Even though oil equities have already pulled back a bit toward the end of last week in anticipation of Rita having a limited impact, it is possible that a further correction could occur in coming days or weeks, which we think might create a particularly attractive re-entry point.
We continue to believe the sector call is more important at this time than the relative stock call, but would continue to highlight our Outperform-rated stocks as our very favorites among our coverage universe. Among our OP-rated top picks, XTO Energy has lagged of late and is particularly leveraged to the strong natural gas fundamentals we expect this winter. We would also highlight Murphy Oil, which has underperformed sharply since Hurricane Katrina hit; Murphy is the only stock we cover that is actually down post Katrina. We continue to see Murphy as having strong expected production growth in coming years and very favorable oil resource exposure in key deepwater areas offshore Malaysia, Congo, and in the Gulf of Mexico. As such, we believe the longer-term risk/reward for Murphy shares is favorable for investors that can look through the near-term lack of exploration catalysts and uncertainty with its Katrina-impacted Meraux refinery and related oil spill, the latter two of which we do not think represent a long-term risk to Murphy's shares.
For investors looking in general for companies that are most favorably leveraged to tight winter heating markets, we would highlight the following Outperform or In-Line-rated North America natural gas-focused E&P companies: -Large-cap E&P: XTO Energy (OP/A), EnCana (OP/A), EOG Resources (IL/A), Devon Energy (IL/A), and Burlington Resources (IL/A) -Mid-cap E&P: Newfield Exploration (OP/A) and Ultra Petroleum (IL/A) (note: Questar (OP/A) remains a mid-cap E&P favorite of ours, but has significant hedges in place that reduces its price exposure which is the point we are making here) -Small-cap E&P: Bill Barrett (OP/A), Cabot Oil & Gas (IL/A), Quicksilver Resources (IL/A), and The Houston Exploration Company (IL/A)
Bill Barrett Corp. (OP/A, $36.83), Burlington Resources Inc. (IL/A, $77.50), Cabot Oil & Gas Corp. (IL/A, $46.16), Devon Energy Corp. (IL/A, $64.74), EnCana Corp. (OP/A, $54.35), EOG Resources Inc. (IL/A, $72.44), Murphy Oil Corp. (OP/A, $48.94), Newfield Exploration (OP/A, $47.89), Questar Corp. (OP/A, $83.84), Quicksilver Resources, Inc. (IL/A, $42.55), The Houston Exploration Co. (IL/A, $65.32), Ultra Petroleum (IL/A, $49.80) and XTO Energy Inc. (OP/A, $42.55)
(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. |
