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If negative interest rates are a disturbing novelty for investors, imagine the impact of negative oil prices?
Your imagination might not be required for long because if current production and storage trends continue, some oil producers are already close to paying customers to take it away.
No prize for guessing what “negative oil” will do to the earnings of producers, or their investment plans which face deferral, at best, or cancellation altogether – which is why leading local oil and gas stocks such as Woodside, Santos and Oil Search have suffered sharp share price falls.
Citi, a leading investment bank, raised the possibility of negative oil in a research note on the U.S oil industry late last week as the price of Brent-quality crude (the global marker) sank to $US25 a barrel, and ended the week at $US27.21, less than half the $US68/bbl of three weeks ago.
Over the next few weeks Citi expects oil to continue falling, perhaps to as low as $US17/bbl, but unless a solution is found to a dramatic increase in stocks held in storage facilities, prices could turn negative.
“Theoretically, the unprecedented stock-build might mean negative oil prices in places, should the world or some regions run out of storage and if higher-cost production is stickier than thought,” Citi said.
The potential for negative oil prices can be traced to a dramatic 12 million-barrels-a-day collapse in demand for oil caused by a sharp fall in economic activity as the coronavirus bites industrial production and countries close their borders, just as an oil war heats up between Russia and Saudi Arabia and supply soars by an estimated 3.5 million barrels a day.
“The magnitude of the global stock-build in the June quarter could be 12 million barrels per day in the base case and 18m/b per day in the bear case,” Citi said.
“In absolute terms, this equals between 1.1 million barrels a day and 1.6 million barrels a day for the quarter compared to perhaps some 1.65 million barrels of effective spare (storage) capacity.”
The twin keys to repairing the oil sector lie in a possible expansion in demand as the worst effects of the coronavirus lockdown is lifted in key consuming countries, especially China, and a willingness of major producers such as Russia and Saudi Arabia to end their price war which has flooded the global oil market.
But if demand destruction and excess supply are not enough to cause concern about the outlook for oil, there is also the possibility that Saudi Arabia is playing a deadly-game of unleashing its oil reserves before the renewables revolution turns them into orphaned energy, trapped in reservoirs that will never be tapped.
Unproven and perhaps unlikely, the “Saudi flood” theory is based on an argument that it would be better now to capture market share by killing high cost rivals rather than become a victim of a progressive decline in oil demand – the so-called “Peak Demand” theory at work.
But if the Saudi-flood theory is right then oil faces a prolonged downturn which will see only the fittest survive.
Until demand recovers, or the flood abates, or preferably both of those events occur, Australian oil producers will remain under pressure and while some investors might see the situation as a good time to buy high-quality oil stocks, more cautious investors will remember the maxim of never trying to catch a falling knife.
The Australian-listed oil company under the greatest pressure today is PNG-focussed Oil Search which has been caught at a delicate point with two expansion projects at an advanced stage, more liquefied natural gas (LNG) in PNG, and an oil-development asset in Alaska for which it is seeking a partner.
Over the past two months Oil Search shares have fallen by 70 per cent from $7.88 on January 22 to a close last week at $2.34, a price which includes a late bounce from a 15-year low on Thursday of $2.03.
The Oil Search collapse has raised the potential for a fresh takeover bid for the company which beat off Woodside’s one-for-four share-swap offer in 2015 which valued Oil Search at the time at $7.70.
Santos also took a look at bidding for Oil Search in the middle of last year after the PNG gas producer suffered a price fall from $8.30 to $7.14, partly because of a major management shuffle which included the retirement of its long-term Chief Executive, Peter Botten.
A handful of banks and stock brokers see Oil Search as a buy, including Macquarie which has a 12-month price target for the stock of $5.50, more than double the $2.23 (and sell tip) from Credit Suisse which reckons Oil Search needs an oil price of $US40/bbl to break even.
A sustained low oil price could see Oil Search breach its debt covenants if the oil price stays below $US30/bbl for the rest of 2020.
“We think oil prices might get worse before they get better, leaving Oil Search as the most exposed given its balance sheet/cost base is less favourable versus its peers,” Credit Suisse said.
Woodside, Australia’s most widely-held oil company by local investors, is riding out the crisis better than Oil Search, down 55 per cent from $36 in early January to latest sales around $16, but its board faces tough decisions over the next few weeks as major expansion projects reach key decision points – with the smart money predicting deferrals.
Scarborough, a proposed gas development off the WA coast in which BHP is a minority partner, is an important development for Woodside if it is to maintain LNG exports at their current rate. Browse, another WA LNG project is bigger but looking less likely by the day.
Morgan Stanley, an investment bank, has a hold tip on Woodside and a price target of $19.70 but it also said in a note to clients late last week that: “it’s fair to assume at least a one-year delay” on Scarborough which would allow time to further de-risk LNG contract sales and wait for an improvement in the oil and gas market.
Santos, down 66 per cent from its early-January price of $9 to latest sales around $3.05, also has a hold rating from Morgan Stanley and a price forecast of $4.25 (well above latest trades at $3.05) and a bullish buy tip from Macquarie which reckons the stock will bounce back to $8.60.
But, like Woodside, Santos faces tough project development decisions at a time of ultra-low oil prices with a final investment decision on the Barossa gas project off the coast of the Northern Territory delayed last month and now likely to be pushed back to the middle of next year.
If there is a section of the Australian oil and gas industry well prepared to ride out the storm caused by collapsed demand and a flood of supply it’s the domestic gas producers which have a captive, albeit recession-hit market.
Senex, a stock I mentioned in my Minefield column earlier this month, is an interesting example of a domestic gas stock which has held up relatively well, if you can call a 43 per cent fall from 28c to 16c since the column was published on March 10.
Morgan Stanley reckons Senex look “very interesting” at its latest price because it has hedged a material portion of its production for the next 12-months with its “fixed-price gas exposure helping at times of lower oil prices”.
Whatever happens locally the big picture for oil and gas will be played out on a global stage with Australia not even an observer as the three “elephants of oil” battle it out with Russia and Saudi Arabia keen to kill the U.S. shale oil industry, and the U.S. promising to fight back.
Given it is the high cost producer out of the big three, it is highly unlikely that the U.S will win the oil war with early signs of a crisis developing as high cost producers and their service companies rushing to restructure debt.
The first big failure in U.S oil might already be in plain sight with Occidental Petroleum’s share price down 78 per cent since early January, partly as a result of the oil-price crash but largely because of the ill-timed and fiercely-expensive takeover of Anadarko Petroleum after a bidding war with U.S. oil-major Chevron.
Times change quickly in oil because while Occidental was hailed as the winner in the race for Anadarko with its $US38 billion offer (versus $US33 billion from Chevron) the entire business (Occidental Anadarko) is now valued at $US9.3 billion, the dividend has been dumped, and Chevron is circling as a buyer in what could be a two-for-one deal (Occidental Anadarko).
Other deals will emerge as the oil industry is gutted and then re-shaped by the oil-price crash but picking winners is a lot harder at this stage of the process than it is of spotting the losers.
For speculators confident of an oil price rebound, these are fertile feeding times. For everyone else its watch and wait.