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Analyst Note, David Meats, 2. december 2014
E&P stocks took a battering across the board in the aftermath of OPEC’s Thanksgiving Day meeting. We doubt consensus among member countries was achieved but the 30 mbbl/d target output was maintained anyway, dashing any lingering hope that the cartel would defend a higher price level by removing supply.
By our estimates, oil markets are oversupplied by roughly 1 million barrels a day, which may increase into early 2015 absent a production response. But the supply surge from U.S. shale oil has been well-anticipated by markets, leaving us to wonder what has changed fundamentally in the market's awareness that has dropped the energy sector by 20% since Sept. 1. Over the medium term we continue to believe that lower crude prices will stimulate demand, supporting our expectation of higher prices in the future. However we caution that further near-term demand weakness could spark another leg down in oil markets before any recovery takes hold.
We are updating our fair value estimates to incorporate recent price movements. Morningstar's price deck is composed of three years of current crude oil strip pricing followed by our midcycle price estimate of $90/bbl, which we still believe reflects the marginal cost of North American shale production. If prices become entrenched near the current level producers will curtail activity and high base declines will truncate North American production fairly quickly, restoring the global supply-demand equilibrium and boosting prices. Under these circumstances the market reaction among E&P stocks appears overdone.
The current pullback in stock prices, therefore, creates a good opportunity to buy quality franchises at a discount. In particular, among oily stocks we like Apache, Concho, Devon, and Pioneer, given their generally low-cost models, strong balance sheets, and meaningful discounts compared with our estimates of intrinsic value.
Bulls and Bears say
Bulls say
- Premium pricing in California is supported by limited transport capacity from other basins and buoys CRC's profitability and returns.
- Separation from Occidental enables cash flows to be fully reinvested, accelerating growth.
- The Monterey Shale has resource potential rivaling or exceeding other U.S. shales and CRC is leading the charge in that play’s delineation.
Bears say
- The geology of the Monterey Shale is highly complex, and widespread commercial exploitation may never be possible.
- The recent pullback in domestic oil prices and the relentless supply growth from other basins reduce the incentive to develop the Monterey Shale.
- Management may need to curtail spending if prices do not rebound as quickly as expected, slowing production growth and reducing cash flows.
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