Low Oil Prices Not Here To Stay, Says Barclays

16-Aug-2011

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By Kenneth Rapoza, Forbes Blog,

Enjoy the drop in oil prices, because it’s not going to last.  In a 114 page global energy outlook published Thursday by Barclays Capital, international energy analysts expect the new price floor for oil to be $100 a barrell.  Oil was $86 in New York, with Brent around $117 a barrel in London.

“Over the next 12 months, as the current risk-off trade subsides, we expect oil prices to be on a rising trend from $100-$130 a barrel, even with potentially slower economic recovery in OECD countries,” analysts wrote about the advanced economies.

Sovereign debt problems in Europe and a lackluster U.S. economy, including consumer numbers on Friday, are all bearish news and data for oil near-term. However, given the current economic situations in the world economy compared with the housing and subsequent credit bubble burst in 2008 and 2009, Barclays expects oil price pressure on the downside is much different this time around.

“Global oil demand growth is on a solid upward trajectory, as structural changes in non-OECD countries underpin most of that rise,” writes Amrita Sen, a Barclays energy strategist in London. “The ineffectiveness of the supply side to catch up with it has created an extended period of supply capacity tightness, which will be apparent in 2012. Against that backdrop, key oil producers seem set on a sustained path of far higher social expenditure and therefore far higher oil price requirements…$100 oil, in our view, is the new sustainable norm.”

Main Street investors can trade oil through futures, options, the iPath S&P GSCI Crude Oil (OIL) fund, or leveraged plays like ProShares Oil & Gas (DIG). Barclays recommends equities of producers with operating leverage to oil. “In equities, we also recommend oil biased names, preferring those that offer growth, whether in production, exploration or cash flow. We see best value at present in the upstream biased integrateds, oil-biased E&Ps and oil services.”

Average upsides to Barclays equity price targets are now over 40% for the oil and gas sector, compared with 10% six months ago.

Another play on robust oil and gas demand is in the fixed income space. Barclays’ Gary Stromberg in New York likes the oil-weighted bonds of exploration and production firms Denbury Resources, MEG Energy, Plains E&P, and Whiting
Petroleum, all of which have greater than 50% of their production as oil.

“Our top high yielding pick in E&P is Chaparral Energy, which we believe should see credit improvement given good organic production growth on CO2 oil development. For short-duration buyers, we believe Chesapeake Energy 2015 bonds
offer good value, as we think the company will target calling these bonds over the next year. Finally, we are Overweight El Paso’s long-dated bonds (2028-37), as we believe there is a high probability that the company will be upgraded
to investment grade following the proposed split of its pipeline and E&P businesses,” Stromberg wrote in the report.

The Asia Oil Trade
Higher oil prices are never good for Asia, especially China and India, both heavy importers of oil. But support from the government to rev up production will help the local names like China’s CNOOC (CEO), for example.

Barclays analyst Timothy Tay likes the bond market here, with an overweight recommendation on India’s Reliance Industries 4.5% coupon 2020s and 6.25% 2040s. “We expect Reliance’s credit profile to improve from the sale of the 30% stake in 21 gas blocks to BP for a consideration of US$7.2 billion,” Tay writes. The deal was approved by the Indian Cabinet Committee on Economic Affairs on July 22. Furthermore, Reliance is also expected to benefit from BP’s expertise in deep sea oil and gas production, as it attempts to increase production from its KGD6 wells.

Tay also likes Thailand’s PTT Exploration & Production bonds, with a coupon of 5.68% maturing in 2021. “The company benefits from a low cost base, as reflected by its lifting cost (under $4/bbl) and finding and development cost of US$13.58/bbl. In the absence of debt-funded acquisitions, we expect the company’s credit profile to improve. We view another acquisition by the company for the balance of 2011 as a low probability event in the light of the recent closing of the acquisition of 40% stake in Canada based Kai Kos Dehseh Oil Sands Project,” Tay wrote.

Brazil Oil Recommendations
Barclays views the Brazil oil and gas sector as positive, especially Brazil and Colombia. Both are the low-drama alternatives to inflation and politically-burdened PDVSA of Venezuela. The São Paulo team likes a low volume name in Brazil, HRT Participações over Petrobras (PBR). It also likes Brazilian diversifed power company CESP, also a local listed equity name. It continues to pay dividend payouts of 10% of paid-in capital, which translates into dividend yields of more than 10.6% for the next three years, Barclays expects.

Although the sovereign crisis and associated risk-off trade have hit energy markets, “we do not see sharply weaker energy fundamentals – whether in commodities, credit or equities,” the Barclays report stated. “The industry is well capitalized, and the biggest energy market – oil – is facing much greater challenges of supply than demand, based on our analysis. Demand remains robust, most notably outside the OECD, and supply is highly constrained, with spare capacity just 2% globally. Recent softening in OECD demand may therefore prevent the oil price from overshooting in 2012, rather than sending it lower.”


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