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Keeping
tabs on oil prices
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Hopes
of a sustained recovery
The strong macro environment is obviously positive for
the energy sector, given that the current prices are
higher than had been expected and are therefore leading
to earnings upgrades and ultimately to better than expected
earnings for the sector. There is potential for the
extra cashflow generated in such an environment to be
given back to shareholders through share buy-backs and
increased dividends. These elements clearly favour the
energy sector in a difficult market environment, explaining
the outperformance of the energy sector against the
market.
Our view on the oil prices is that the current levels
are not only driven by fundamentals (supply/demand including
the impact of increasing demand from China/Asia, low
inventory levels and limited spare capacity within OPEC)
but by a number of extraordinary factors, the main one
being the political unrest in the Middle East (e.g.
Iraq and Saudi Arabia). In the short term, we do not
see any immediate solution to this issues but would
expect oil prices to ease towards $30-$35 by the year
end, helped by comments from OPEC (in particular, Saudi
Arabia) that they will increase their production in
order to stabilise prices.
In relative terms, the sector has done very well compared
to the overall market. In absolute terms however, over
the past three years, multiples in the overall market
have contracted and the energy sector has not been immune
to this movement. It is also noteworthy that with the
strong oil prices, costs and capital expenditure requirements
have also risen. Taxes are partly linked to oil prices
and when oil prices are high, there is an increase in
the tax burden on the sector.
The CapEx element is particularly important as a large
portion of the cash flow that has been generated over
the last 3-4 years has been reinvested in new areas
of oil exploration (including Angola and the Caspian
Sea) and infrastructure needs to be developed.
With regard to the outlook for equities, we consider
that integrated oil companies are fairly well supported
around current levels and do not feel that lower oil
prices will immediately lead to strong selling pressure.
The
sector remains well supported by dividend yields and
share buy-backs. We see more potential in the smaller
names where newsflow is expected to be positive in the
months ahead.
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