Merrill Lynch thoughts on Energy Lots of Gas in Energy
TSE 300 index down almost 4% so far this week (to a 4-month low), but guess what? The oil & gas subindex is up 4.7%. The recent pullback was a great buying opportunity, and any further corrections in this segment of the market should be used as such – we’ve just completed year #1 of what will likely prove to me a multi-year bull market in energy, especially natural gas – far and away the fastest growing component of global energy consumption. The cash flow/earnings potential and modest multiple expansion suggests that there is as much as 50% to 100% upside to the sector over the next three years (after rising more than 30% over the past year). The energy companies begin reporting their Q3 results early next week. Stay tuned!
Heightened tensions in the Middle East add on more brick to the market’s wall of worry but is another positive for oil stocks. There are already signs that Iraqi oil exports have been cut back sharply in recent weeks. The fact that crude oil prices never managed to break below $30/bbl even after the announcement of the SPR release should be viewed as a sign of just how tight the market is and that this is a threshold that will be tough to break in the absence of a sharp slowdown in global economic growth. The inventory situation hasn’t eased at all – even with the March and June OPEC boosts (of 2.4 mbd), OECD oil stocks are practically as tight now (104 mln barrels below normal) as last January (114 mln below normal then). Iran, Venezuela, Indonesia and Nigeria are so tapped out that they’re not even able to produce tat June’s quota level. And prices have remained firm even in the face of much higher Saudi and Kuwaiti output – in September, the two combined are producing well above the higher quota level set out for October 1 st .
According to Steve Pfeifer, U.S. crude oil stocks are 24.9 million barrels (8.1%) below normal; gasoline inventories are 1.8 million barrels (0.9%) below normal, and U.S. distillate inventories are 30.5 mln barrels (21.2%) below normal. On the natural gas front, all we know is that more than half of U.S. households now rely on this form of energy and the share is growing, and over 90% of the burgeoning development of new utilities south of the border are being fired by gas. Demand is locked in at2%to3% annually at a time when U.S. natural gas reserves are at an all-time low relative to year’s supply. No country stands to benefit as much as Canada, which is already the#1 supplier of natural gas to the U.S. (nearly 20% share and destined to grow sharply in coming years).
Not only is there a shortage of energy, but there is a shortage of geologists, roughnecks and drilling equipment – this is one classically underinvested sector, yet still there is still no shortages of non-believers. While the latest ML global investor survey showed that international PM’s are net bullish on energy, they shaved their exposure in the past month (and moved most heavily into banks – this, after substantially lifting their weighting in tech stocks in August). Keep in mind that this is a sector that is still priced for the low-$20’s on WTI and $2.50/mcf on gas. The tightest supply backdrop in a quarter century, relatively high multiple on oil services, the Saudis as the swing producers and conflict in the Middle East - might as well be the cast of The 70's Show.
Energy bears – pray for El Nino. But thecall frommost of the meteorologists suggests that we are likely to see temperatures in the Midwest (Chicago, in particular – key for natural gas) roughly to 6 to 7 degrees cooler this winter compared to the average of the past three (figures obtained from the National Weather Service). Now you know why the Energy Department decided to brace homeowners and landlords for a 44% hike in their natural gas bill this winter and +25% for heating oil – note that heating oil futures broke above the Dec/90 high of $1.10/gallon yesterday and is set to take out the prior March/81 peak of $1.12.) According API statistics, U.S. heating oil inventories are 51% lower today than they were in October/99.