A 20% oil price decline has upset the directly impacted sectors and broader markets. Below, a short view on impact and action on oil, shale gas, utilities, renewables, and broader energy markets. That view is on the hypothetical case of more protracted weakness rather than just a short term correction. At this stage, there is no indication of that, futures are still up. Energy services are the most leveraged to the impact, look for power and gas exposure within services. Yield names are on the positive side as are gas utilities. I see the limited negative impact on shale gas and lng.
The unhelpful combination of materially increased supply and acute concerns on demand weakness resulting from the reduced IEA expectation has led to a 20% decline in the oil price over the past four months. The inaction by Saudi Arabia has contributed.
Conspiracy theories range from Saudi Arabia looking to hit US production to it looking to harm Russia in the context of the Syria situation.
In any case, there is unlikely to be any OPEC action on production cuts at the next meeting at the end of November. It is a question of discipline enforcement within OPEC.
The oil sector is broadly hedged, so the impact will come with a time delay, most likely one to two quarters.
Negative impact on shale oil, but not the end of it: Industry estimates for break-even for the bulk of projects range from USD 50-85, thus most projects are still viable at the prevailing level. According to IEA estimates, 4% of global shale projects require oil prices above USD 80/bbl. US tight oil accounts for less than 10% of global projects that require USD 80/bbl or above. The US IEA still expects good output growth from the Permian Basin, Eagle Ford and Bakken fields. But, a number of developers have been running on cash flow deficits for development capex. Capex cuts loom, but development is put out not put off. Risk of reserve write downs if the longer term view adjusts to current levels.
Limited impact on shale gas. Focused gas developers are few and far between. Gas activity will not be spared from impact on oil operations as companies consider global budgets. Some wells in the US where gas is a by product to crude as the prime driver might be on shaky grounds. Beyond that, gas has its own price and demand drivers. Henry Hub is down 18% but overall has had a more resilient performance than oil as a whole. Outside of the US, the quest for shale gas will continue on grounds aplenty, first and foremost energy independency. The focused names in the concept story segment will continue to see downside in the absence of uplifting other news flow. Short IGas (IGAS LN). Long Woodside Petroleum (WPL AU).
Positive impact on utilities and yieldcos: Positive inflation impact will lead to a prolongation of the prevailing low interest rate environment. Utility yields will support ratings. Long National Grid (NG/ LN), Enagas (ENAG SM), note on Abengoa Yield plc: The yield does not offer a high enough premium to the sector in my, when considering the risks of the business on a relative basis. Neutral SNAM (SRG IM), attractive yield stands against negative lng impact (see below)
Positive impact on utilities, II: European gas prices see a degree of weakness, much less than in the past, but still some impact from remaining oil price link. Positive for gas supply names more so than power generators. Power prices will not see a major impact, coal is the marginal driver. Gas will not see a materially higher rate of utilisation, for that over-capacity is still too large in the major European markets. There is no expectation in the pricing for materially improved gas plant profitability, according to my gage. Long E.ON (EAON GR)
Global gas prices: Asian gas prices fall, as a result of the prevailing oil price link. Assuming limited demand elasticity under current economic growth concerns, lng shipments will divert to Europe. Europe will benefit from lower gas prices (see above). Long Centrica (CNA LN).
LNG sees lower volumes and lower returns. Most of the more complex and higher cost projects are conditioned upon an expectation of lng as an enabler. Marginal projects will not make the cut. There is risk for a number of lng projects on the horizon. I retain my long term positive view on lng. Short GDF Suez (GSZ FP). Negative impact on Shell’s (RDSA NA) extensive lng business. Much less impact on Total (TOT FP) which has a higher degree of long term contract protection.
Negative impact on energy services from capex reductions across the board, the consensus view and in my view the correct one over the next quarter. Drilling equipment is worst of as drill rates decrease. USD 80/bbl is a first stop for capex cuts, USD 70/bbl the next. The opportunities lie in yield enhancement, undifferentiated underperformance provides opportunities.
Renewables. Negative headline sentiment from sector performance oil price correlation and perception of deteriorating relative economics. Real impact only in those areas where there is direct competition with gas, ie North America. Suggested pairs trade: long solar/short wind