JP Morgan published its 2016 outlook for the integrated oil and gas majors today. The report spelled out that the sector has done well to adjust to a $40 per barrel crude environment by cutting cost and streamlining operations. However, the recent plunge in crude prices has posed new challenges to the oil companies. Crude oil prices have slid below $40 per barrel, following Organization of Petroleum Exporting Countries (OPEC) meeting on December 4.
West Texas Intermediate (WTI) at 1:04 PM EST was up 3.66% at $37.64 per barrel, while the global benchmark Brent Crude was up 2.9% at $39.02 per barrel. JP Morgan mentioned that the integrated oil sector has underperformed the S&P 500 Index in the last four years. Weaker natural gas prices and increase in costs have led oil and gas majors to collectively underperform the S&P 500 Index by 31%. In 2014 and 2015, the sector underperformed the S&P 500 Index by a further 38%, driven by declining crude prices.
Oil and Gas Underperformance of the S&P 500
Despite underperformance, the oil and gas sector has life in it, according to the sell-side firm. The sector saw a 10% rise as compared to the S&P’s 8% rise in October. A 15% increase in Chevron Corporation (NYSE:CVX) brought stability to this sector, but things were quite different back then. Oil prices were much stable in October, and no one predicted that the prices would drop to their current levels.
OPEC in its December 4 meeting highlighted that it would increase its daily production target from 30 million barrels of oil equivalent per day. Despite the cartel’s tactics and a bleak 2016 oil demand estimates by the Energy Information Administration (EIA), JP Morgan is slightly bullish on oil prices.
JP Morgan’s View on Crude Oil and Natural Gas
The current crude oil price scenario will make it difficult for non-OPEC members to sustain production. Therefore, JP Morgan estimates that a decline in production from the non-OPEC members can come in 2016, which can lead to surplus neutrality by 2016. The company takes into account OPEC’s production increases, which can come following the removal of sanctions on Iran and its access to the international markets.
As mentioned above, JP Morgan remains slightly bullish on oil, but the natural gas outlook by the sell-side firm isn’t that optimistic on natural gas prices. The US is a prime driver of natural gas supply. The technology possessed by the US also allows it to ramp up natural gas production quickly. Moreover, growing pressure by environmentalists on oil companies has exerted severe pressure on energy companies in order to increase exposure to natural gas. Many new LNG projects such as Chevron’s Gorgon and Wheatstone are likely to come online soon, and add to the natural gas supply glut.
Even if the crude oil price rebounds in the future, a higher crude price will be difficult to sustain. The US oil companies have significantly increased productivity and possessed top of the line shale technology. In case of a rebound, the US can revamp production without much difficulty. Another difficulty would be the lower projected crude demand. Crude demand at higher crude prices is likely to fall further and negatively impact crude prices.
EPS and CAPEX Outlook
JP Morgan expects EPS for the oil and gas industry to bottom in the first half of 2016. The 2015’s upcoming fourth quarter can also see a further reduction in capital expenditure. The 2016 free cash flow (FCF) for oil and gas majors is to come in a better position, compared to the preceding year. Cash obtained through capital reduction would weigh in, and help sustain the 2016 FCF.
The downturn in crude oil prices is also expected to stimulate merger and acquisitions activities in the oil and gas arena. A larger company size allows it to gain economies of scale, and lower its cost of production.
Favorite Stocks
JP Morgan considers Occidental Petroleum Corporation (NYSE:OXY) as its favorite stock with an Outperform rating and 12-month price target increase from $76 to $81. Argus in a sell-side report published on December 11 also gave it a Buy rating. The company’s execution is considered to be well on its track. Moreover, the company is also planning for a divestment of non-core assets and streamlining operations. JP Morgan, along with Argus also remain bullish on Occidental’s exposure in the Permian basin. JP Morgan expects the firm to have a favorable exposure to oil, with a low break-even dividend coverage.
Another stock on which JP Morgan has a positive outlook is the Chevron stock. The company has an average exposure to crude oil, and has numerous LNG projects in the pipeline. The company’s ability to execute the project on time will play a key role in sustaining FCF.
JP Morgan, however, has a negative outlook for ConocoPhillips (NYSE:COP). Although the integrated oil major has done well to cut its capex and maintain its production growth outlook, it has a significant exposure to natural gas. Moreover, JP Morgan is also concerned over its relative dividend coverage and balance sheet.
JP Morgan published its 2016 outlook for the integrated oil and gas majors today. The report spelled out that the sector has done well to adjust to a $40 per barrel crude environment by cutting cost and streamlining operations. However, the recent plunge in crude prices has posed new challenges to the oil companies. Crude oil prices have slid below $40 per barrel, following Organization of Petroleum Exporting Countries (OPEC) meeting on December 4.
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