What next for Brent crude and energy shares?

The price of Brent crude will have a bearing on the stock market fortunes of oil majors like BP, Occidental and Schlumberger. 

Brent crude has been a rollercoaster since last summer. After a supply shock rally that took Brent to almost $120, the oil market has now concluded that the sanctions noose and currency collapse will force Iran to backdown on its nuclear programme. A surge in Saudi and Iraqi production will offset any supply shock and the World Bank’s pessimism on Chinese/Asian growth will hit oil demand.

Riyadh and Washington are both comfortable with $100 Brent and no money printing from global central banks or gunfire in Gaza or Aleppo/Hatay can negate the sheer power of energy’s most critical bilateral geopolitical equation. An oil spiral ($5 a gallon, gasoline in Ohio?) on the eve of the November election could cost Obama the White House – and so this will not happen.

Any investor who thinks oil prices are set up by supply and demand obviously never heard of Gulbenkians, the Texas Railroad Commission, Juan Pablo Perez Alfonso, Saudi Aramco, Marc Rich, Vetol, the Kremlin’s petro-oligarchs, NYMEX and IPE. My call? Brent trades between $100 and $110 in the next three months. The US and China are the world’s two largest oil consumers and constitute one third of global demand.

Schlumberger’s valuation
Schlumberger (SLB), the world’s preeminent oil services firm, has had a mediocre 2012, with a February peal near 81 and a June low at 59. It is now obvious that Schlumberger will not reach its peak valuation multiple of the past in the current oilfield services cycle, since global growth, margins, ROE are all so much lower. Yet, I cannot believe that we will remotely see the 24–26 per cent earnings hit now priced into estimates.

Schlumberger’s international franchise, particularly with the BRIC/EM/GCC state owned oil and gas colossi was its traditional strength and argument for a valuation premium. However, Baker Hughes and Halliburton have scaled up their international footprint, with aggressive pricing and key contract wins.

In any case, Schlumberger margins suffer as the integration of Smith International means low margin drilling fluids have a bigger revenue weight than in the past. Schlumberger also is vulnerable to the clear overcapacity in seismic, reservoir management and natural gas/fracking. Can valuation multiples contract for SLB? Sure.

Weatherford has lost three multiple points down to 11 times earnings as investors derated its growth paradigm (four per cent revenue growth does not cut it, even Halliburton offers six per cent CAGR revenue growth!). So let me utter Texas Tea heresy: Schlumberger valuation multiples at risk. So are the shares. I believe the shares can well down to $60–64 in the next three months.

Occidental (OXY) is arguably the world’s highest production growth super major (and a strategic partner of ADNOC in Abu Dhabi’s Shah gusher field and Mubadala’s but it guided towards a lower Gulf of Mexico rig count. This is bad news for energy producers and bad news for Oxy shares because it means production growth in North America will slow.

However, this is a high Brent beta shares and will fall to $76–78 if Brent falls to $100 or lower. Yet this is a stellar level to buy Oxy, the world’s best play on the Permian Basin, California, Rocky Mountain onshore fracking and Arab LNG/crude (Abu Dhabi, Iraq, Qatar, Libya). My value zones for Oxy are buy at $76-77 and sell at 100–102 in this oil cycle.

BP looks promising
BP has been a disastrous investment since the fateful April 2010 Deepwater Horizon disaster in the Gulf of Mexico created the biggest oil spill since the oil tanker Exxon Valdez ran aground in Alaska’s Prince William Sound. BP has exited Russia, restructured its global franchise under CEO Robert Dudley, settled more than $20 billion in Macondo legal liabilities and sold more than $35 billion in non-core oil, gas, pipeline and downstream assets.

BP is now the cheapest oil super major in the world and I want to buy its New York ADR at 40–41 to benefit from several specific year end catalysts. One, BP will settle with the US Justice Department now that it has sold its operator fields in the Gulf of Mexico. BP’s $38 billion divestment will be completed next year. Two, BP valuation metrics relative to Shell are far too low. BP reserves are valued at 11 barrels of oil equivalent (boe) while Shell is 20 boe. In any case, BP trades at a mere eight times earnings and offers a dividend yield of almost five per cent. I believe BP New York ADR is a deep value buy at $38–40 for a $52–54 one year target.

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