OPEC+ Production Cuts - Stifel's Opinion on Mar 4

[dan_s]

I received the following note from Derrick Whitfield, an energy sector analyst at Stifel.

Oil & Gas Exploration and Production - Stifel's Crude But Refined Thoughts: Expectations for the March OPEC+ Meeting
By Derrick Whitfield

Ahead of the March 5-6th OPEC meeting, we updated our macro models, conducted sensitivity analyses and outlined top picks based on two scenarios. In short, we focused on two OPEC+ scenarios, including Scenario 1 (2020 incremental cut of 0.3 mmbpd) and Scenario 2 (2020 incremental cut of 1.3 mmbpd). Based on our marketing and analysis, we believe the market anticipates an incremental 1.0 mmbpd cut for 1H20 and an extension of the existing cuts (1.7 mmbpd) for 2H20. We believe the risk-reward equation is balanced for the commodity (equal upside and downside in our scenarios) and favorable for energy stocks (Scenario 2 upside at +15-30% versus Scenario 1 downside at -10-20%). Additionally, Scenario 1 downside would be capped by updated 2020 budget announcements (beginning in April) and 2021 fundamentals. For Scenario 1, we favor CXO, EOG, TPL, BKR and KMI. For Scenario 2, we favor PE, WPX, BOOM and TRGP.

Key Points
The progression of Covid-19 and the widespread shutdown of China's economy has significantly hurt global oil demand, leading
to a +20% sell-off in crude prices. In our view, the recent crude oil sell-off is principally due to global oil demand implications from the
outbreak of the novel coronavirus (Covid-19). In the IEA Oil Market Report (OMR, published on February 13, 2020), the agency noted demand
is expected to fall by 0.435 mmbpd y-o-y in Q120, the first quarterly contraction in more than 10 years. In total, the IEA expects global
demand impacts of 1.1 mmbpd and 0.435 mmbpd in Q120 and Q220, respectively, or 0.4 mmbpd for 2020. In our view, recent weekly storage
reports indicate the demand impact could be more than 1.5 mmbpd in Q120. Based on the progression of Covid-19, we believe the IEA's
base assumption for the restoration of demand during Q220 is also at risk. Net-net, we expect the next OMR (March 9, 2020) to highlight
incremental demand revisions on the order of ~0.2 mmbpd.

We expect OPEC+ to announce a 1.0 mmbpd cut for the 1H20 and outline a plan to extend 1.7 mmbpd of cuts through year-end.
Based on our collective marketing efforts and group analysis, we believe the market anticipates an additional 1.0 mmbpd cut (beyond the 0.6
mmbpd messaged in the OMR) for the 1H20 and to extend 1.7 mmbpd of cuts through year-end (as suggested by the JTC on February 8,
2020). We believe these supply cuts (Scenario 2, total cut of 2.7 mmbpd in 1H20, 1.7 mmbpd in 2H20) are necessary to offset the demand
loss related to Covid-19 (incremental 0.2 mmbpd) and the oversupply situation pre-Covid-19. We currently believe the risk-reward equation is
balanced for the commodity as the upside (expect crude to trade up to $55/bbl WTI for Scenario 2) is nearly identical to the downside (expect
crude to trade down to $40/bbl for Scenario 1). Additionally, the downside in Scenario 1 would be capped by 2020 budget revisions during
Q120 earnings as we estimate the industry, in aggregate, is outspending cash flow by +$18B at $40/bbl in the U.S. alone.
We believe the riskreward equation is favorable for Energy stocks as the upside (expect 15-30% potential stock outperformance under Scenario 2)
outweighs the downside (10-20% stock underperformance).
We are increasingly constructive on the 2021 oil macro irrespective of OPEC's decision. In concert with our OPEC meeting preview,
we conducted an extensive analysis of the U.S. Onshore for over 200 oil-focused type curves. Despite industry efforts to high grade activity,
increase well spacing (wider horizontal spacing), and optimize D&C designs (higher proppant intensity), the U.S. E&Ps were only effective
in improving per well productivity (bopd/k-ft) in two out of the seven basins. Further, we noticed a modest decrease in B-factors (outer
period decline behavior) as a result of full-field development. While these two developments might seem negative for the stocks, the cost
improvements more than offset the productivity loss in every play. In fact, our half-cycle PV-10 break-evens are ~4% lower on average.
Netnet, our 2021 U.S. supply is down ~0.1 mmbopd based on type curve revisions alone. As outlined in Figure 5, we estimate the global markets
are under supplied by 0.4 mmbopd in 2021 assuming no revisions to activity, which is another reason to believe crude prices are biased
higher post the price action associated with OPEC's decision.

We believe U.S. E&Ps are pricing in less than $40/bbl WTI.
We believe the E&P stocks are pricing a level slightly worse than our Scenario
1 ($40/bbl). As shown in Figure 6, we provide P/NAV calculations for $40/bbl (Scenario 1), $45/bbl, and $50/bbl (strip) scenarios. We favor
large-cap E&Ps, including Concho Resources Inc. (CXO, $67.59, Buy), EOG Resources, Inc. (EOG, $62.43, Buy), Diamondback Energy,
Inc. (FANG, $61.76, Buy), and Pioneer Natural Resources Company (PXD, $120.03, Buy), and Minerals, including Texas Pacific Land Trust
(TPL, $671.08, Buy) and Viper Energy Partners LP (VNOM, $17.90, Buy), for Scenario 1 and high-quality smid cap E&Ps, including Callon
Petroleum Company (CPE, $2.04, Buy), Parsley Energy, Inc. (PE, $12.75, Buy), WPX Energy, Inc. (WPX, $8.49, Buy) and Cimarex Energy
Co. (XEC, $31.09, Buy), for Scenario 2. For natural gas equities, we expect highly-levered and beta names to outperform their peers in a
rising oil (and NGL) price environment and underperform in a lower oil price environment. We favor Cabot Oil & Gas Corporation (COG,
$14.79, Hold), CNX Resources Corp. (CNX, $5.11, Hold), and Comstock (CRK, $5.75, Hold) for Scenario 1 and Range Resources Corp.
(RRC, $2.60, Buy), Antero Resources Corp. (AR, $1.35, Buy), Gulfport Energy Corp. (GPOR, $0.60, Buy), and Montage (MR, $3.05, Hold)
for Scenario 2.

Tanker equities are the highest beta segment relative to OPEC in the energy complex. Global seaborne transport of crude oil is 41.0
mmbopd, just shy of half of global consumption. We believe a 1.0 mmbopd cut to OPEC production would result in a 2.5% negative impact
on tanker demand. The ton-mile impact is north of 3%. This magnitude of demand decline can have a significant impact on tanker rates and
profitability. When OPEC cut in November 2016, average VLCC rates were $50,000/day and then averaged $15,000/day for the following
two years. Similarly, when OPEC cut production in January 2019, rates fell from $40,000/day to $17,000/day for the first half of the year
Given the negative correlation between oil prices as a response to OPEC action and tanker rates/equity values, we believe crude tanker
equities could be an interesting hedge to the broader energy group. We favor International Seaways (INSW, $20.59, Buy) and Diamond S
Shipping (DSSI, $10.18, Buy) in Scenario 1.

Oil Service stocks are currently trading at a roughly 35-45% discount and a 55-85% discount to the median five-year EV/EBITDA
based on 2020 and 2021 estimates, respectively. If Scenario 1 plays out and oil slides to $40 per barrel, we believe domestic E&P capital
spending would drop more than our current expectation of a low double-digits year-over-year decline. Although this appears to at least be
partially reflected in valuations, especially in light of the recent market sell-off related to Covid-19 fears and a global economic slowdown,
oil service stocks would likely continue to underperform. Assuming Scenario 2 occurs and oil trades in the $50-$55/bbl level, we expect
a short-term rebound in oil service shares followed by an upward trend over the next several quarters because we believe our current
estimates for 2020-21 would remain intact. Our current estimates are based on a c.10% drop in U.S. E&P spending and a rise of 5% in
international spending. We favor BKR (BKR, $15.53, Buy) and SLB (SLB, $26.81, Buy) for both scenarios and NEX (NEX, $4.32, Buy) and
BOOM (BOOM, $36.33, Buy) for Scenario 2.

Expect a more muted response from Midstream stocks. Since the widespread outbreak of the coronavirus (January 20, 2020) the AMZ
has declined 22% compared to WTI’S, XOP’s and S&P’s decline of 20%, 31% and 7%, respectively. That said, the AMZ has historically
shown a more muted response to OPEC production decisions compared to other sub-sectors. Assuming Scenario 1, we would be positioned
in more conservative stocks with a focus on long-haul natural gas assets (KMI, WMB). Assuming Scenario 2, we would expect companies
with Permian (PAA) and direct commodity exposure (DCP, TRGP) to outperform.