Morgan Stanley's take on the Oil Market - July 8
Posted: Wed Jul 08, 2020 1:35 pm
Devin McDermott – Morgan Stanley
July 8, 2020 4:01 AM GMT
Post recent weakness, US E&Ps trade close to "fair value" at the oil strip. While this points to a more balanced risk-reward, we continue to expect a bumpy recovery and backdrop of regulatory uncertainty. Reiterate defensive bias with a focus on quality & low cost: CVX, HES, NBL, PE & XEC.
As the disconnect between equities & commodities closes, the recovery path remains protracted and uncertain. Since the end of April, prompt WTI has more than doubled from $19/bbl to just over $40/bbl and the 2021 strip has risen ~25%. However, E&Ps have now declined 4% over the same period as the combination of a slowing demand recovery, reversal of supply curtailments, and uncertainty around a Covid second wave have dampened investor sentiment on the pace of the oil market recovery.
Furthermore, this week's unprecedented decision by a federal judge to shut an operating oil pipeline (Dakota Access) has brought regulatory risk back to the forefront. Now, after intrinsically pricing in high $40s WTI in early June, our coverage now reflects a median oil price of closer to $43/bbl, just above the 2021 strip of $42. While the convergence between the equities and commodity does point to a more balanced risk-reward, we continue to expect a protracted and bumpy recovery. This, coupled with growing regulatory uncertainty as we approach election season, reinforces our preference for more defensive positioning within the sector. Restoring the business amid macro & regulatory uncertainty.
As we have outlined in prior notes (Looking Through the Cycle & Sizing the Potential for US Shale Growth), sharp activity reductions in response to low oil prices, while necessary, are on pace to cause US shale oil supply to exit this year 1.8-1.9 MMbbl/d (~20%) below 4Q19 levels - leaving much of our coverage with "impaired" production bases.
Fully restoring production may take time and depends on commodity prices, with ~$40/bbl WTI needed to hold total US supply flat in 2021. We continue to prefer quality stocks that offer a competitive value proposition through the cycle, with a specific focus as we head into 2H20 on those low on the cost curve and best positioned to reverse curtailments and stabilize volumes. With growing regulatory uncertainty,geographic and asset diversity is also increasingly important.
Our top picks are CVX within Integrated Oil; HES, NBL, PE and XEC within E&P. We also remain OW COP & PXD, but see limited valuation upside for both absent oil prices moving higher. Conversely, we are most cautious on OXY, CLR, MRO, MUR and high-yield natural gas E&Ps (AR, RRC, SWN).
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My take is that $40/bbl WTI is not high enough to get the active drilling rig count to triple; which is what it will take to stabilize U.S. oil production.
July 8, 2020 4:01 AM GMT
Post recent weakness, US E&Ps trade close to "fair value" at the oil strip. While this points to a more balanced risk-reward, we continue to expect a bumpy recovery and backdrop of regulatory uncertainty. Reiterate defensive bias with a focus on quality & low cost: CVX, HES, NBL, PE & XEC.
As the disconnect between equities & commodities closes, the recovery path remains protracted and uncertain. Since the end of April, prompt WTI has more than doubled from $19/bbl to just over $40/bbl and the 2021 strip has risen ~25%. However, E&Ps have now declined 4% over the same period as the combination of a slowing demand recovery, reversal of supply curtailments, and uncertainty around a Covid second wave have dampened investor sentiment on the pace of the oil market recovery.
Furthermore, this week's unprecedented decision by a federal judge to shut an operating oil pipeline (Dakota Access) has brought regulatory risk back to the forefront. Now, after intrinsically pricing in high $40s WTI in early June, our coverage now reflects a median oil price of closer to $43/bbl, just above the 2021 strip of $42. While the convergence between the equities and commodity does point to a more balanced risk-reward, we continue to expect a protracted and bumpy recovery. This, coupled with growing regulatory uncertainty as we approach election season, reinforces our preference for more defensive positioning within the sector. Restoring the business amid macro & regulatory uncertainty.
As we have outlined in prior notes (Looking Through the Cycle & Sizing the Potential for US Shale Growth), sharp activity reductions in response to low oil prices, while necessary, are on pace to cause US shale oil supply to exit this year 1.8-1.9 MMbbl/d (~20%) below 4Q19 levels - leaving much of our coverage with "impaired" production bases.
Fully restoring production may take time and depends on commodity prices, with ~$40/bbl WTI needed to hold total US supply flat in 2021. We continue to prefer quality stocks that offer a competitive value proposition through the cycle, with a specific focus as we head into 2H20 on those low on the cost curve and best positioned to reverse curtailments and stabilize volumes. With growing regulatory uncertainty,geographic and asset diversity is also increasingly important.
Our top picks are CVX within Integrated Oil; HES, NBL, PE and XEC within E&P. We also remain OW COP & PXD, but see limited valuation upside for both absent oil prices moving higher. Conversely, we are most cautious on OXY, CLR, MRO, MUR and high-yield natural gas E&Ps (AR, RRC, SWN).
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My take is that $40/bbl WTI is not high enough to get the active drilling rig count to triple; which is what it will take to stabilize U.S. oil production.