Energy Prospectus

From the Raymond James report dated 9-19-2011

Our global oil model still looks bullish. Earlier this year, the strength in oil prices coincided with concerns over supply disruptions resulting from political turmoil in the Middle East/North Africa, along with optimism about the pace of global economic recovery. Today, it feels like sentiment has done a complete 180-degree turn – as Libya begins to restore its oil production to pre-war levels (albeit slowly) against the backdrop of weak global macroeconomic data (both in the U.S. and abroad). While acknowledging the broader demand uncertainties in the near term, we would underscore that (barring a global economic meltdown) our oil model shows much tighter oil supply/demand in the coming quarters.

Specifically, OECD (Organization of Economic Cooperation & Development) inventories are poised to fall below their 10-year range even as OPEC excess capacity falls below 1 million bpd. Longer term, we remain fundamentally bullish. On the supply side, we believe that non-OPEC supply is in the process of plateauing. The risk of a limited buffer of excess OPEC capacity is further heightened by the risk of more geopolitical supply disruptions. As the global economy rebounds over time, we project higher highs and higher lows for oil prices over the long run, though of course with continued volatility. Bottom line, we believe oil fundamentals are more encouraging than the short-term stock market gyrations – although, we recognize that doesn’t necessarily clear up the near-term stock investing picture.

Wells Fargo Securities has advised clients over the last week to lighten up on the energy sector.

September 19, 2011
Equity Research
"Crude Reality
Energy Sector Underweight
• We downgraded energy from Market Weight to Underweight last week, amid a
number of sector allocation changes meant to position more defensively. Our
relatively negative outlook for energy stems from the following concerns: (1)
waning macroeconomic momentum, (2) lofty oil price expectations, (3) flat
natural gas trends, (4) increasing currency risks, (5) stubborn micro estimates,
and (6) a weakening relative price trend for the sector. Given this lengthy list,
we see the real possibility for the sector to bear the brunt of recession fears as
estimate downgrades are priced in.
• Risks to the momentum of global growth continue to mount, in our view.
Recently, we have been observing poor trends in cyclically sensitive indicators
such as the ISM and its component sub-indices, which were previously areas
of relative strength for the economy. At the same time, our economics team's
global GDP forecast has fallen from 4% in 2011 and 4.4% in 2012 to 3.5% and
3.4%, respectively. This slower growth environment brings into the question
the strength of energy demand assumptions going forward.
• Underlying commodity prices (i.e. crude oil and natural gas) for the sector are
also reasons for concern, in our opinion. The current median forecast calls for
WTI prices in excess of $100 per barrel for 2012 and beyond, which seems to
exclude any consideration for a global slowdown in growth. Our economics
team has a more tempered projection of $88.75 for WTI in 2012, and our
earnings forecast assumes $90. Concurrently, natural gas prices remain rangebound
providing little in the way of upside support for the gas-heavy
companies in the sector.
• Recent currency trends provide yet another risk for the sector. Over the last
three months, the Fed's dollar index has rallied by about 2.6% against the
major currencies. While the dollar index is still down 6.5% from a year ago,
slowing growth and mounting political tensions in Europe may result in
pressure on the Euro and continued flight to the dollar as a safe haven. A
dollar rally may bode ill for oil prices. The correlation between the dollar and
crude oil has averaged -0.81 over the last three years.
• Taken together, all these factors provide very tangible risks to aggregated
bottom-up earnings forecasts, which remain quite optimistic, in our view.
Current consensus estimates imply energy sector earnings growth of 40.4% in
2011 and 9.2% in 2012, with forward revision momentum still in positive
territory. Our forecast suggests more subdued growth of 15% in 2011 and 5%
in 2012.
• Where could we be wrong? We see two major risks to our view. First, if the
Fed engages in another round of quantitative easing (QE3), commodity prices
and energy stocks could very well rally. Such a move seems unlikely given
continued upward trending inflation measures, in our view. Instead, a balance
sheet neutral "Operation Twist" seems more likely. Second, an economic
recovery could reignite from a combination of effective domestic fiscal policy
and/or easing monetary policies in emerging economies. Neither seem
particularly plausible yet, as the political climate and federal deficit may make
it difficult to pass any robust legislation in the U.S. while inflation trends
abroad remain elevated. Further economic downside, not upside, is the
greater concern to us at present."

I attended the Wells Fargo Energy Forum in Houston last Wednesday. At that meeting, with approximately 300 clients attending, their panel was bullish on energy. The only sub-sector they were subdued on was utilities.

My question to them: "Where should your clients move the money?"

At their new "tempered" WTI forecast of $88.75/bbl for 2012, the E&P companies heavily weighed to oil (our focus) will do just fine next year.

Even if global oil prices remain flat, I see WTI drifting higher as Cushing is debottlenecked.