BofA Equity Research Oil Price Forecast - Feb 15
Posted: Tue Feb 15, 2022 2:06 pm
From BofA Equity Research with my comments in blue.
Geopolitics present volatile near term oil risk
With Brent near $95 driven by a myriad of contradictory issues and near-term risks that
could pull oil lower are building led by a potential seasonal roll over in demand and a
JCPOA resolution. Per our commodity team the impact on oil could be swift with
inevitable pressure from paper markets as technical ceilings once again become a
self-fulfilling prophecy. With that said, the long end of the curve now stands >$70 and
remains a critical barometer for long term fundamentals. Any lull in demand is expected
to be transitory ahead of summer and the long awaited recovery in jet demand that
continues to run below pre-pandemic levels.
But per the IEA oil markets are much tighter than thought
Over the last few days an additional factor has been introduced that we see as more
confirmation of conditions behind underlying price strength and has perhaps been
overlooked by the broader market. The IEA’s (International Energy Agency) revisions of
demand estimates over the past 15 yrs, published with its Feb-11 oil market report and
the numbers are not immaterial. Per the IEA ‘A reassessment of historical data has
resulted in a significant upgrade to demand estimates …lifting baseline demand for Saudi
Arabia & China by nearly 800 kb/d.' To be clear the IEA still sees oil market returning to
surplus in 2022; but we see the message of its latest report that the oil market is much
tighter than previously believed.
Sector outlook remains 2 steps forward, 1 step back
Where does that leave the sector outlook? At the start of year we suggested 2022 could
be a year where investors are forced to reset expectations of sustainable long term oil
prices, within a higher long term sustainable trading range within $60 - $80 range. At
the mid-point of this range upside to fair value on an ex growth DCF basis, constrained
by cashflow remains material for the US oils within a wide range (0-80%) and the
average at 26%. At this scale the gap between equity value & free cash remains
sufficiently wide to leave our constructive view of the US oils intact, albeit with
expectations that trading dynamics could remain 2 steps forward, 1 step back.
Resetting valuations to $65 Brent implies upside of 26%
In our view, the challenge for investors is to avoid prematurely chasing momentum, but
also to recognize a trajectory that may continue to reset absolute valuations. Late last
year we revised POs for the US oils to the average of the BofA long term deck ($60
Brent from 2025) and what at that time was a $65 long dated Brent curve; given the
continued upward reset in the forward curve, and implications of a tighter supply
demand balance by the IEA, we move this up again, to a $65 Brent basis - still well
below the current strip but acknowledging that calling an end to the oil sector recovery
is likely far from over. We still advocate relative focus on those names that can exploit
the biggest dislocations in value through rate of change via deleveraging the second
order effect of reduced equity volatility, and share buy backs, of those names still to
report our focus is on OXY, APA, FANG and OVV. But with the forward curve now at
c.$70 overall the sector looks undervalued.
----------------------------------
Because size and balance sheet strength does matter in this business, the Elite Eight in our Sweet 16 are the "Safe Bets" and they still have significant upside even if WTI does pull back to $70/bbl. On the other hand, in Post-Pandemic World I believe oil prices are not going to pull back this year. I believe IEA will need to keep raising their oil demand forecast and that OPEC+ is already at peak production. OECD petroleum inventories are dangerously low. By "dangerously" I mean that any supply disruption could cause regional shortages of transportation fuels; especially diesel. My full-year forecast is that WTI will average $85/bbl and we will see a significant price spike in Q2.
Geopolitics present volatile near term oil risk
With Brent near $95 driven by a myriad of contradictory issues and near-term risks that
could pull oil lower are building led by a potential seasonal roll over in demand and a
JCPOA resolution. Per our commodity team the impact on oil could be swift with
inevitable pressure from paper markets as technical ceilings once again become a
self-fulfilling prophecy. With that said, the long end of the curve now stands >$70 and
remains a critical barometer for long term fundamentals. Any lull in demand is expected
to be transitory ahead of summer and the long awaited recovery in jet demand that
continues to run below pre-pandemic levels.
But per the IEA oil markets are much tighter than thought
Over the last few days an additional factor has been introduced that we see as more
confirmation of conditions behind underlying price strength and has perhaps been
overlooked by the broader market. The IEA’s (International Energy Agency) revisions of
demand estimates over the past 15 yrs, published with its Feb-11 oil market report and
the numbers are not immaterial. Per the IEA ‘A reassessment of historical data has
resulted in a significant upgrade to demand estimates …lifting baseline demand for Saudi
Arabia & China by nearly 800 kb/d.' To be clear the IEA still sees oil market returning to
surplus in 2022; but we see the message of its latest report that the oil market is much
tighter than previously believed.
Sector outlook remains 2 steps forward, 1 step back
Where does that leave the sector outlook? At the start of year we suggested 2022 could
be a year where investors are forced to reset expectations of sustainable long term oil
prices, within a higher long term sustainable trading range within $60 - $80 range. At
the mid-point of this range upside to fair value on an ex growth DCF basis, constrained
by cashflow remains material for the US oils within a wide range (0-80%) and the
average at 26%. At this scale the gap between equity value & free cash remains
sufficiently wide to leave our constructive view of the US oils intact, albeit with
expectations that trading dynamics could remain 2 steps forward, 1 step back.
Resetting valuations to $65 Brent implies upside of 26%
In our view, the challenge for investors is to avoid prematurely chasing momentum, but
also to recognize a trajectory that may continue to reset absolute valuations. Late last
year we revised POs for the US oils to the average of the BofA long term deck ($60
Brent from 2025) and what at that time was a $65 long dated Brent curve; given the
continued upward reset in the forward curve, and implications of a tighter supply
demand balance by the IEA, we move this up again, to a $65 Brent basis - still well
below the current strip but acknowledging that calling an end to the oil sector recovery
is likely far from over. We still advocate relative focus on those names that can exploit
the biggest dislocations in value through rate of change via deleveraging the second
order effect of reduced equity volatility, and share buy backs, of those names still to
report our focus is on OXY, APA, FANG and OVV. But with the forward curve now at
c.$70 overall the sector looks undervalued.
----------------------------------
Because size and balance sheet strength does matter in this business, the Elite Eight in our Sweet 16 are the "Safe Bets" and they still have significant upside even if WTI does pull back to $70/bbl. On the other hand, in Post-Pandemic World I believe oil prices are not going to pull back this year. I believe IEA will need to keep raising their oil demand forecast and that OPEC+ is already at peak production. OECD petroleum inventories are dangerously low. By "dangerously" I mean that any supply disruption could cause regional shortages of transportation fuels; especially diesel. My full-year forecast is that WTI will average $85/bbl and we will see a significant price spike in Q2.