Why Oversupply Concerns Are Outweighing Geopolitical Risks for Oil Prices Ahead
Crude oil prices have had a bumpy year. As of Thursday’s close, prices were right around their mid-December 2018 level of $52 and change. Over the past six months, the spot price for West Texas Intermediate (WTI) has dropped by about $14 a barrel, a decline of more than 20%.
The market has been rattled by its inability to drain inventories and decrease supply to meet lower demand. The continuation of production cuts by OPEC and its partners is likely to continue into next year, but even that may not be enough to lift prices.
Analysts at Credit Suisse have just lowered their crude oil price forecasts for 2020 and beyond, commenting “we see the market tipping back into oversupply next year even if OPEC+ extends its cut agreement through  and assuming a pick-up in demand growth.” The analysts now forecast a price of $55 a barrel for WTI and $63 for Brent crude. They also have cut their forecast for 2021 and beyond by $5 a barrel to $55 for WTI and $65 for Brent.
Lower forecasts don’t stop there. Cash flow per share, net asset value and price targets for exploration and production (E&P) companies also have been slashed. The outlook for cash flow per share has been cut by about 6% for this year and by 11% for 2021. Net asset values and price targets were lowered by 25% and 20%, respectively. Earnings per share (EPS) estimates and price targets for integrated oil companies have been cut by around 12% and 7%, respectively.
Credit Suisse noted that E&P companies remain out of favor due to skepticism that they can achieve and sustain free cash flow yields over the long run as a result of declining proved production from developed fields and WTI prices in the mid-$50 range.
Credit Suisse’s 30,000-foot view:
[W]e expect this multiple de-rating trend will continue unless either we see a sustained rally in oil prices (unlikely absent a significant geopolitical event in our view given loosening [supply/demand] balances into 2020) and/or E&P equity valuations become so inexpensive on traditional metrics that it serves as a catalyst for the Majors to consolidate the sector.
As always, adjusting industry estimates involves adjusting the way analysts rate specific companies. Credit Suisse announced downgrades this morning to three E&P firms: Continental Resources Inc. (NYSE: CLR), Range Resources Corp. (NYSE: RRC) and Whiting Corp. (NYSE: WLL). Analysts also dropped WPX Energy Inc. (NYSE: WPX) from their list of E&P top picks, replacing it with Parsley Energy Inc. (NYSE: PE).
The analysts cut Continental’s rating from Outperform to Neutral and cut their price target from $42 to $34 per share. Noting that the company has shown consistent production and free cash flow growth, that growth “is less differentiated today with >75% of Large & Mid-cap E&Ps generating [free cash flow] and growing production (+9.6% YoY).” Free cash flow yield may fall from around 4.0% this year to just 0.4% next year, while it should rise from 0.6% to 1.0% for Continental’s competitors. Estimates of cash flow per share for 2019 were dropped by 3%, as well as by 6% for 2020.
Range Resources also has been downgraded from Outperform to Neutral, and its price target was cut from $8 to $4 per share. Based on strip oil and natural gas prices, Credit Suisse forecasts Range’s net debt to EBITDX ratio will rise from about 3.2 times at the end of 2018 to about 3.9 times at the end of this year and approximately 4.5 times in 2020 and 2021, well above the 2 times or so of its peers. Range is expected to post no growth in capital spending next year, leaving the company free cash flow neutral in each of the next several years.
Whiting Petroleum’s rating was cut from Neutral to Underperform, and the company’s price target was slashed from $11 to $5 a share. In the analysts’ words: “We don’t believe the worst [is] over yet given an uncertain macro outlook, no free cash flow at strip prices, levered balance sheet (>3.0x), and most concerning, looming debt maturities.” More worryingly, Credit Suisse says, are “concerns around the company’s asset duration.” The firm sees approximately five years of core drilling inventory remaining “at a pace of development that keeps oil production flat.” What that means, of course, is that Whiting is a captive of crude prices that are not going up but must if investors are going to be happy: “At strip prices, we see [Whiting]’s [net asset value from proved developed production] at ($3.89)/sh[are], or a still low +$1.75/sh using discounted market debt value, and investors are unlikely to give much credit for undeveloped assets.”
The analysts did not say much about the addition of Parsley Energy to their top picks list other than: “We expect relative outperformance from E&Ps that offer a combination of competitive growth, above-average FCF yields, willingness to return cash to shareholders, and attractive relative valuation.” WPX, apparently, no longer fills the bill. Other top pick E&Ps include ConocoPhillips, Diamondback Energy, Pioneer Natural Resources, Marathon Oil and Viper Energy.
Continental Resources shares traded down about 3.4% late Friday morning, at $28.72 in a 52-week range of $27.54 to $70.10. The consensus price target on the stock is $49.40. compared to Credit Suisse’s new target of $34 a share.
Range Resources traded down about 3.3% to $3.50, in a 52-week range of $3.33 to $18.60. The consensus price target on the stock is $7.76, far above Credit Suisse’s new target of $4 a share.
Whiting’s shares traded down more than 4% to $7.01. The 52-week range is $6.00 to $50.70. The consensus price target of $18.34 is much higher than Credit Suisse’s revised estimate of $5 a share.