Today’s Blog – Thursday 7th January 2016

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Today we turn from yesterday’s global oil and gas predictions for 2016 to some local predictions for the Australian E&P sector, as follows:

  1. The Big Australian, BHP, will likely face further write-offs over its US shale assets this year, which were bought at a time of considerably higher oil and US gas prices.  The rest of BHP’s legacy oil and gas production assets, high quality but fairly mature, will keep chugging on.  Acquisitions could be possible – but we think unlikely in the context of the market’s focus on dividends.  Recent media speculation of BHP (and Rio) raising a big lick of equity to be used to chase weaker prey could change that if accurate.
  2. The two pure-play oil and gas companies at the top of the Aussie E&P charts, Woodside Petroleum (WPL) and Oil Search (OSH), were well placed to weather the pricing storm of the last 18 months due to their position in the project development cycle – i.e. projects were or nearly were finished.  Luck played a role, as well as having high quality assets.  We don’t expect a WPL/OSH takeover given the lack of synergies and current comparative pricing – but egos have been known to trump shareholder value before.
  3. Santos (STO) still has a weak balance sheet, notwithstanding its rights issue of late last year.  We consider it distinctly possible that it may have to go back to this well in 2016.  As we have noted before, one revenue raising option for the Board will be to sell tickets to what we expect to be a feisty AGM in May.  If no Board changes are announced before then, we expect a “first strike” vote at least.
  4. Regular readers will know our views on Origin Energy (ORG) – that in 2016  the company could sell off its upstream business (primarily APLNG) – with partner Sinopec being a possible acquirer.  The company should change its longstanding leadership by year end.
  5. We do not expect a lot of other corporate transactions in the year, other than at the smaller end.  Here we anticipate a goodly proportion of ASX E&P companies to be re-born as IT/bio-tech/etc ventures – perhaps more than 10% of the sector by number of companies.  Otherwise the small number of medium sized companies will be bunkering down and Director & Management job retention may well trump shareholder value (although we would be “shocked, shocked” in the manner of Captain Reynaud if that was the case).  A big boost of shareholder activism, of the type seen in the US in recent years could however emerge to shake up the status quo.

Commodity prices

Crude prices were smashed over-night to 11 year lows (in nominal terms – likely 18+ years in real terms), with Brent down ~6% to US$34.26 and WTI also down ~6% to US$33.95.

The weekly EIA report showed a fall in crude inventories of 5.1 mmbbls (but with a build at the key Cushing location of 1 mmbbls).  However this was completely over-shadowed by a massive 10.6 mmbbl build in gasoline (the highest since 1993) and 6.3 mmbbls of distillate.

On the “events” side, the market continued to absorb the negative consequences of the escalating Sunni/Shia conflict in the Middle East and what it means for uncontrolled OPEC production.

One bright spark that we found – a report in today’s daily Economist note that the US dollar was materially over-valued using its “Bic Mac” index measure of purchasing-parity-power.  Currencies should trend towards equality on this measure over time, and if the US dollar retreated, that would benefit oil prices.  Clutching at straws I hear you say!

The Henry Hub gas price fell ~2.5% to US$2.28.

LNG and international gas

Those hardy souls who might consider investing in Russian gas giant Gazprom might want to note the following recent quote from the company’s CEO, Alexie Miller:

“We see a new year of 2016 approaching. Let it be beneficial for Russia, for Gazprom Group and for each of us. I wish happiness, robust health and all the best to you and your families!”

No surprise that Russia’s interests come before those of lowly shareholders.

Company news – ORG

Regular readers may note some occasional cynicism in this blog about ASX reporting and one manifestation of that is that dogs that don’t bark are rarely reported.  One current example of this is the un-announced delay in first LNG cargoes from ORG’s APLNG venture in Queensland.  ORG announced in mid-December that first cargoes were due by year end.

Company news – STO

We note news overnight from the US that Permian tight oil focused player Pioneer Resources has just gone out to raise equity to allow it to continue to fund its drilling efforts (clearly operating cash-flow cannot do this).  The relevance of this to STO is that Pioneer’s CEO sits on the STO Board and would presumably find it hard to say no to the Australian company raising more equity.

This Pioneer development demonstrates the amazing resilience of US tight oil (and gas) players in the face of falling oil and gas prices.  Continuing support from capital markets, combined with a focus on the best rock using the best geological/engineering/drilling teams, has meant that production has held up much better than many (ourselves included) predicted a year ago.  Our view is that until the best rock starts to run out (and we don’t know when that will be), this trend of over-performance will continue.  After that – “la deluge”.

Other company news

This remains thin on the ground as the holidays continue.  More shareholder activism required to shake up sleepy Boards and executives!

Quote of the day

“Nothing is economic at today’s prices… We’re drilling the best of the best rock right now.  At some point we’ll have to move to lesser-quality rock, which will increase the break-even costs.”

James West, an analyst at Evercore ISI

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