“In energy, investors have typically benefited from consistently strong returns provided by the large integrated oil companies, such as ExxonMobil, Royal Dutch/Shell and British Petroleum.”
LONDON, 3 March 2003 — Energy is the lifeblood of the modern economy and its growth is related to global GDP. The energy sector involves companies engaged in hydrocarbon exploration, transportation, transmission, processing, trade and distribution, as well as companies providing goods and services. In energy, investors have typically benefited from consistently strong returns provided by the large integrated oil companies, such as ExxonMobil, Royal Dutch/Shell and British Petroleum. Three sub-sectors of energy that are attractive are oil refining, US natural gas, and oil field services.
Over the last fifteen years, global oil demand (excluding the former Soviet Union) has grown at a compound rate of 2.3 percent or 1.3 million barrels/day. Demand growth during this period was split nearly evenly between OECD, the developed countries, and non-OECD countries. Oil supply during this period was characterized by OPEC’s growing market share — more than 60 percent of the incremental oil supply.
Several OPEC countries faced capacity constraints in meeting their 2000 production quotas. Additional investments will be required to meet future demand growth. A combination of growing market share, as well as capacity constraints in several countries, should allow OPEC to exercise greater influence on oil prices. OPEC has been very successful at managing oil prices in the $20-$30 a barrel range over the last three years.
Today, the global oil and gas industry is in the midst of important changes which can be described as the end of an era of overcapacity. Virtually all segments of the energy value chain were plagued with over-capacity during the last two decades. The supply overhang was a consequence of the industry’s demand growth expectations, which proved to be too optimistic. As a result of tightening supply/demand conditions, several large segments within energy, such as oil and US natural, have benefited from higher margins over the last several years.
In 2003, OPEC will be challenged in maintaining stability in the oil market due to the strike in Venezuela and a possible war with Iraq. Any downturn in oil prices beyond 2003 is likely to be short-lived. Also, fiscal pressures are likely to force individual OPEC countries to exercise production discipline.
Our medium-term view is that oil prices are in the midst of a secular upturn. From 1989 through 1999, oil prices averaged $19 a barrel; from 2000-2002, they have averaged $25 a barrel. This upturn was due to OPEC’s desire for higher revenues, which it achieved by relinquishing market share. Our expectation is for oil prices to average around $25 a barrel over the next several years. In this environment, many companies have assets and reinvestment opportunities, which will allow them to create shareholder value. Companies such as ExxonMobil, Royal Dutch/Shell, and BP benefit from profitable legacy assets and the ability to reinvest the cash flow from these assets into new areas such as the deep-water provinces of West Africa and the Caspian Sea.
Natural gas is one of the fastest growing components of world energy consumption, and is expected to almost double by 2002, with an average annual growth rate of 3.2 percent. Developing countries as a whole within Central and South America and Asia will likely account for the largest incremental increase in natural gas consumption.
Both US natural gas prices and oil refining have also recently witnessed profit margins above historical levels. The industry responded by increasing drilling activity. However, as the following chart illustrated, US gas production barely increased despite record drilling activity.
Looking ahead, our expectations are for prices to be higher. US natural gas, at around $3/thousand cubic feet is an attractive price for many North American independent producers.
The improvement in the US refining environment is due to growing demand and closure of some marginal refining capacity. The US and European Union regulations call for cleaner products in 2005. Refiners’ compliance is expected to result in additional capacity closures, which, in turn will further tighten the supply/demand balance and result in healthy margins.
The oil field service sub-sector conducts initial seismic studies and then drills, completes and maintains oil and gas wells for its clients, the major national and integrated oil companies. Several major themes characterize this subsector:
* Need for a strong global presence with industry-leading technologies. The “big three” international majors are Schlumberger, Baker Hughes and Halliburton.
* Ownership of important new technologies that permit a steady reduction in industry finding and development costs. Schlumberger, IHC Caland and Technip-Coflexip are examples.
* Participation in the inevitable recovery of US natural gas drilling and production. Three leading offshore drillers are GlobalSantaFe, ENSCO and Rowan plus the best onshore natural gas driller – Helmerich & Payne.
* Participation in deep offshore oil drilling. Companies such as Transocean and Noble will drill while the leading product lines of Varco International and Cooper Cameron will produce the required sophisticated equipment.
* Purchase undervalued or misunderstood securities through intensive research.
Oil field service earnings were under severe pressure in 2002 due to a significant decline in US natural gas drilling. The sub-sector will rally as investors look beyond current earnings to a more normal 2004.
In conclusion, energy is and will continue to be an attractive sector for investors. The sector is dominated by large, integrated firms, which have a demonstrated record of delivering competitive shareholder returns. Historically, the sector has provided superior returns. We believe that the various sub-sectors in the industry offer opportunities for capital appreciation in their respective investment cycles. Investment professionals are best suited to identify these areas.
(The information contained herein is for information only and should not be construed as an offer or a solicitation to purchase, subscribe, sell or redeem any investments. While Clariden Bank uses reasonable efforts to obtain information from sources, which it believes to be reliable, Clariden Bank makes no representation or warranty as to the accuracy, reliability or completeness of the information)
