Slightly over a year ago, the price of oil plummeted to a cyclical low of $27 per barrel. Here's good news: Oil is in recovery — not a steady recovery, mind you, but one that will hit a price peak of about $70 by year's end, says Pavel Molchanov, energy equity analyst at Raymond James & Associates, in an interview with ThinkAdvisor that includes his top oil stock picks.
Yes, oil inventories are down because of companies' production cutbacks. But what Molchanov is watching carefully, too, is another key indicator: oil companies' capital spending, which, over the past three years, saw an enormous 60% in investment reductions.
Molchanov, RJ's energy analyst for 14 years, is indeed bullish on oil in light of the recovery. But he is hardly upbeat in his outlook for natural gas this year. That energy source is still suffering from oversupply and reduced demand.
During Barack Obama's presidency, America became the world's fastest growing producer of oil and gas, as well as a substantial generator of wind and solar power. Coal was a loser, largely because natural gas replaced it. A decade ago, coal had 50% of the electricity market; now it takes only about a third of market share, according to Molchanov.
In the interview, the RJ senior vice president, based in Houston, talks about whether President Donald Trump can save the coal industry and names several oil companies that he favors. He also discusses the chances of America's becoming energy independent, among other issues. Here are highlights of our conversation. (Disclosure: Molchanov spoke in his capacity as an analyst, not as a financial advisor.)
THINKADVISOR: What are your expectations for oil?
PAVEL MOLCHANOV: Bullish is exactly the right word. We're looking for oil to reach a cyclical high around $70 a barrel for WTI (West Texas Intermediate Grade) by the end of 2017. But we're not expecting it to stay at $70 forever. That would be too high, in fact. In the long run, it should be coming down toward a longer-term rate of perhaps $60.
And what do you forecast for the price of natural gas?
We're not nearly as upbeat about that. Unlike the global oil market, which is in recovery mode, we think that U.S. natural gas prices will remain quite depressed. Gas supply is growing. We're forecasting an average price of less than $3 [at] Henry Hub over the next twelve months. We're much more positive on oil industry fundamentals because supply is still struggling to keep pace with growing demand.
Why do you anticipate oil prices going as high as $70?
U.S. oil inventories are way down, though the decline wasn't as rapid as some had expected. We think that global inventories are probably coming down even faster than in the U.S. Real-time data on that won't be available till later in the year. We expect inventories everywhere to be falling at a faster rate in the second half than in the first.
One of the reasons oil inventories have been shrinking globally in recent months is because OPEC implemented production cuts as of January. Right now there's debate within OPEC as to extending the agreement beyond June 30 for another six months. [On May 25, OPEC extended the cuts to March 2018.]
What else do you take into consideration when forecasting the oil market?
The most important trend we're keeping track of is how oil producers the world over are approaching their investment strategy. Oil companies have been retrenching during the absolutely epic downturn that we've seen over the last three years. In 2013, global oil and gas investment was about $600 billion. This past year, it was down to less than $300 billion.
What does that mean to oil production?
If companies don't invest in oil and gas fields, production falls. If companies are slashing their investment — capital spending — left and right, that means less drilling, which means less production.
Just how bad was the downturn?
Painful. We've had three consecutive years of cutbacks in global oil and gas investment, and each cutback was steeper than the one before. That's extraordinary. Oil and gas investment globally plummeted 33% in 2016. That's the steepest one-year decline since the beginning of the century — and maybe since the 1980s.
What about the immediate prior years?
In 2015, it was also down 26%. Even in 2014, when [oil production] peaked, it began to fall. Global investment was down 7% that year. From 2013 to last year, the total reduction was approximately 60%. In 2013, global oil and gas investment was about $600 billion; this past year, it was down to less than $300 billion.
But are companies now increasing their investment?
Yes, but at a very slow, subdued rate, based on budgets. That's according to what the companies are telling us. When we aggregate all the capital budgets, we see 2017 investment recovering by only 13%. That's not much of a recovery.
What's going to prompt companies to step up their willingness to drill and invest more?
Higher oil prices. Just about every oil producer the world over has a balance sheet that's more levered than it was five or 10 years ago. So continuing to borrow and live beyond their means isn't an option.
What oil companies do you like?
Our focus is on companies with leverage to strong leverage, to oil price recovery: On the large-cap side, drilling companies or E&P [exploration and production] companies like Pioneer Natural Resources, Marathon Oil, Occidental Petroleum and Halliburton.
And on the small-cap and mid-cap side?
Some of our best ideas would be Oasis Petroleum, Kosmos Energy and Superior Energy Services. All of those companies are significantly tied to oil prices.
What's your forecast on earnings for these companies, and for other oil companies?
We think 2017 will be much better than 2016 and that 2018 should be better than 2017. If companies are levered to oil — not to natural gas — then, of course, a rising tide lifts all boats. The ones I mentioned are particularly focused on oil.
What are your expectations for the natural gas market, then?
Unlike the global oil market, which is in recovery mode, we think that U.S. natural gas prices will remain quite depressed. There's definitely too much supply. But even more importantly, demand is simply not materializing at the rate the industry would have liked.
What's the status of the U.S. as an energy exporter?
The U.S. is already a natural gas exporter, since last year.
Technically, some oil is being exported, but relatively small quantities. The amount of oil the U.S. is importing is much greater. When we net it out, the U.S. is the second biggest importer of oil in the world behind China — because the U.S. is the biggest consumer of oil in the world. The U.S. consumes twice as much oil as China despite having a much smaller population.
Can America ever become oil independent?
