Energy sector analysis: OPEC+ - The gloves come off

finnCap Energy Sector analysis: OPEC+ meeting March 2020

Please note: prices quoted are correct at the time of publishing

• OPEC+ talks fall apart and Saudi is threatening a price war
• Brent falls to $35/bbl - In the 2014-16 price war Brent bottomed below $28/bbl
• Oil focused names with heavy debt burdens most exposed – Enquest, Premier and Tullow
• Gas names offer some protection - Serica, Energean, Wentworth and Diversified Gas & Oil
• Even better is a fully funded gas developer not bringing production on for ~18 months – Independent Oil & Gas

Friday’s OPEC+ meeting ended in disarray with Russia baulking at Saudi’s demand for a much larger than expected 1.5mmbpd production cut to tackle the demand impact caused by the coronavirus. So not only do we not have an agreement to cut output further, but at the end of March the existing 1.7 mmbpd of production cuts will end.

Russia’s economy is less reliant on crude than Saudi, and some believe Putin is keen to take on US shale, which has been stealing market share in recent years, possibly also in retaliation against US sanctions. Drilling activity levels had already started to fall in the US. With WTI nearing $30/bbl, further reductions and bankruptcies are likely.

Saudi has retaliated by taking the gloves off and is threatening to ‘open the taps’ – it, of all the producing nations, has by far the largest amount of spare capacity. Saudi produced 9.7 mmbpd in January and has a nameplate capacity of 12 mmbpd, although it is unclear how quickly it can ramp up to that level. Production is, however, expected to move to 10-11 mmbpd in April.

Newswires are reporting that Saudi has already started to offer steep discounts for its crude in key markets. With a commodity that is set to be phased out, why would the world’s largest and cheapest potential oil supplier not open the taps to take back market share and crush the competition? Key Saudi royals were also arrested over the weekend, consolidating Crown Prince Mohammad bin Salman’s grip on power and sending a clear deterrent against any potential coup.

Brent closed down 9% on Friday at $45/bbl and is currently trading over 20% below that at $35.7/bbl. In the 2014-16 price war Brent bottomed below $28/bbl. This is clearly a disaster for an already besieged sector, as none of the companies do little more than cover cash costs at that level, although there are relative winners and losers.

Within the UK E&P sector, those with a high degree of oil exposure and heavy debt burdens will suffer – notably Enquest, Premier and Tullow. Other oil exposed names but without such balance sheet issues include Cairn, Jadestone, Pharos, Genel, Gulf Keystone, Hurricane, PetroTal, VAALCO, and Lekoil. Seplat, RockRose, Savannah, and SDX are also oil producers, but have a balance between oil and gas. President’s growth is shifting to gas.

Trinidad exposed Columbus, Touchstone and Trinity are all oil producers, although Trinidad’s tax terms provide a little shelter as the 18% Supplemental Petroleum Tax does not apply below $50/bbl. Touchstone has also just found a significant amount of gas, which will dramatically alter its oil/gas mix going forward. It did well with the timing of its recent US$11m raise too, so is funded for further drilling.

For oil-focused explorers, lower long-term crude futures expectations will impact prospective NAV – this includes 88 Energy, Eco Atlantic and Bahamas Petroleum. Farm-outs will get tougher too, which isn’t helpful for Jersey, Providence, Lansdowne, Chariot or Europa.

Longer term expectations for gas prices, which are also very weak currently, should not necessarily be impacted. Current gas price weakness is coronavirus and seasonally warm weather related and longer term the LNG market is expected to tighten. If there is a sustained period of weak oil prices and US Permian producers reduce activity, associated gas production may even fall, or at a minimum see growth rates slow. 

As such, gas-focused producers should offer some relative protection. Here we would highlight Serica, Energean, Wentworth and Diversified Gas & Oil. Even better is a fully funded gas developer not bringing production on for ~18 months – Independent Oil & Gas.