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Oil

Shale is the name of the game

The oil price continued to move up in February, gaining another 5.5% to close the month at USD 57.22 per barrel (WTI). The XOP index of US shale oil & gas producers fell 2.5%, while our selection of stocks shed 4.75%.

shaleOil VsWTISource : Bloomberg

Nearly all shale oil companies have now reported their 2018 results, providing some insight on their future drilling and fracking intentions. Most have decided to rein in 2019 expansion plans, aligning them with the cash flow they expect to generate if the oil price stays around the current level (USD 55-60). In turn, this suggests that overall production volume growth will be limited to 10-15%. This is positive news as pertains to shale producers’ balance sheet strength (debt will not increase) but negative news in terms of their cash flow and earnings. These will come in below prior expectations, which explains why the share prices lost ground in a month that saw further oil price gains.

Large shale oil companies (e.g. Concho, EOG, Pioneer, Diamondback and Continental Resources) are now trading at an expected EV/EBITDA ratio of 6-7x, which seems reasonable at the current oil price. Smaller companies, however, remain cheaper, with an expected EV/EBITDA ratio of 3.5-5x, and we expect that valuation gap to close somewhat.

That said, the bigger question is whether the oil price will remain at USD 55-60 ?

We are convinced that oil will instead trend up towards last year’s USD 75 high, provided the OPEC/Russia cartel keeps its production discipline and, of course, the world economy does not fall into recession (not our scenario).

The evolution of oil inventories indicates that the market is (seriously) undersupplied for the time being and should become tight again over the course of this year. As such, a USD 75+ oil price is by no means impossible and current 2019 EBITDA expectations for shale oil companies could be overshot by a wide margin – paving the way for (much) higher stock prices.

(Update : 03.2019)

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