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Oil

Shale is the name of the game

The oil price continued to move up in April, gaining a further 6.3% to close the month at USD 63.91 per barrel (WTI). The XOP index of US shale oil & gas producers was close to flat (+0.7%), while our selection of stocks gained 3%.

WTI XOPSource : Bloomberg

Oil producer share prices continue to lag the commodity. As the graph shows, the disconnect dates back to early January and has since gradually expanded to over 25%. Explaining this performance gap is difficult. A possible interpretation is that investors fear a renewed oil price collapse or are scared that environmental concerns will eventually hit the sector (in the post-Trump era).

With sanctions against Iran now in full force, OPEC/Russian production complying with the agreed upon cuts, Venezuela output in free fall, and oil demand still strong, we see no reason to fear a serious oil price correction in the near term. On the contrary, production having fallen below consumption, large oil inventory drawdowns are likely to occur once refineries come out of their maintenance period at the end of May and run at the full capacity required to provide new low-sulphur fuel and much greater quantities of marine diesel oil for the shipping sector, as well as gasoline for the US driving season.

The disconnect cannot be a matter of valuation either. At the current oil price, shale producer stocks are trading at an expected 2019 EV/EBITDA multiple that averages 5x (6x for the larger companies, 4x for the midsize and small companies) and an estimated 25% discount to net asset value (15% for the larger companies, 35% for the midsize and small companies). Should oil rise to USD 75 per barrel, and shale stocks not follow suit, the estimated discount to net asset value would exceed 50% on average. Such large undervaluation has not gone by unnoticed by the major oil companies: Chevron recently made a bid on Anadarko, one of the bigger shale oil producers, at a premium of roughly 35%, followed by an even higher bid by Occidental Petroleum (at a premium exceeding 50%).

After a couple of years of very low exploration spending – due to the oil price having dropped below the production cost price of new deep-sea projects – oil majors are currently cash-rich and looking to expand their oil reserves. The most certain and interesting way to achieve this goal is to buy (cheap) US shale companies, as opposed to investing in the exploration and exploitation of deep-sea projects that will take at least five years to come online. Shale oil reserves are proven and ready to drill. It takes only a couple of months to be in production mode and the larger part of the wells can be exploited within three years. As such, majors can avoid the longer-term oil price risk related to upcoming renewable energy and changes in environmental laws.

Further bids by majors on independent US shale companies are thus likely in the near future, which could (finally) serve as the catalyst to much higher stock prices in the sector.

(Update : 05.2019)

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