Fadel Gheit: U.S. refiners benefit from the wide Brent/WTI discount. The Russian invasion of Ukraine has increased global tension, boosted Brent prices and widened the differential. With this cost advantage, U.S. refiners are able to significantly increase refined product exports, mainly to Latin America and Europe, which tightened U.S. supplies and boosted margins, despite flat demand.
Unfortunately, the U.S. does not have an energy policy, and we still have a ban on exporting crude oil, which has been in effect for 40 years. Even with the Russian invasion, we seem paralyzed, confused and unable to respond to Russia's aggression. Lifting the export ban and supplying Europe with oil and refined products would reduce dependence on Russian oil and lower global oil prices, which in turn would hurt Russian exports and boost the economies of the U.S. and Europe.
TER: In your last interview, you talked about the impact of instability in the Middle East on companies like Apache Corp. (APA:NYSE). Do you see the situation stabilizing there? Are you more comfortable with companies operating in Egypt and Turkey?
FG: I believe the Middle East will remain volatile and unstable—not an attractive business environment. Apache sold 30% of its interests in Egypt to Sinopec, which is a step in the right direction. The sooner Apache exits Egypt and uses the proceeds to buy back stock, reduce debt and increase investment onshore in the U.S., the better off the shareholders will be. Why invest in Egypt or Turkey when you have the huge energy resources we have in the U.S.?
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TER: You also said natural gas prices in North America are severely depressed compared to the rest of the world. You called that a good thing because it would result in a second industrial renaissance. Are you still bullish on the prospects for natural gas as an economic engine for the U.S.?
FG: Low natural gas prices are good for the consumer and drive U.S. manufacturing. But I also believe in free trade, and the U.S. government should allow LNG exports to higher-price markets, mainly in the Far East and Europe. If we had built large LNG export terminals, we could have significantly reduced Europe's dependence on Russian gas.
TER: What companies are benefitting from the fracking boom?
FG: Domestic oil and gas producers, as well as oil service companies. Infrastructure and transportation companies are also joining the party, despite regulatory hurdles.
TER: How are the large, integrated oil companies faring in the new energy environment? What catalysts are you watching during earnings season?
FG: The stocks of the large international oil companies have not performed well in the last 10 years, as they lagged all other energy sectors and the market in general. They are viewed as defensive investments, but offer no real growth. They have above-market dividend yield, but are not attractive enough for investors who favor the pure plays of refiners or oil and gas producers.
"We expect Royal Dutch Shell Plc to generate free cash flow of over $20B over the next two years."
As far as individual company catalysts, Royal Dutch Shell's (RDS.A:NYSE; RDS.B:NYSE) new CEO, Ben van Beurden, has increased the emphasis on profits, capital efficiency and returns. Lower CAPEX and increased divestments should reduce net investments. We expect Shell to generate free cash flow of over $20 billion ($20B) over the next two years. We think this is a good start and rate it a Perform.
We will be watching production growth, cost trends, capital spending and plans to return cash to shareholders in the form of dividends and share buybacks.
TER: What about the prospects for the large independent exploration and production (E&P) companies?
FG: The large E&P companies are more attractive than the integrated companies, less volatile than the refiners and more stable than the small producers. Each has a catalyst. Anadarko Petroleum Corp. (APC:NYSE) benefited from a legal settlement, Apache benefited from restructuring, and so did Hess Corp. (HES:NYSE) and Murphy Oil Corp. (MUR:NYSE). EOG Resources Inc. (EOG:NYSE) and Pioneer Natural Resources (PXD:NYSE) benefited from oil production growth, while investors are waiting for the restructuring of Occidental Petroleum Corp. (OXY:NYSE) to take place. Marathon Oil (MRO:NYSE) and Devon Energy Corp. (DVN:NYSE) have lagged, but offer the lowest valuations in the group. Cabot Oil & Gas Corp. (COG:NYSE) and Range Resources Corp. (RRC:NYSE) will continue to reflect natural gas prices and additional pipeline capacity, which have constrained production growth.
As I mentioned in a recent research report, with higher production growth than the majors, a higher dividend yield and a lower valuation than E&P peers, ConocoPhillips (COP:NYSE) offers an alternative to both groups. We raised our 12-18 month price target to $85 from $80 to reflect an improving outlook on stronger financial and operating results and rated them outperform.
TER: Thank you for your time Fadel.
FG: Thank you.
Fadel Gheit , an energy analyst since 1986, is a managing director and senior analyst covering the oil and gas sector for Oppenheimer & Co. He has been named to The Wall Street Journal All-Star Annual Analyst Survey four times and was the top-ranked energy analyst on the Bloomberg Annual Analyst Survey for four years. He is frequently quoted on energy issues and has testified before Congress about oil price speculation.
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