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Oil

Shale is the name of the game

The oil price took a serious dive in during the second half of May, closing the month at USD 53.50 per barrel (WTI) – down 16.3%! The XOP index of US shale oil & gas producers dropped 17.3%, while our selection of stocks fell 18.1%, pushing the certificate into the red on a year-to-date basis (-6.2%).

WTI XOPSource : Bloomberg

The fact that US oil inventories remain not only above expectations, but also above their 5-year average, alongside President Trump’s tariffs threats on Mexico, triggered the selloff in the oil market. Investors are worried that oil supply continues to grow at a rapid pace even as demand is set to slow, in line with world economic growth. It would appear that, after months of patiently waiting (in vain) for the OPEC+ production cuts to show up in oil inventories, they have thrown in the towel. This reminds us of the sudden oil price crash that occurred during the final quarter of 2018, when President Trump truly begun his “trade war” with China – introducing a 10% import tax on USD 200 billion worth of Chinese goods – and unexpectedly decided to postpone the sanctions on Iran. Investors also threw in the towel at that point, only to shortly see the oil price bounce back markedly. That said, a strange pattern then developed. Oil producer share prices did not follow the oil price back up. In effect, they have been tracking the oil price on the downside, but not on the upside… a phenomenon that is difficult to understand and has driven shale oil stocks ever cheaper.

They are currently trading at an expected 2019 EV/EBITDA that averages 4.5x and an estimated 35% discount to net asset value. Indeed, they have become so cheap that larger oil companies are getting into action. Continental Resources, for instance, one of the bigger shale oil producers, has announced that it will use USD 1 billion of its free cash flow to buy back a portion of its own shares. And, last month, oil major Chevron made a bid on Anadarko, also one of the larger shale oil producers, at a premium to market cap of roughly 35%, followed by an even higher bid by Occidental Petroleum (at a premium exceeding 50%). We expect more such moves and remain convinced that the oil price will trade (much) higher in the second half of the year, because of the already tight physical market (thanks to OPEC+ discipline) and the higher demand to be expected from the global shipping sector, where an engine shift towards low sulphur fuel oil or marine diesel oil will soon be mandatory. The major risk to our optimistic scenario would be a very serious slowdown in world growth, or even a recession, due to further escalation in the trade war.

(Update : 06.2019)

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