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Oil has no reason to melt down: energy analyst

Lawrence Lewitinn
Lawrence Lewitinn

Worries about China and near-record production from OPEC and the U.S. have knocked oil prices below $40 a barrel. But one energy analyst thinks the markets may have beaten up crude a little too much.

Oil has fallen by a third in the past month and a half, with the price of crude tumbling some 7% in the last five days alone. Bad economic data out of China and the country’s subsequent devaluation added to concerns that there’s more supply of oil than demand in the markets.

Data from the U.S. Energy Information Administration show American production at 9.4 million barrels per day, still close to its all-time highs of 9.61 million barrels per day set in June. OPEC production is at 31.5 million barrels per day, which is a 3-year high.

However, Pavel Molchanov, energy analyst at Raymond James, maintains nothing has happened in the past few days to merit such a steep selloff.

“Nothing happened in the oil market in the last 24 hours or 72 hours to cause this kind of meltdown other than just sentiment on all commodities and all equities being so negative right now," he said.

He continues to hold his $55 per barrel price target for West Texas Intermediate crude (CLV15.NYM) and $62 for Brent crude (BZX15.NYM).

Molchanov dismisses the downturn in China’s equity markets as a harbinger of things to come in the country’s economy. After rallying 60% in the first 5 months of the year, the Shanghai Composite (000001.SS) suffered a massive selloff that sent the index into negative territory for 2015.

“Chinese oil demand, which is ultimately what matters for oil fundamentals here, is actually doing fine,” he said. “It’s growing modestly. Nobody was expecting Chinese oil demand to grow 10% or even 7%. It’s growing at about 3% which is actually very fast for an extremely large economy – much faster than it’s growing in the U.S. or in Europe.”

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On the supply side of the equation, energy companies have reduced their capital expenditures by 25% globally and as much as 50% in North America, Molchanov said. “This austerity means that the supply response is going to be move visible, even more pronounced in the years ahead – a lot more in 2016 than what we’ve seen now and possibly even more in 2017,” he added.

The year-long decline in crude prices has meant bad news for the stocks in the industry. The S&P 500’s energy sector index (^GSPE) has tumbled 35% in the last 12 months and is the worst-performing sector in the broad market index (^GSPC) this year. Yet Molchanov expects a few stocks to benefit from a crude bounce.

“Obviously we’re in a tough tape,” he said. We want to focus on are companies that can support their capital investment program and also support dividends. Dividends are particularly critical in this kind of environment when obviously the share price is hypervolatile day-to-day. Balance sheet safety and dividend sustainability are really critical metrics to watch.”

Molchanov is particularly optimistic about Occidental Petroleum (OXY). “They’re about 80% oil in terms of the asset base, the best balance sheet in the industry, and a dividend yield that is approaching 5%,” he said, adding that Chevron (CVX), Marathon Oil (MRO), and Hess (HES) “are all companies where we look at dividends as safe and that have a balance sheet, that investors do not have to worry about the company going to a liquidity crisis, or a Chapter 11 or anything like that.”

But that Molchanov tempers his optimism with a caveat about other energy stocks.

“Certainly there are companies out there that are going to face very, very tough conditions in the current commodity landscape,” he warns. “There will be bankruptcies across the energy sector unfortunately.”

 

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