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Reports of the unrest in the Middle East and North Africa have drifted on and off the front pages, but the resulting volatility in oil prices has led to a continuing headache for investors.
The reaction of the equity markets has been puzzling. Share prices of energy companies haven’t followed oil prices up and down, as might have been expected. While the price of Brent crude oil leapt 24% earlier this year, global energy stocks rose by just 12% (see graph at the bottom of this story). Is this an opportunity or an illusion?
To answer that question, investors face a particularly challenging conundrum. Getting a grip on the outlook for oil pushes us out of our comfort zone and requires complex analysis, spanning politics, socioeconomics and markets.
I’m no expert on the Middle East or North Africa. But when we started to tackle the issues, it was clear that regional instability wasn’t going away any time soon. With low per capita GDP and income, young populations and a lack of basic freedoms, countries in the region were likely to face prolonged turbulence.
When Libyan oil production shut down, oil prices spiked to $125 a barrel, because markets feared that the relatively stable Gulf states, which account for most of OPEC’s spare capacity, might be next. There’s little excess supply available, even though Saudi Arabia has increased production by 1 million barrels a day and the US and other oil-consuming countries have released some strategic reserves.
Before the ‘Arab Spring’ began, our analysts estimated that the fair price of Brent crude was between $85 and $90 a barrel. That estimate was based on global supply-and-demand trends, taking into account a range of factors, from global economic growth to Chinese demand to spare capacity in oil-producing countries.
We think that oil prices will stay high for at least the next six to 12 months if the global economy avoids a double-dip recession and continues its gradual recovery, and Chinese demand for energy stays firm. We also see upside potential if the situation in the Middle East remains tense or deteriorates further from here. Yet in the long term, we’re sticking with our initial analysis: market fundamentals should eventually bring oil back to about $90 a barrel.
How do we invest, given the gap between our near-term and long-term outlook? We’re looking for energy stocks that are attractively valued based on our long-term estimates for oil prices and earnings, and that will also generate plenty of excess cash if oil stays high through the year ahead. Some Russian companies trade below six times our long-term estimates, and several major integrated oil groups trade at seven or eight times our forecasts. At these prices, I’m finding it hard to resist those energy companies that have less production exposure to the most troubled countries in the Middle East and North Africa.
Kevin Simms is the Global Director of Value Research at AllianceBernstein
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio management teams.
