by Sumit Roy
An energy analyst talks about the importance of the Marcellus Shale on the natgas market, the Brent-WTI price spread and why Anadarko is priced to buy.
Fadel Gheit is a managing director and senior analyst covering the oil & gas sector for NewYork-based Oppenheimer & Co. He has been an energy analyst since 1986 and was named to The Wall Street Journal All-Star Annual Analyst Survey four times. He was also the top-ranked energy analyst on the Bloomberg Annual Analyst survey for four years. HAI's Sumit Roy caught up with Gheit recently to discuss the latest developments in the oil and gas markets.
Hard Assets Investor: We've seen a huge decline in crude oil prices over the past several months, falling 30 to 40 percent depending on which benchmark you use. What were the catalysts for this move?
Fadel Gheit: The rise in oil prices was driven mainly by concerns about potential supply disruptions from the Middle East. The sharp decline in the last three months was mainly due to a weak demand outlook on slower economic growth amid fears that the European debt crisis could lead to a global recession.
HAI: Does OPEC matter anymore, with Iran crippled by sanctions and Saudi Arabia pumping flat-out, despite calls from other members to cut its production?
Gheit: OPEC does matter, because it produces 30 million barrels per day. On one hand, it needs higher export revenues to increase domestic spending to avert more uprisings. On the other hand, given the weak demand, it must cut production to prevent an even sharper decline in oil prices. However, high oil prices would impede global economic recovery. So, there is a balancing act here that OPEC must do.
HAI: The spread between WTI and Brent has come down significantly from its record near $28, but it still remains substantial. The reversal of the Seaway pipeline didn't seem to have an impact, or did it? When do you see the gap ultimately closing?
Gheit: The spread peaked last year when the civil war in Libya shut down oil exports, which tightened supplies. The spread, which is currently $10-$13 a barrel, will ultimately narrow to reflect the cost of transportation from the Bakken shale oil play to the Gulf Coast refineries. If pipeline capacity expansions outpace production growth, the spread narrows, and if incremental production exceeds pipeline capacity, the spread widens.
HAI:. U.S. crude oil production is surging by hundreds of thousands of barrels per day and is now at the highest level in 13 years, according to the EIA. What is causing this and how much can output climb going forward?
Gheit: The oil & gas industry has successfully cracked the shale resources wide open through the use of horizontal drilling and hydraulic fracturing, or what you hear as "fracking." Production has been increasing in the last four years and as long as oil prices remain above $70 a barrel, this trend will continue for many years to come.
HAI: Natural gas is finally perking up after crashing to decade-lows below $2 earlier this year. Has the market finally turned the corner?
Gheit: We think natural gas prices have bottomed and are likely to move higher. Barring any major government policy changes and unusual weather impacts, natural gas prices should climb above $4/mmbtu in the next two years. However, barring a major shift in Washington, in favor of accelerating the use of natural gas in power generation — replacing coal, and in transportation— replacing gasoline and diesel — we think natural gas prices above $4.50/mcf are not sustainable.
HAI: You recently said the Marcellus Shale is "single-handedly" keeping natural gas low. Can you tell us more about this resource and is there a way for investors to capitalize on it?
Gheit: The Marcellus is probably the largest onshore gas field in North America and even the world. With the largest gas-consuming market [in the U.S. Northeast] within a few hundred miles, liquids content and fast-growing transportation, it has decisive competitive advantages over all other gas plays in North America. There are more than 50 companies operating in the Marcellus. The largest players are Range Resources (NYSE:RRC), Chesapeake Energy (NYSE:CHK), Anadarko Petroleum (NYSE:APC) and Cabot Oil & Gas (NYSE:COG).
HAI: What is the top pick in your coverage universe and why?
Gheit: Anadarko Petroleum (APC)—This is a premiere exploration company, which has made more discoveries in the last one, three and give years than any other company.
- It has a balanced portfolio between oil and gas, onshore and offshore, U.S. and international.
- It has 7 million U.S. onshore acres of fee land, where oil & gas revenues are exempt from U.S. royalties of 20 percent, which is a huge competitive advantage.
- It recently settled potential liabilities from the [Gulf of Mexico] oil spill by paying BP $4 billion.
- It recently won the tax dispute with Algeria, worth $1.8 billion.
- It recently made a huge natural gas discovery offshore of Mozambique, which could potentially boost its market value by more than $10 billion.
After reaching a record high of $88/share earlier this year, the stock plummeted by 34 percent on potential environmental liabilities by Kerr-McGee, which Anadarko acquired five years ago. We expect a settlement in the next two months, which would remove investor concerns and boost the stock substantially.
Disclosure: No positions