Equity Strategy
10 April 2024
Drilling down on the Lagging Australian Energy Sector
Oil Price Reaches US$90/bbl

Energy stocks are drawing investors’ attention as the price of oil climbs. 

The recent surge in oil prices to $90 a barrel can be attributed to a confluence of factors:

Production Cuts by OPEC+

The decision by OPEC+, led by Saudi Arabia and Russia, to maintain current production cuts has limited supply, a tailwind for prices. To maintain market stability, OPEC+ countries will continue to withhold an additional 2.2 million barrels per day (bpd) from production until at least June. This builds upon the 3.66 million bpd reductions they previously agreed to in 2022.

Geopolitical Tensions

Ongoing conflicts in the Middle East, particularly the Israel-Hamas situation, raise concerns about potential supply disruptions, leading to increased risk premiums baked into the oil price.

Rising Demand

Global demand for oil is on the rise, particularly in Asia with strong demand recovery in China and India. This increased demand, coupled with restricted supply, is creating upward pressure on prices.

Figure 1: Australian energy majors have underperformed the oil price and global peers

Australian Energy Majors Lagging Global Majors

Australian energy stocks have lagged behind the price of Brent crude oil (in Australian dollars) and global oil majors so far this year (2024). This underperformance is likely due to lower prices for liquid natural gas (LNG) from Japan and Korea (JKM), which have fallen ~15% year-to-date. This decline in JKM prices has impacted Woodside (WDS) more than Santos (STO). WDS is currently down 1.5% year-to-date, whereas STO is up 4%. 

WDS has a larger share of its LNG production uncontracted. This exposes WDS more to gas price swings than STO, which has a higher proportion of contracts indexed to the rising oil price. This difference in contracting strategies explains WDS's recent underperformance.

Figure 2: Gas prices have softened over the past 6 months

LNG Soft in the Short Term

The global LNG market rebalanced throughout 2023, driven predominately by softer-than-expected demand amidst benign weather dynamics (i.e., a warmer-than-expected European winter). Looking ahead, while LNG prices could soften further over the near term, with gas storage levels currently at record highs in Europe and Asia, the outlook for LNG is still positive. 

Figure 3: Asia will drive demand for LNG over the next 5 years
Figure 4: LNG is expected to be in deficit in 2025

Remain Long LNG

From a bigger picture perspective, the LNG supply-demand dynamic remains attractive over the medium term. 

Gas demand in non-OECD Asia is expected to almost quadruple by 2040, driven by the combination of population growth, economic progress and industrialisation in the Asian markets. LNG is set to be a key component of the energy transition across Asia. In contrast to much of the West, major Asian countries are currently building out gas fired electricity generation, switching from coal to gas and scaling up their gas use as the foundational energy source across the region. As such, LNG demand is likely to remain on an upward trend for the rest of this decade, at least. 

Meanwhile, supply growth will be relatively limited over the next few years and Russian gas supplies will likely remain to some extent excluded from the European market. Together, the combination of strong growth in Asian demand for LNG and limited new supply is likely to see global LNG market tightness persist over the medium term, leaving the market susceptible to supply shocks and hence dramatic upward moves in spot prices. 

Therefore, the softness in the global gas market is seasonal rather than structural and the outlook is still positive. 


Oil Price Still Important for Australian Majors

While the Australian oil and gas majors have less exposure to oil than the global majors, the oil price is still instrumental in driving earnings.

Oil is still 30% of WDS production and while 45% of production is LNG, ~60% of these are contracted and indexed to the oil price. 

Therefore, we estimate that ~56% of the WDS’s earnings are driven by the oil price. 

We remain positive on the oil price over the medium term.

Demand should remain robust, with growth from Asia offsetting the decline in developed countries.

Supply is still constrained from a lack of investment in new oil production over the last decade.

The market is tight and, like gas, risk of price squeezes remains elevated.


Buying Opportunity for Australian Energy Majors

  • Australian oil and gas stocks are an opportunity at current levels. 
  • Earnings upgrades will flow through if the oil price continues to remain elevated. For example, WDS should see 15% FY24 earnings per share (EPS) upside at spot oil.
  • The LNG market will recover, boosted by demand coming from Asia over the next few years.
  • WDS is now trading at implied oil prices from ~$70/bbl. This is attractive considering our base case that the oil market will remain tight over this decade.
  • WDS trades well below global peers on an earning-to-value/ earnings before interest, taxes, depreciation and amortization (EV/EBITDA) basis.
Figure 5: Global peers trade on higher multiples vs WDS
Global peer median 5.5 4.8 4.8
Global peer avg 5.6 5.1 5.1
WDS 4.5 4.6 4.9
STO 5.6 5.4 4.7

Source: Refinitiv, Wilsons Advisory. 

WDS Our Preference

  • WDS has passed peak capex. FCF yields should improve from FY25 and beyond. STO still has a significant amount of capex over the next 3-4 years, a headwind for FCF growth. 
  • WDS has a stronger balance sheet that is steadily degearing over the next 5 years.
  • WDS are the lowest cost producer in Australia, with a barrel of oil cost of $8.30.
  • WDS has high quality growth projects in the pipeline with Trion in the Gulf of Mexico, Scarborough off the North West Shelf, and then Senegal Sangomar.
Figure 6: WDS's capex is peaking and free cash flow (FCF) yield is improving
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Written by

Rob Crookston, Equity Strategist

Rob is an experienced research analyst with a background in both equity strategy and macroeconomics. He has a strong knowledge of equity strategy, asset allocation, and financial and econometric modelling.

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