Neither energy companies nor analysts are really confronting the possibility of a permanent drop in oil prices, says Oppenheimer analyst Fadel Gheit, setting CAPEX targets and earnings estimates higher than current prices (both the spot price and futures for WTI is below $60). He says that investors should get ready for deeper cuts as well as downward earnings revisions.
“Most energy companies are still in denial as they are unprepared for a prolonged period of low oil prices, which could be a big mistake as wishful thinking is not a strategy”, He write in a December 29 report titled Survival of The Fittest.
He says that even CAPEX cuts in the 20% – 40% range that have already been announced are too low, because energy companies are expecting that they will still have some moderate production growth. But Gheit says those cuts will only be enough if oil goes above $70 and stays there. While they think an average price of $70 is a lot more reasonable than $50 or $90 (with speculators causing a lot of the price volatility), there’s a good chance we will see more CAPEX cuts next year.
Consensus earnings estimates are even more optimistic, assuming that oil prices will average $85 next year. Sudden drops in oil prices have rebounded pretty well in the past, but history can be misleading because OPEC price manipulation has been such a major factor. Now that OPEC (Saudi Arabia in particular) is more interested in fighting for market share than supporting prices, the market may not behave the same way.
“It appears that Saudi Arabia is at it again, signaling that it is comfortable with $60/b Brent, as its estimated $740B foreign reserves could fund its expected 2015 budget deficit of $38B ($191B revenues vs $229B expenditures) for many years,” he writes.
While Gheit thinks investors should expect to see more borrowing by energy companies and even lower CAPEX spending, they warn to watch out in particular for layoffs as a sign that oil companies are digging in for oil prices to remain low and business conditions difficult for the foreseeable future. If that happens, investors can expect earnings to fall even further.
According to TipRanks.com, which measures analysts’ and bloggers’ success rate based on how their calls perform, analyst Fadel Gheit has a total average return of 7.4% and a 61.2% success rate. Gheit is ranked #662 out of 3442 analysts.