Oil’s rally may be overblown but gas still offers some interesting plays

Oil prices have rebounded strongly since the West Texas Intermediate (WTI) crude benchmark plummeted into negative territory in April.

The upward trend is pinned on the hope of a strong rebound in oil demand as more countries emerge from COVID-19 restrictions.

The WTI is currently trading above $US40 ($57.87) per barrel while the broader Brent crude benchmark is testing the $US43-per-barrel mark.

Some analysts have already started slinging more bullish forecasts for the near-term, with Bank of America noting that Brent crude could return to $US50 per barrel in 2021.

This is predicated on three factors holding true: the continued rebound in demand, deep supply cuts, and OPEC, Russia and other major oil producers (OPEC+) sticking to agreed production cuts.

However, it is unclear if OPEC+ will maintain the current 9.7-million-barrel-per-day (MMbpd) production cut into August, while concerns remain that another wave of infections could bring demand recovery to a grinding halt.

Stockhead’s resident resources expert Peter Strachan is sceptical about the oil recovery, noting that the market might be too optimistic about how quickly demand is recovering.

“My feeling is that the market is looking and saying, ‘Europe’s opening up, COVID-19 is being beaten and we are on the road to recovery’,” he noted.

“I think there will be a point where it will go ‘Oh, we’re still producing 80MMbpd to 85MMbpd of oil and only consuming 70MMbpd.

“This could result in another downturn that will have a knock-on effect on global oil production and we will probably come back into some sort of balance as we come into the northern hemisphere’s winter period.”

And he isn’t alone in his thinking.

UK supermajor BP last week slashed its long-term price expectations by 27 per cent to an average of just $US55 between 2021 and 2050.

It said that was because of the lingering impact of the pandemic on oil consumption and a growing expectation that this would result in an accelerated transition to a lower carbon economy.

Rystad Energy’s head of oil markets Bjornar Tonhaugen also warned that $US40-per-barrel oil was the new normal and that further gains would not be justified as there were still valid concerns on the demand side.

Gas is decoupling from oil

That is not to say that there are no bargains to be found in the oil and gas sector.

Strachan believes that the key point for investors to note is that gas prices in Australia are a “little bit divorced” from the global energy market.

He noted that while domestic gas prices on Australia’s east coast had fallen from $9-10 per gigajoule (GJ) to around $4 per gigajoule, it was still attractive enough for liquefied natural gas (LNG) producers in Gladstone in Queensland, to reduce exports and sell gas domestically.

“It costs $US1.50/GJ to ship the LNG, between $US1/GJ to $US1.50/GJ to process while the usual cost of gas is $US3/GJ,” he explained.

“That is a minimum of $US6/GJ just to get your money back and they are selling it for $US3/GJ on the LNG spot market.

“Rather than do that, they can just put it into a pipe and sell it on the domestic market and still make money.”

Longer term, a price of over $US6/GJ would be required to support LNG production and export.

Energy picks

Strachan pointed to some of the stocks he thinks have potential in oil and gas space.

“One of my favourites is 3D Oil (ASX:TDO). They have got these very good looking gas structures in the Otway Basin and ConocoPhillips has just farmed in to earn an 80 per cent interest by shooting seismic and then covering the first $30m of cost towards drilling a well,” he said.

The T/49P permit prospective resources are estimated at about 10 trillion cubic feet (Tcf) of gas and can be quickly developed in the event of a discovery thanks to its proximity to existing gas infrastructure.

This is timely given that gas production in southeast Australia is declining, with existing fields in the Gippsland Basin set to reach the end of their lives between mid-2023 and mid-2024.

The upcoming constraint in supply has contributed to the Victorian government’s decision to allow conventional onshore gas exploration.

Exploration risks are also low with Strachan noting that since the industry started using 3D seismic in the offshore Otway Basin, there has not been a single well drilled on 3D seismic anomalies that has not found gas.

Other East coast gas producers such as Cooper Energy (ASX:COE) are also worth looking at, according to Strachan.

“They have gas coming on from the Sole gas field and they also have gas in the Otway Basin,” he said.

Looking further afield, Strachan pointed to Invictus Energy (ASX:IVZ) as another company with potential.

“The whole of the southwest of Africa does not have much in the way of gas and yet they need about 1,000 megawatts of power each year, which has caused huge shortages of power,” he told Stockhead.

Invictus holds the promising Cabora Basin project in Zimbabwe that was first explored by Mobil in the 1980s and early 1990s.

While Mobil was quick to see its gas potential, it exited the project as there wasn’t much of a gas market at that time.

No drilling has been conducted to date but what the company has uncovered from reprocessed seismic data is the presence of stacked objectives – some with amplitude versus offset anomalies that are an encouraging pre-drill indictor of possible hydrocarbons.

“I think that would be very valuable gas if they were to find some gas there,” Strachan added.

Strachan also favours ADX Energy (ASX:ADX), which has a project in Austria and a gas discovery in Romania that will be tested in the next month or so.

“Again gas in that location is quite valuable because everyone in Europe currently buys their gas from Russia and smelling the bear’s breath down your back is a scary thing,” he noted.

“So everyone wants to diversify away from Russia, so that will be quite an interesting prospect as well.”

ADX is already carrying out gas commercialisation studies for its Romanian project to study either the delivery of gas to the nearby Satchinez-Calacea gas plant or the on-site conversion of produced gas to power and connection to a high voltage power line just 2km from the well location.