Investment bank Citi says “big oil” needs to get its house in order to fight persistent lower energy prices, after Iran and six world powers struck a nuclear deal which will end tough economic sanctions on the oil-producing giant.

Citi analyst Alastair Syme said the return on investment for global big oil, which was already at a 17-year low, was expected to fall further, after the investment bank lowered its forecasts for oil prices by 8 per cent in 2015 and by 10 per cent in 2016 earlier in the week, as the stronger US dollar, Saudi exports, stockpiling inventories and the impending Iranian production “could setup a bearish end to the year”.

Citi analysis forecast incremental Iranian production of 300,000 barrels of oil entering the market in early next year, ramping up to 500,000 by the end of 2016.

Meanwhile, Morgan Stanley expected lower crude oil prices in the longer term, despite the uncertain timing of the extra Persian supply entering the market.

The lifting of the sanctions were unlikely before late 2015 or early 2016, Morgan analyst Vinay Jaising said, but the deal could lead to up to 700,000 barrels entering the market.

In a research note titled ‘Feet to the Fire’, Mr Syme said Big Oil firms with high quality management teams will be the ones placing a priority in putting their house in order.

“Step one is to accept that we live in a $US65 to $US75 a barrel world or lower,” Mr Syme said. “Step two is to use that view to drive self-help.”

Mr Syme said big oil would be seeing lower earnings per share growth, cutting the sector’s earnings per share by an average of 4 per cent in 2015 and by 9 per cent in 2016.

He said it was expecting the return on investment to trend lower, which was already at a 17-year low of 7 per cent in second quarter of 2015, to below 6 per cent in the fourth quarter of the year.

Mr Syme said attacking costs provides a boost to return on investment, and it also sent a clear signal to shareholders around management’s due care on capital allocation.

He said many firms would be promising to keep costs in focus, but lacked the “deep-seated cultural change” that was necessary to survive.

“With the oil market remaining in oversupply we think prices, for a period, will trade closer to cash than marginal incentive costs,” he said, expecting US shale activity to pick up pace in the second half of the year, while Saudi Arabia will continue to defend its market share.

Looking at the big players in the global oil sector, Citi said small moves in the oil price, which lost around 50 per cent of its value last year, have a big impact on the company’s stock earnings.

Citi said BP’s earnings were sensitive to changes in oil and gas prices, all of which can fluctuate significantly due to economic and geopolitical forces — a $US1 a barrel move in oil prices is thought to have an impact of 2.2 per cent on BP’s earnings per share.

A $US1 a barrel move is estimated to affect Chevron’s earnings per share by 1.4 per cent, ExxonMobil by 1.1 per cent and Royal Dutch Shell by 1.8 per cent.

The lower energy prices have hit Australian oil and gas producers, With Santos (STO) and Woodside (WPL) both posting soft revenues in the June quarter.

Santos today unveiled a drop in quarterly revenue of almost 20 per cent due to falling energy prices, as the oil and gas producer fights back by slashing spending.

Australia’s Woodside Petroleum, a larger rival to Santos, yesterday revealed a 47 per cent plunge in quarterly revenue, as oil and gas prices weigh on the company’s balance sheet.

Morgan Stanley, looking at the Asian oil market, tipped companies with strong production growth amid a weak crude oil price would be the best performing firms in the longer term.

Asian refiners will stand to benefit from the weak crude environment, because of their lower cost feedstock advantage or cheaper industrial processes, Mr Jaising said.

Citi said the capital investment necessary for oil drilling in Iran was significantly below that for shale or offshore drilling, which would be a negative outcome for all oilfield service operators. But the opening up of Iran’s oil markets will be also be an opportunity for the western energy industry, with firms likely able to re-enter the country and aid further production expansion. Citi said engineering and construction firms could be net winners.

Source: www.theaustralian.com.au

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