If you didn’t catch last week, I wrote to you about my US$150 per barrel oil price prediction. Although this target may seem unlikely, crude oil hit this price level back in 2007 — albeit, this had everything to do with supply and demand.
This time around, it will be because of geopolitical risk.
If you don’t believe me, and I don’t normally advise this, you should take a look at any mainstream newspaper. It will be filled with stories on the Middle East civil war, Japanese and Chinese tensions, Russia’s ‘invasion’ of Ukraine, and US sanctions on Russia. And the list doesn’t stop there…
Given the poor condition of the real global economy, these situations will only escalate further in the future. Governments are pointing the finger at everyone else but themselves for their issues. And the people are deeply dissatisfied with almost everything — they want better living standards and opportunities.
Based on the high level of geopolitical risk, which only continues to rise, US$150 oil certainly isn’t out of the question in the next couple of years. As such, I’m not expecting an exponential price rise. Increasing geopolitical tensions should see the oil price steadily rise towards my target over time.
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This means that, putting short term supply and demand to the side, I see higher oil prices as the new normal.
Given the oil and gas industry is one of the most profitable in the world, quality oil and gas stocks are set to gain under higher oil prices. One company set to benefit will be Australia’s top oil and gas company, Woodside Petroleum [ASX:WPL].
Woodside produces and sells liquefied natural petroleum (LNG), pipeline gas, oil condensate and LPG. Crude oil generated 20% of the company’s revenue in the first half of 2014. This number will only increase if crude oil takes off in the years ahead.
The company is trading at a low forward price to earnings valuation ratio of 12 times. This is below the Australian stock market average, which is around 15 times earnings. The low multiple implies that the market doesn’t like something about Woodside’s future.
With a high fully franked dividend yield of 6.7% and a very strong balance sheet, you have to wonder why.
It comes down to the company’s growth plan.
Woodside’s flagship asset is the North West Shelf project. The issue is that the North West Shelf should see its production decline in 2019. Given that it contributes 43% of total operating revenue, this is a big problem.
This means that shareholders will be heavily relying upon the Pluto project to pay dividends. Pluto is an excellent asset, contributing 42% of revenue. But it also has its problems. Primarily, that there’s not enough natural gas under the ground for expansion.
So what else is left?
Too be honest, not much. What I find more concerning is Woodside’s growth pipeline, or lack thereof. There are still a number of years before the Browse floating LNG project achieves production.
In fact, given the problems with Browse, I doubt floating LNG will ever go ahead. It’s likely that the company will end up going back to the drawing board and develop Browse onshore at James Point.
You may be thinking: this is true but Woodside has acquired a lot of projects around the world recently. You are correct. But these projects are at the exploration stage and are still one to three years away from drilling.
Woodside needs to embark on an acquisition splurge — and has plans to do. Woodside needs development and production assets for its business to grow.
And here lies the broader issue. Because of the need for expansion and development funds, shareholders could very easily see Woodside chopping its dividend in the medium term. As the stock is known for its higher yielding dividends, some shareholders and fund managers may not like this.
Nonetheless, let’s take a look at the technical picture. The chart below tracks the Woodside Petroleum share price. Each bar represents one week.
I want you to focus on two trend lines. Woodside has been trending upwards since the start of this year, following the red trend line (short term trend line). If the share price falls and holds below this trend line, it could signal a change in share price direction for the company.
The blue line (long term trend line) shows the upwards trending resistance line since 2011. If Woodside wants to breakout to higher levels, the share price needs to hold above this resistance.
In my view, given the current pattern, the long term and short term trend lines should merge heading into 2015. Given that I’m wildly bullish on the stock market, it seems that good is on the cards for Woodside shareholders.
But let’s have a look at the Fibonacci sequence lines.
Although not shown on the chart, the Fibonacci sequence lines have significance dating back to the financial meltdown of 2008/09.
For example, the 0% Fibonacci line marked the support level when Woodside’s share price fell from $50 dollars to around $35 dollars in one week. And the 100% Fibonacci line acted as a major support area for the market bottom of roughly $31 per share. These levels also mark the closing low and high dating back to 2011.
More importantly, we’ve seen the share price range between the 61.8% ($37.59) and 50% ($39.82) Fibonacci levels. Recently, the share price quickly broke this range. It seems that new support is around the 38.2% ($42.07) Fibonacci level. But given the share price momentum along the short term trend line, it may not be long until $44.86 is support.
Given the rocky fundamentals and my analysis on the short term correction into October, investors could easily sell the share price back to the 50% ($39.82) Fibonacci level. This would see the green trend line being brought into play.
In the future, the company’s capital management and mergers and acquisitions strategy will likely be the narrator of the Newcrest story. At the moment, Woodside is caught between a rock and a hard place.
Jason Stevenson+
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