Saudis Open Spigots as War Looms
www.quicken.com By Dimitra DeFotis Wednesday, March 19, 2003 11:59 PM ET Printer-friendly version
ON THE VERGE of another Persian Gulf War, the United States has eked out unexpected support from Saudi Arabia.
When it was revealed that most of the September 11 hijackers held Saudi passports, the backlash was palpable: alternate oil alliances would be cultivated.
Fast forward 18 months: the Saudis have allowed the number of U.S. troops, mostly based at the Prince Sultan Air Base, to double in the past month. There are now roughly 7,500 coalition troops in the Kingdom of Saud.
And with Iraq's 1.8 million barrels of daily crude production dwindling as war looms, the Saudis have been surprisingly vocal about picking up the slack, and are now pumping roughly 9.5 million barrels a day.
So while some in the Organization of Petroleum Exporting Countries won't take action perceived as supporting the United States, the Saudis have quietly lent support to the U.S. mission. (The invasion could start within hours, possibly as early as 8 p.m. tonight.)
The Saudis reportedly have 50 million barrels of oil already in tankers, one way it can prevent a precipitous drop in oil prices. They want sustained oil prices near $25 per barrel to encourage consumption.
Prices near $25 should boost global economies by lowering energy costs for consumers and manufacturers, and help some exploration and integrated oil companies whose shares still reflect uncertainty about the impact of the war.
"The Saudi government and the U.S. government go back 60 years," says Michael Rothman, a senior energy market specialist at Merrill Lynch. "And while the relationship might be strained, there is mutual interdependence. The Saudis are the source of supply outside emergency stocks."
The Saudis could produce as much as 11 million barrels a day with more investment, says Tom Petrie, president of Petrie Parkman & Co. in Denver. Saudi Arabia has proven reserves of 262 billion barrels -- 25% of the world's proven reserves and Iraq places second with 113 billion, according to Fadel Gheit, an analyst at Fahnestock & Co.
Oil prices, closing below $30 Wednesday, have dropped 25% from recent highs near $40 as traders conclude U. S. military strength will prevent catastrophic destruction of oilfields and distribution facilities.
In 1991, after U.S.-led efforts were declared a success, oil prices dropped to near $20. OPEC can live with those prices, that's what the major oils budget for, and it provides a great operating environment for exploration and production companies, says John Kilduff, an energy trader at Fimat USA, a New York-based commodity brokerage.
Several energy analysts tell Barron's Online that the remaining war premium of as much as $5 per barrel will dissipate and that oil prices will fall to $28 near term and settle near $25. That's higher than the two-decade average of $20, but inventories are low partly because of disrupted Venezuelan production (see Weekday Trader, " Venezuela Crisis May Fuel Oil Firestorm," December 10, 2002).
Saudi Arabia is almost betting on a quick U.S. victory in Iraq by "pumping as much as it can get out of the ground, because in a week or two, prices could be much lower," says Gheit.
So, which energy companies does all of this help?
In the past year, while oil prices are still up more than 20%, shares in both refiners and energy equipment companies have fallen roughly 24%, according to Thomson Baseline. Integrated oil companies have not fared much better, losing 21%, and drillers are down 18%. Oil and gas exploration companies have held up best, declining 10%.
Roger Mortimer, lead manager of the AIM Global Energy Fund, expects to see oil near $25, but that some energy stocks price in $20 oil.
One is independent Canadian E&P Talisman Energy (TLM, news) . He thinks its shares may not reflect a positive: Talisman sold its business in Sudan last October because investors did not like the political volatility of projects there. Meanwhile, shares are "still extremely attractively valued vs. other companies with its size and scope."
Talisman's international exploration plan launched in 2002 is its most aggressive ever. It expects a roughly 10% annual gain in production in the next two years, according to Standard & Poor's.
The shares trade at a 38% discount to their median forward price-to-earnings multiple of 17.8 times, according to Baseline. And it is trading below its historical discount to its E&P peers.
The other stock Mortimer likes is BP (BP, news), whose diverse businesses buffer it from oil price volatility. That's because it can make up for higher crude prices with higher gasoline prices in the near term -- and can benefit long term from sustained prices near $25 that will spur more exploration projects.
Mortimer thinks earnings estimates will be ratcheted upward as crude prices stabilize, and in the meantime, investors get a dividend (see At A Glance).
"We like BP. You have company with a very strong balance sheet, low net debt, a tremendous amount of cash flow and has been buying back stock," Mortimer says.
Of course, prices would spike higher if Saddam attacks Saudi or Kuwaiti oil fields, and the idea of a quick war is absurd to many Middle East experts.
But for now, Saudi Arabia's massive oil reserves, ramped up production and cooperation with the U.S. should help stabilize volatile oil prices – and calm jittery investors.