Major outages and a stand-off between the U.S. and Iran are sending oil back into bull mode. What a change from when crude made 12½ year lows in 2016 and fell again late last year. Many investors must be wondering: “Should we believe this rally?”
In my view, it’s more than just Iran. There are also fundamental forces pushing oil higher.
For instance, the world’s appetite for oil products is growing faster than many forecasters expected.
Demand for crude grew by 1.55 million barrels per day (bpd) in January alone, mostly driven by consumption in emerging markets.
Gasoline demand is particularly strong. Research by Goldman Sachs shows gasoline consumption grew by 510,000 bpd, the highest since May 2016.
Reasons include the move away from diesel engines in Europe, a value-added tax cut in South Korea, and a drop in gasoline prices relative to biofuel in Brazil.
But it’s in China, a key engine of demand, where the effect is most pronounced.
China’s oil consumption grew by 340,000 bpd in January and February … and socked away 360,000 bpd. A buildup that runs counter to the seasonal trend.
In China, a key engine for oil demand, oil consumption grew by 340,000 bpd in January and February, according to Goldman. The Chinese also stocked away 360,000 bpd, a buildup that runs counter to seasonal trends, the bank says.
Gasoline demand in particular is surprisingly strong. Over the last three months, Goldman’s subsample of consumers shows gasoline consumption growing by 510,000 bpd, the highest reading since May 2016.
Goldman sees catalysts around the world, including the move away from diesel engines in Europe, a value-added tax cut in South Korea and a drop in gasoline prices relative to biofuel in Brazil.
As Goldman said:
“Any further meaningful rally in oil prices will likely lead to further U.S. pressure to ease (output cuts by OPEC and its allies). So far, however, the ongoing OPEC ‘shock and awe’ strategy has shown no signs of wavering after the latest U.S. presidential oil tweet.”
The U.S. Energy Information Administration (EIA) forecasts crude oil production in the OPEC countries will average 30.3 million barrels per day (b/d) in 2019, down by 1.7 million b/d from 2018.
It’s a perfect storm for higher prices, and a good way to play it is via the SPDR S&P Oil and Gas Exploration & Production ETF (XOP).
And top players in the field should leave everyone else in the dust …
In February, I had a chance to sit down with Kyle Preston of Canadian producer Vermilion Energy (NYSE: VET).
VET’s production is booming. For 2019, the company is guiding production between 101,000 and 106,000 barrels of oil equivalent per day. That’s year-over-year production growth of 18%.
Compare that to a 6%-per-year rate through 2012. This company is really hitting the accelerator!
And free cash flow — negative as recently as 2011 — is now charging into the black.
Plus, Vermilion’s reserves are growing due in part to the recent acquisition of Spartan Energy Corp.
Unlike a number of its Canadian peers, Vermilion has zero exposure to heavily discounted Western Canadian heavy crude.
And it has worldwide reach.
For its production outside North America, Vermilion enjoys premium pricing for Brent crude.
And its European natural gas trades near the global liquified natural gas rate of around $11. Compare that to a recent U.S. Henry Hub price of $2.60!
The higher margins generate a LOT of capital that can be invested in new projects, expand existing ones …
… or for paying its monthly dividend.
Vermilion’s recent yield was over 8%. Nice! Compare that to 4.3% for ExxonMobil, or 1.8% for ConocoPhillips.
And Vermilion has NEVER reduced its dividend, even when other oil companies did through the 2015-’16 bear market.
With this company being such a great combination of cost-saving efficiency, low discounts and production in pricey markets, I expect to see its cash flow rise and its dividend rise along with it.
Just the kind of cushion you want if the floor drops out from below Mr. Market’s feet.
Yet by many metrics, Vermilion is seriously undervalued.
As Aretha Franklin might ask, why doesn’t Vermilion get the respect it deserves?
In February, I sent out a special subscribers-only video talking about my views on this market, in an interview with Kyle Preston of Vermillion Energy. I’m giving you free access HERE.
I believe investors just can’t figure this company out.
It’s in that awkward middling space — neither a wildcatting explorer nor a big major.
It’s also tarred with the same discount brush as the Canadian oil sands companies, even though it doesn’t have any of the oil sands product that is sold at a markdown.
And no credit is being given for its high-priced European gas.
All this should soon change. And my subscribers are paid every month to wait. If you’re doing this on your own, do your due diligence and keep your position size manageable.
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All the best,