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Sunday, March 15, 2009

Provocative Research: Downgrade Integrated Oil

Credit Suisee downgraded integrated oils to 20% underweight recently, citing:

1. Price outperformance of about 30%;
2. Rich valuation with (a) P/Es close to the top of the historical range relative to the market ex-financials and (b) stock prices reflecting $60 per barrel oil, 31% above the current levels.
3. Oil Price: There is a good chance of demand disappointing and the prices staying low for longer. (a) at current prices, most other commodities have around 10% to 30% of production operating at a cash loss, compared to virtually none of oil production - yet, cartel and depletion rates are similar to other commodities (indeed, only around 10% of oil production is operating below berakeven, compared to 54% for steel and 17% for copper); (b) oil demand is likely to disappoint. The IEA expects a mere 1.2% decline in oil demand this year; yet, half of demand comes from developed countries, all of which are going through a severe recession (only 8% of demand comes from China). In the last major US consumer recession in the early 80s, US oil demand fell by 22% (compared to 7% so far). Miles driven in the US are still falling, down 4% yoy in December, despite gasoline prices halving. If demand disappoints, then OPEC discipline may crack (with OPEC spare capacity now at 6.5% of global demand); (c) bear markets in oil historically last 11 to 27 years. Investors appear to have too much faith in depletion rates and OPEC to protect against downside risk.
4. Big oil consistently appear as overweight in analyst recommendation;
5. High dividends of integrateds are inconsistent with low leverage of these companies.

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