From the October 2009 issue of Research Magazine • Subscribe!

October 1, 2009

Powering Up

A select number of companies in the energy sector are getting the attention of equity analysts thanks to their access to resources and their capable management.

A select number of companies in the energy sector are getting the attention of equity analysts thanks to their access to resources and their capable management.

Robert Jakobsen
Jyske Bank
+44-8989-7044
jrj@jyskebank.dk

We do not consider an oil price of $70-$80 unlikely over the next 12 months. So far, the price has mainly risen due to reductions in the supply (quotas), and further increases are thus to be driven by increases in demand.


In the long term, the current oil price still seems low despite the recent weeks' increases. The Energy Information Administration expects in its base-case scenario an oil price of $113 in 2030. Of course, this involves great uncertainty, but even in our worst-case scenario we see an oil price of $69, while we see a price of $186 in our best-case scenario.

In the long term, we anticipate that the demand for energy will increase significantly, and despite the continuing rising consumption of alternative energy sources we do not believe that this can offset the marginal demand, and the consumption of oil will also continue to rise for a good long time to come. This is supported by EIA's International Energy Outlook 2008.


Royal Dutch Shell (RDS.A)
: We introduce Shell and commence our coverage with a Buy recommendation. Contrary to many of its rivals, Shell has the advantage that it covers the upstream (exploration and production) as well as the downstream market (distribution) and holds strong positions in both business areas. This has been a valuable combination over the past year. We do not believe that the market has fully discounted this, and the share is thus currently much undervalued. There are several reasons why we commence coverage.

Shell has a good financial basis with e.g., a low gearing and decent cash flow. This is to contribute to ensure future growth through considerable investments, which will make Shell emerge stronger from the financial crisis - well prepared for better times. The reasonable financial position makes massive investments in new capacity and research/development possible.


The company has an excellent track record for dividends - it paid in 2008 a dividend corresponding to a dividend yield of almost 7 percent. Offhand, we see no risk that Shell will have to reduce its dividend yield considerably over the coming years. We expect that the company's new CFO will take a critical look at the organizational structure and initiate savings and rationalization plans to reduce costs to the sector level.

The company has a well-diversified business model - geographically as well as in terms of products. In addition, the company is present in all links in the value chain.

Carl Kirst, CFA
BMO Capital Markets Corp.
713-546-9756
carl.kirst@bmo.com

While correlations remain in the below-historical 50 percent range, natural gas liquid (or NGL) prices are still on the rise, and frac-spreads (the margin between NGL and natural gas prices) have climbed back to well above 10-year averages, and should continue to strengthen in 2010. Companies with exposure to NGLs and/or widening frac-spread, include Williams Companies, Southern Union, Spectra Energy, Oneok, Questar, Fort Chicago Energy (units), and Inter Pipeline (of Canada).

Questar (STR)
: Our top commodity-levered stock remains Questar ($47, Outperform). We believe its mix of 60 percent to 75 percent hedged position through 2010, high return Pinedale and Haynesville asset base (of which we now include $7/share of non-conventional value), discounted E&P reserves (implied E&P valuation is $1.59/Mcfe of proved and 4.5x EBITDA, a 40 percent discount on both counts to the BMO large/mid-cap E&P universe average) makes a compelling valuation story even with gas prices coming under pressure.


Our net earnings outlook was recently reaffirmed (and above guidance); the company showed further progress in the Haynesville (another top well, lower drilling costs and more acreage), improving Rockies basis (from ~$1.25 discount in June to only ~$0.50 in July), and it expects a horizontal test in the Granite Wash by year end (potentially putting it in another high-profile play).


We like the fundamental foundation of STR, particularly for a stock whose implied E&P value is trading at under half the average E&P on a unit reserve basis, and below that of its pipeline peers. In short, we think investors should take advantage of any weakness at current levels.

We'll keep the earnings overview to the clean headline of $0.54, on target with consensus ... After several hours of model tweaking, analysis, et. al., we came away with an earnings outlook unchanged - continuing our belief that management guidance is conservative - and that the fundamentals continue to support owning this name at its current valuation.

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