(MENAFN- Khaleej Times) It is ironic that inflation risk fears on Wall Street and an escalation of tensions in the Middle East coincided with a 10 per cent fall in the prices of both West Texas and North Sea Brent crude. After all, a spike in the Volatility Index (VIX), romours of colossal hedge fund losses, a rise in the US rig count, an (admittedly modest) safe haven bid in the US dollar meant a correction in crude oil was inevitable. This was all the more true since Brent had surged from $45 last summer to $71 on euphoria after a Saudi-Russian brokered Opec output cut and a plunge in global excess inventories of black gold. Profit taking was long overdue and a 2,000 point in the Dow Jones index and the EIA report that US oil output hit 10.25 million barrels a day was the catalyst for the crude carnage. The US has now replaced Saudi Arabia and Russia as the world's leading energy superpower, an event of seismic importance for international relations and world finance.
There are three reasons why crude oil prices will not go into a free fall in 2018. One, Saudi Arabia plans to privatise Aramco with a historic IPO and the kingdom's State Budget has expanded to $261 billion. Russian President Vladimir Putin will win election next month and will need to appease the Kremlin oligarchs whose wealth has been hit by recession and post Crimea Western banking sanctions. This means Saudi Arabia and Russia will continue the output cut discipline that anchors their joint "swing producer" strategy in the global oil market. Two, the IMF just upgraded global economic growth to 4 per cent and acceleration in the global economy boost demand for petroleum products.
Three, the safe haven bid in the US dollar is mild. Once the stock market selloff ends, the foreign exchange markets could well pressure the greenback due to a sharp rise in Uncle Sam's budget deficit as well as the political polarisation in Washington.
Since I expect bond yields and wage inflation to continue to rise in 2018, I have a natural bias for value over growth, making Big Oil a classic deep value sector. With a Relative Strength Index (RSI) in the early 30s, Chevron is credibly oversold on Wall Street after its earning miss. Chevron's fourth quarter revenues were $37.62, up 19.4 per cent from a year ago. Chevron's Permian Basin franchise alone makes it one of the most interesting of the Big Oil majors to me other than Total.
Chevron shares were slammed after its fourth quarter 2017 earning miss. America's second largest oil and gas supermajor after Exxon Mobil has traditionally delivered some of the highest production growth and reserve replacement ratios in Big Oil. True, Chevron has been impacted by low oil prices and mediocre refining/chemical returns, Exxon's Achilles heel, but this is reflected in the $20 hit in its share price from 134 to 113 as I write. Yet Chevron now offers a 3.8 per cent cash dividend. Now that its Australian LNG, Permian Basin, Angolan projects are on steam, its capex budget will drop, as will its financial leverage.
Chevron produces 2.7 million barrels of oil equivalent barrels a day (one fourth of its output is in the US) and operates in 180 countries worldwide. Its growth engine is the Permian Basin in Texas, where output could well rise to 500,000 barrels a day in the next three years. Outside the US, the Tengiz oilfield in Azerbaijan, the Vaca Muerta shale oil reserve in Argentina and offshore Gulf of Mexico are winners. As long as Brent remains above $60, Chevron could well buy back shares and boost its dividend in 2018 given $8.7 billion pre-dividend free cash flow. My buy/sell range for Chevron in 2018 is 106/124. Total is my favourite European supermajor, ideally in the 42-44 euro range.
Total has the highest output growth target (5 per cent) and lowest operating cost structure ($27 Brent pre-dividend cash breakeven). Its Maersk Oil, Eagle LNG and Brazil's Lapa oilfield acquisition boost its output growth and reserves while the fall in capex means a rise in free cash flow. Total is undervalued at 12 times forward earnings and a 4.9 per cent dividend yield.
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