By OGJ editors
HOUSTON, Mar. 4 -- The US integrated oil sector underperformed the broader equity market despite strong oil prices during the second half of last year, which UBS Warburg LLC attributed to a combination of factors, including market expectations that oil prices will fall sharply after resolution of the US-Iraqi dispute.
UBS Warburg analyst Matthew Warburton said the sector's stock price "disconnect with oil prices" also stemmed in part from the exclusion of Royal Dutch Petroleum Co. of the Netherlands from Standard & Poor's benchmark S&P 500 index (OGJ, July 22, 2002, p. 7). Consequently, US portfolio managers who were benchmarked against the S&P 500 found themselves having to reduce energy holdings to avoid becoming overweight on that sector.
And, contrary to popular view, US integrated oil sector performance has not been closely correlated to oil prices during the last several years, he added.
"With oil companies and investors apparently refusing to increase their long-term oil price views despite OPEC's continued success in maintaining prices, we continue to believe that it is highly unlikely that sector valuations will ever fully incorporate current oil prices," Warburton said.
Long-term sector valuations
The operational structure of the integrated oil sector also could be influencing investor sentiment, he said.
"There is a common perception that rising oil prices always result in poor refining and marketing margins and vice-versa. While there is evidence that this does often occur, it is by no means an absolute certainty. Therefore, given the very weak downstream earnings for the integrated sector in 2002, investors may be incorporating an expectation of continued (refining and marketing) weakness in 2003 to offset current high oil prices," Warburton said.
He noted that the sector "has proved remarkably resilient in instances since 1998 when oil prices have fallen by at least 20%." Given low levels of global oil inventories, Warburton believes oil price weakness will be limited to the mid-$20s/bbl for West Texas Intermediate following an Iraqi resolution.
"Oil sector performance has consistently demonstrated that oil investors do not incorporate either materially above-average or below-average oil prices into their investment decisions on whether to own oil equities or not. In other words, until the broader equity market and/or oil company community raises its current consensus view of around $20/bbl (WTI), the impact of higher than normal oil prices will always be viewed as temporary and therefore not incorporated into equity market valuations," he said.
