Last week, the price of Brent crude oil reached a 2016 high of almost US$54 per barrel. It has been pushed upwards by improved investor sentiment following Opec's deal to cut oil output to between 32.5 million and 33 million barrels of oil per day (bopd). The oil price was also supported late last week by a decline in petrol stocks of 1.2 million barrels and a drop in distillates in storage of 3.7 million barrels.
A higher oil price is good news for oil and gas companies Santos Ltd (ASX: STO), Woodside Petroleum Limited (ASX: WPL) and Oil Search Limited (ASX: OSH). However, I believe that the oil price faces an uncertain future. That's why I'm bearish on Santos's outlook.
Oil price fall
Assumptions that the supply and demand of oil are back in balance were put into doubt by the Energy Information Administration (EIA). It reported a rise in raw crude reserves of 4.9 million barrels last week. This follows the International Energy Agency's (IEA) statement that a glut of supply will continue to be a feature of the oil market until at least mid-way through 2017.
Although Opec has agreed to cut production, it is not widely seen as a firm deal to do so. This will only come once it has been decided which countries will cut production and by how much. Opec's all-time high production levels in September mean that it may be harder to persuade its members to reduce supplies. That's especially the case since Nigeria and Libya are ramping up production after short term interruptions and Iran has repeatedly stated its intent to move towards pre-sanction era levels of production.
LNG price
It's a similar story for LNG prices. Global LNG capacity is forecast to rise by 50% to 370 million tonnes a year between now and 2020. This could fully offset the planned increase in demand from China and elsewhere. In the short term, there may be an increase in LNG pricing ahead of a key winter period for major importers such as Japan and South Korea. However, seasonality aside, the medium term trend is set to be a downward one in my opinion.
Outlook
Santos has made progress in improving its financial position. For example, in the first half of the 2016 financial year it reduced net debt by US$220 million to US$4.5 billion. Further, Santos has sufficient liquidity through US$1 billion in cash and undrawn facilities of US$2.3 billion. Its decision to postpone dividends is also prudent given its reported underlying net loss of US$5 million in the first half of the 2016 financial year.
However, more losses could be ahead if oil and LNG prices fall. Due to the potential for an exacerbation of the current demand/supply imbalance within those markets, I have a bearish stance on Santos.
