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Is now the time to buy Santos Ltd shares?

The oil price broke through US$50 per barrel this week.

That’s the first time that Brent has been above US$50 per barrel since late August and it now trades at a three-month high. This follows a deal between Opec members which will see output reduced. This may seem like good news for oil stocks Santos Ltd (ASX: STO), Woodside Petroleum Limited (ASX: WPL) and Oil Search Limited (ASX: OSH).

In my view, Santos could struggle to record share price gains over the medium term.

Opec production cut

Opec has agreed to reduce output from 33.5 million barrels of oil per day (bopd) to between 32.5 million bopd and 33 million bopd. Although this has caused the oil price to rise in recent days, in my view it will have only a marginal impact on the price of oil over the medium term.

That’s because it is only a small cut in production. Supply is still likely to exceed demand over the medium term. The International Energy Agency (IEA) estimated in April that the supply overhang was 1.5 million bopd. Since then production has increased to its highest level in recent history, while demand growth has been sluggish.

Uncertain outlook

Further, the details of the Opec deal have not yet been finalised. A decision on how much each individual member will cut its production will be decided at the planned meeting in November. This  means there is still a risk that a deal will not go ahead. This could send the oil price downwards in Q4 and in 2017, which may hurt Santos’ financial performance.

Beyond that, demand for oil may prove to be below previous expectations. The IEA stated last week that demand was weaker than many people had thought. Even if a deal to cut production is in place following November’s Opec meeting, the outlook for the oil price is likely to be bearish.

LNG challenges

Alongside the potential for a weaker oil price, Santos faces the prospect of lower LNG prices. Although demand is forecast to rise over the medium term, it is expected to be outpaced by higher levels of supply.

For example, global LNG supplies are due to rise by over 10% per annum over the next four years as 130 million metric tonnes per annum are forecast to be added to global supply. In the last two years, demand for LNG has risen at an annualised rate of 5.4%. This means that the supply/demand imbalance which has put pressure on the LNG price in recent years looks set to worsen.

Outlook

Santos faces an uncertain future. The prices of LNG and oil could fall and this would leave its financial position in a worse state. It has made progress in reducing upstream production costs by 15% in the first half of 2016 and has adopted a more disciplined capital expenditure programme. Due to its status as a price taker and the downbeat outlook for oil and LNG prices, I think now is not the time to buy into the company.

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Motley Fool contributor Robert Stephens has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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