Since Opec announced a cut in production on 28 September, crude oil prices have risen by over US$3 per barrel. This has improved investor sentiment towards oil stocks. Woodside Petroleum Limited (ASX: WPL) has risen by 9% in the last week. Its peers Santos Ltd (ASX: STO) and Oil Search Limited (ASX: OSH) are up by 13% and 11% respectively.
But in my view, Woodside faces a challenging long term outlook.
Positive news
The oil price has been boosted by US government data which showed a fifth straight week of declines in US crude inventories. They fell by 3 million barrels to a total of 499.7 million barrels in the week to 30 September. This has pushed Brent prices to their highest level since June.
Having a bigger impact on Brent prices has been Opec's deal to reduce output. It will cut production to between 32.5 million barrels of oil per day (bopd) and 33 million bopd. This represents a reduction of at least 700,000 bopd. The aim of the production cut is to reduce the imbalance between demand and supply after demand growth has proven to be slower than anticipated.
Reality check
The Opec deal does not signal the end of an era of lower oil prices yet. It may offer support to the price of oil between now and 30 November when Opec next meets. But the details on the size of cuts to be made by each Opec member have not yet been agreed. As such, a deal may continue to prove elusive and the price of oil could fall.
I'm also bearish on the prospects for oil even if the supply cut is confirmed in November. The International Energy Agency (IEA) stated last week that demand for oil is very weak. It could take many months and possibly years for supply and demand to move into equilibrium.
More problems
This would be bad news for Woodside. The company also faces a difficult outlook for LNG. It faces a mix of increasing supply and uncertain demand growth.
On the supply side, LNG production is forecast to rise by 50% over the next four years as new projects come onstream in Australia and the US. The demand side should be boosted by China's switch from coal power to LNG to improve air pollution. The two biggest importers of LNG, Japan and South Korea, are utilising other forms of energy. Japan has restarted five nuclear power reactors and South Korea could rely to a greater extent on coal over the medium term.
Looking ahead
The bearish outlook for LNG and oil prices could hurt Woodside's financial performance. Its shares could fall heavily in response since they lack a margin of safety. For example, Woodside has a forward P/E ratio of 24.9 using financial year 2016's forecasts. This compares to a P/E ratio of 19.9 for the wider energy sector. Despite the increased optimism surrounding the oil price, I believe that Woodside is a stock to avoid.
