Oil prices are tumbling from recent highs as analysts predict more volatility in oil markets grappling with how a global recession could curtail demand amid ongoing supply problems following Russia's invasion of Ukraine.

West Texas Intermediate (WTI) crude closed at US$104 a barrel last Thursday, taking the two-week losses to 16 per cent, just short of bear market territory. The downturn has been attributed to fears over US recession, while Chinese and Indian buying of Russian oil may be easing a supply crunch in global markets.

The recent decline contrasts with earlier in 2022, when Russia’s invasion of Ukraine saw global benchmark Brent crude hit a 14-year high of US$140 a barrel. Prices fell from those heights in late March, only to slowly trend higher in the lead up to June as oil markets reacted to European import bans on Russian oil and a reopening Chinese economy.

Morningstar senior equities analyst, Mark Taylor expects the oil and gas sector to ease further in the near term.

“We haven’t changed our long-term view – we’re still projecting Brent crude to be back to US$60 a barrel by mid-2024,” he says. “We think that’s the point where oil supply meets demand, due to increased US shale production and new gas supply such as Woodside’s Pluto LNG train two and its Scarborough LNG project.

“Hopefully also the Ukraine conflict will have died down, although that doesn’t mean Europe will resume imports of Russian oil and gas. They will have made alternative arrangements and diversified.”

The abrupt reversal in energy prices has sent the local oil and gas sector into reverse. On 9 June, the benchmark S&P/ASX200 Energy Index hit 11,203, the highest level since February 2020, reflecting skyrocketing oil and gas prices.

However, the index, which contains companies such as Santos (ASX: STO), Woodside Energy (ASX: WDS) and Whitehaven Coal (ASX: WHC), retreated 14% in the days to 24 June.

A rally this week pared losses to 9% as of midday on Tuesday, underscoring the volatility gripping oil markets currently.

RBC Capital Markets analyst Michael Tran sees benchmark oil prices stabilising at around US$90 a barrel, due to strong physical demand, as seen by high petrol, jet fuel and other energy prices.

Underinvestment in supply could also keep prices stronger for longer, according to Goldman Sachs.

In contrast, Société Générale’s Albert Edwards argues oil could join other bellwether commodities such as copper in a protracted bear market, amid the potential for a “hard landing” of the US economy due to rising interest rates.

Copper prices, a bellwether for expectations of economic growth due to widespread use in industry and construction, are down 14% since early June.

An abrupt retreat in global oil prices would have limited impact on Morningstar fair value estimates for the local energy sector, according to Taylor, who already forecasts prices to retreat by 2024. 

Local energy picks remain undervalued

Australia’s largest listed energy company, Woodside has seen its share price surge by more than a third this year, aided by higher gas prices and the successful completion of its merger with BHP Petroleum.

Investment bank Morgan Stanley has described Woodside as “one of the best global plays on gas,” giving it an “overweight” recommendation following the 1 June transaction.

Morningstar’s Taylor has a fair value estimate of $40 per share on the four star-rated Woodside, well above its Monday close of $31.32.

“Under its watch, the number of Karratha Gas Plant LNG ‘trains’ has grown from one to five, taking gross output to 16.4 million metric tonnes per year. This pedigree is unmatched in the Australian oil and gas space, and there’s more potential development in the pipeline if prices will allow,” according to Taylor.

Also rated four stars by Morningstar, Santos is similarly trading well below Taylor’s fair value estimate of $10.20 per share. Taylor forecasts production will double to around 180 million barrels of oil equivalent by 2028, thanks to “east-coast coal seam gas to liquid natural gas and Papua New Guinea…LNG projects, and via the Quadrant and ConocoPhillips acquisitions and Oil Search merger.”

Taylor also highlights Beach Energy (ASX: BPT), which similar to Woodside and Santos is trading well below its “fair value” estimate of $2.70 per share. The five-star rated company is Australia’s largest domestic oil producer, producing around 23 million barrels of oil equivalent per year of oil, gas and gas liquids.

However, Taylor notes that “Beach is a higher-risk investment proposition and is not for conservative investors. Its appeal stems from the potential for conversion of large contingent resources into reserves and economical production.”

Also in the fossil fuel sector, coal miners such as Whitehaven have surged in market value amid moves to block Russian coal exports. The company reported a jump in 50% coal production in the year to March due to better weather and fewer logistical issues, helping it take advantage of soaring coal prices.

Morningstar analyst Jon Mills says three-star rated Whitehaven continues to benefit from “strong demand for thermal coal as energy demand increases on faster economic growth,” together with the impact of the Ukraine war. Russia previously supplied around 15 per cent of globally traded thermal coal.

Shares closed on Monday at $4.75, just below the Morningstar fair value estimate of $5.20.