Australian Energy Sector
Oil Price Upgrades -
Breaking all records
Where has the cycle gone?
Oil markets continue to be characterised
by tight fundamentals, difficult
geopolitics, US dollar concerns and slow
elasticity responses that might bring
about lower prices. Prices could be
impacted by a global slowdown in GDP.
Triple digit oil prices are not going anywhere
John Hirjee
Research Analyst
(61) 3 9270-4318
john.hirjee@db.com
Hugh Morgan
Research Analyst
(61) 3 9270-4385
hugh.morgan@db.com
Deutsche Bank AG/Sydney
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DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1
Top picks
Santos (STO.AX),AUD21.85 Buy
Woodside Petroleum (WPL.AX),AUD66.38 Buy
Oil Search (OSH.AX),AUD6.40 Buy
Nexus Energy Ltd (NXS.AX),AUD1.76 Buy
Companies featured
Woodside Petroleum (WPL.AX),AUD66.41 Buy
2007A 2008E 2009E
P/E (x) 25.2 18.3 15.9
Div yield (%) 2.4 3.3 3.8
Price/book (x) 6.8 7.5 6.3
Santos (STO.AX),AUD21.15 Buy
2007A 2008E 2009E
P/E (x) 15.2 19.8 21.4
Div yield (%) 3.2 1.9 1.9
Price/book (x) 2.5 3.4 3.1
Oil Search (OSH.AX),AUD6.40 Buy
2007A 2008E 2009E
P/E (x) 26.2 22.5 21.6
Div yield (%) 2.4 0.7 0.7
Price/book (x) 3.9 4.2 3.6
Caltex (CTX.AX),AUD12.69 Buy
2007A 2008E 2009E
P/E (x) 14.0 9.5 8.5
Div yield (%) 3.4 5.2 5.8
Price/book (x) 1.9 1.1 1.0
AWE (AWE.AX),AUD4.20 Buy
2007A 2008E 2009E
P/E (x) 39.3 5.6 5.2
Div yield (%) 0.0 0.0 0.0
Price/book (x) 3.1 2.0 1.4
Nexus Energy Ltd (NXS.AX),AUD1.76 Buy
2007A 2008E 2009E
P/E (x) 409.2 – –
Div yield (%) 0.0 0.0 0.0
Price/book (x) 3.0 2.8 1.9
AED Oil Ltd (AED.AX),AUD2.75 Hold
2007A 2008E 2009E
P/E (x) – – 9.1
Div yield (%) 0.0 0.0 0.0
Price/book (x) 20.9 0.7 0.7
DB Forecasts
CY08F CY09F CY10F
WTI (US$/bbl) 120.00 120.00 100.00
US$/A$ ex rate 0.931 0.912 0.881
Related recent research Date
Oil price upgrades
John Hirjee / Hugh Morgan 28 Mar 2008
Global Markets Research Company
Triple digit oil – a long term reality?
The macro reality of rising triple digit oil prices in CY08 has resulted in upgrades to
our forecasts yet again. Now we see triple digit oil prices as a medium-term
reality. Our oil price upgrades have had significant short and long-term earnings
impacts across our coverage. Our WTI forecast for CY08 is US$120/bbl (from
US$96/bbl) and CY09 is also US$120/bbl (prev US$102.50/bbl). Our mid-cycle price
stands at US$100/bbl (prev US$85/bbl). Our preferred exposures are selected
from those that have leverage to oil prices, growth in volumes or
existing/increasing exposure to the LNG industry. Our basket of preferred
exposures includes Santos (Buy) for its leverage to Coal Seam Gas (CSG) and the
game-changing GLNG project, Woodside Petroleum (WPL) as the proven LNG
player through the NWS project and Pluto and Oil Search (OSH) for its emerging
exposure to our favoured thematic of LNG. Amongst the small caps, we favour
Nexus Energy (NXS), which has impressive growth prospects at Longtom, Crux
and potential LNG exposure with Echuca Shoals.
US$100/bbl-US$150/bbl: the “extreme level”?
Oil is currently trading towards the upper end of the extreme level implied by a
number of valuation measures, recently passing US$140/bbl for the first time.
Notwithstanding Saudi Arabia’s plans to increase supply, we believe the oil
producers are becoming more accustomed to higher prices and our review of the
extremes in oil valuation suggests that prices would have to rise much further in
order to reach excessive levels. We discuss the oil market in this report.
The impact of global economic slowdown
We see projected energy demand increasingly coming from developing and
emerging economies. While these economies, such as China and India are yet to
experience economic pressures besetting the US and Europe, inflation is an
emerging issue. However, even with an economic slowdown, we expect demand
to rise in 2008 and 2009.
Valuations increasing due to higher longer term oil price forecasts
We value the sector using DCF analysis to estimate a net asset value (NAV) using
DB oil price assumptions. In addition, we also assess the NAV using the crude oil
futures curve. We set our price targets by taking the mid point of the two NAVs
and add a risk adjusted exploration potential for those that we can identify. Risks:
production delays, sector cost inflation, oil price.

Investment thesis
Outlook
With oil trading consistently above US$100/bbl so far this year (average YTD is US$110/bbl),
2008 is proving to be another very strong year for the oil sector. Oil price upgrades ensure
earnings momentum continues to improve although partially offset by the continuing strength
of the Australian dollar. While prospects for the oil market look robust, industry cost inflation
is crimping margins. Swings in sentiment means that it won't be a smooth ride but the
Energy sector looks like a default sector of choice with earnings momentum accelerating due
to the commodity, undemanding valuations and gearing levels relatively low.
Volume growth is important, not only because it implies a successful company in itself, but
also because in oil it implies rising returns. With heavy up-front capex, oil fields produce no
growth until the majority of the capex phase is over. At that point, growth starts, and so does
growth in returns. A company with growth has its capex behind it, and rising returns in front
of it. The next question becomes whether there are sufficient projects down the queue to
maintain growth. Woodside Petroleum fits this theme well with its strong growth, notably
due to Pluto and new oil projects such as Vincent and Neptune. Nexus (Buy) provides
significant growth prospects through its development projects, and mobility as a small cap
E&P player.
Our preferred key thematic which we believe warrants investment attention is liquefied
natural gas (LNG). In Australia, exposure to LNG straddles the sector from established players
like Woodside and Santos to emerging players such as Oil Search. We like Santos for its
exposure to coal seam gas and LNG through the GLNG project as well as its defensive
portfolio of domestic gas contracts. Among the small cap players, Nexus has exposure via its
Echuca Shoals interests. However this is a capital intensive industry and significant cost
pressures still persist. Success factors are built on adequate gas reserves, access to markets,
customer relationships as well as balance sheet capacity. LNG pricing dynamics are changing
with movement to oil parity.
Santos (STO: Buy PT $25.40/sh) - Santos has been elevated to our preferred exposure
amongst the Australian E&Ps. It has exposure to LNG via its 11% interest in Darwin LNG and
emerging exposure to PNG LNG and the potential game changer, GLNG. The arrival of
Petronas as a JV partner lends credibility to the GLNG project, and elevates the project to
front-runner status in CSG to LNG production. We are also buyers of the defensive qualities
of Santos’ domestic gas business which is not affected by volatile oil prices and the portfolio
benefits this offers.
Woodside Petroleum (WPL: Buy, PT $72.70/sh) - Woodside has been our preferred
exposure for many years and it has the largest exposure to the world’s rapidly expanding
LNG markets in our coverage universe. It’s share price performance is more closely
correlated to oil prices and hence can be volatile. While we still upside (+16%), this upside is
less than Santos (+30%). Strategically positioned as the operator of the North West Shelf
project, Woodside is an established and reputable LNG supplier to Japan and more recently
to China. The commissioning of projects such as NSW Train 5 and Pluto in a timely manner
and within budget will be critical to the delivery of this growth and is not without risk, in our
view.
Oil Search (OSH: Buy, PT $8.15/sh) – is significantly levered to global oil prices. Purity of oil
exposure with a lower impact from the Australian dollar than its peers are key features of the
investment case. Oil Search is embarking on the commercialisation of gas via LNG. This

could significant value accretion if the 5tcf of gas is commercialized. Supermajor partners
such as ExxonMobil add credibility to LNG execution with the project in the FEED process.
Nexus Energy (NXS: Buy, PT $3.20/sh) – Nexus has an impressive suit of development
projects, and has emerging company exposure to the major league of the LNG industry
through its Echuca Shoals asset. Partners of the calibre of Shell serve to de-risk the
company’s projects.
In refining, we maintain our view that this is ultimately a cyclical business that is in need of
some new capacity, but retains strong GDP sensitivity. We retain a Buy on Caltex Australia
(CTX: Buy, PT $17.05/sh) as our refiner margin forecasts imply the shares are undervalued.
Valuation
We value the sector using discounted cash flow analysis (DCF) leading to an assessment of
net asset value (NAV) using DB oil price assumptions. In addition, we also assess the NAV
using the crude oil futures forward curve at the beginning of each quarter. We set our price
targets by taking the mid point of the two NAVs and adding a risk adjusted premium for
exploration upside.
Risks
A material variance to our oil price assumptions to the downside could have a meaningful
impact to our sector outlook. One factor that could significantly influence this is a downturn in
the global economy and the demand for oil.
Other risks include sector cost inflation pressure on (new and existing) exploration and
development projects, reducing the returns of oil companies.
The market is also acutely aware of production disruptions/delays which can have a material
impact on share price.