S&P Equity Research Issues Energy & Materials Sector Predictions for 2011

NEW YORK, Jan. 6, 2011 /PRNewswire/ -- Analysts at Standard & Poor's Equity Research see largely positive signs for both the Energy and Materials sectors in 2011.  In the Energy sector, they see continued outperformance by crude oil relative to natural gas.  This should benefit the bigger players, despite uncertainty in the U.S. Gulf of Mexico, according to Stewart Glickman, Energy & Materials Group Head at S&P Equity Research.  

In Materials, S&P Equity Research thinks the bull run in gold will continue, there will be a faster-than expected recovery in building products, and there will be gains by petrochemical players.  The one cloud on the Materials horizon could be the potential impact of China on base metals, according to Glickman.  

Standard & Poor's Energy and Materials equity analysts have these seven predictions for 2011.

1. Gold prices should move higher.

For 2011, Standard & Poor's Equity Research Services (ERS) expects gold will consolidate in a sideways pattern for part of the year following 2010's 30% gain. In our view, some backing and filling is normal in an ongoing bull market and we look for gold to finish 2011 at the $1,600 level, up from $1,421 per ounce at the end of 2010. We believe the fundamentals for the market will remain the same, with the threat of sovereign debt defaults and general currency instability increasing the appeal for gold as an alternative monetary asset. Also, a possible upside acceleration in commodity prices in 2011 could add to the demand for gold as a hedge against falling currencies.

2. There will likely be a Gulf rig exodus.

The current rig count of deepwater floaters in the U.S. Gulf of Mexico (32, not including three newbuilds due for delivery in the second half of the year) is expected by ERS to drop by as many as eight units as operators lose patience with the slow pace of permit issuance in the region. Despite the official end of the drilling moratorium on October 12, permits - which are required from the regulatory body, BOEMRE, before work can begin - have been hard to come by, and even then mainly for ancillary work but not for core drilling activities. Using data from RigLogix, ERS estimates that of the 32 currently active floaters in the Gulf, 15 units are slated to start 3+ year contracts during the next six months, and one is now idle after the operator canceled the contract. For the three drillships currently under construction and contracted to come to the Gulf during the second half of 2011, ERS expects alternative plans will be reached. With the vast majority of the combined 35 units capable of drilling in ultradeepwaters (i.e., 7,500 feet of water or more), and more than half the current customer list for these units comprised of global heavyweights such as Shell [NYSE: RDS.A 65 ***], Chevron [NYSE: CVX 91 *****], BP [NYSE: BP 46 ***], Eni [NYSE: 45 NR], and Statoil [STO 23 NR], ERS thinks the odds are good that customers and their respective rig contractors may come to agreements to modify existing rig contracts to have these rigs move to alternative overseas projects. ERS also expects such moves to put pressure on leading edge dayrates as more rigs chase jobs outside of the U.S. Gulf. While ERS expects the permit process to eventually recover, rigs that do go overseas are unlikely to come back for some time, and the average remaining term length on these 35 units is about 3.1 years.

3. We expect more M&A in the oil patch.

Integrated oil and gas companies were late to arrive on the scene for onshore unconventional natural gas plays, and have started to make inroads via acquisition (ExxonMobil's [NYSE: XOM 75 *****] June 2010 acquisition of former independent XTO Energy for approximately $41 billion is a notable example). While ERS thinks natural gas remains a solid long-term play, short-term natural gas prospects continue to look weak given depressed prices, putting pressure on smaller players that lack access to the currently more promising liquids-rich plays. ERS thinks this will spur more natural gas acreage deals in a buyer's market We see the integrateds increasing production of natural gas by 10% in 2011, fueled by acquisitions, compared to just 1% growth in liquids production.

4. Energy MLPs will likely raise dividends.

ERS sees energy MLPs, which typically distribute a high proportion of their cash flows in the form of dividends, raising their distributions by an average of 5% in 2011. Our projected increase is based on our view of rising volumes and new projects placed into service. We see these MLPs benefiting from expectations for improved real gross domestic product growth in 2011 and continued low interest rates. One example is Sunoco Logistics Partners [NYSE: SXL 84 ****], which ERS sees growing its distribution by 6% to $4.90 per unit, which at current prices would imply a yield of about 5.8%, well above S&P's projected 3.2% yield for a U.S. 10-Year Treasury bond.

5. We believe China concerns will weigh on base metals.

For 2011, ERS looks for rising prices and volumes for base metals and minerals on our expectation for continued growth in the global economy and tight supply for such commodities as copper and iron ore. However, ERS's positive outlook is tempered somewhat by concerns that growing imbalances in China's property markets could lead to less vibrant demand for base metals used for construction. As ERS sees it, what appears to be excessive construction of both commercial and residential buildings along with high ratios of property prices to rents could lead to reduced demand and lower prices for base metals and minerals.

6. Demand for building products will improve in 2011, according to ERS, on a faster than expected housing recovery.

Affordable housing, reduced lumber capacity following the downturn, and rising interest rates (which could cause buyers to act sooner rather than later) may act as catalysts, according to ERS. We also note that overseas demand for lumber and fiber remains high, and that lumber futures have increased significantly in recent weeks.

7. Petrochemical players are in a sweet spot.

Petrochemicals manufacturers, which use natural gas as feedstock in the production of their petrochemicals, should continue to benefit in 2011 from weak natural gas prices while their oil-based product prices remain firm, according to ERS. Companies which may benefit, in our view, include Westlake Chemical [NYSE: WLK 43 ***], Dow Chemical [NYSE: DOW 35 ***], PPG Industries [NYSE: PPG 84 *****], and Olin [NYSE: OLN 20 ****].

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