OpCo's Fadel Gheit: Why Q4 Refiner Earnings Will Be Lower and How PetroPlus Became Insolvent

Fadel Gheit, managing director at Oppenheimer & Co. covering the oil and gas industry, gave Benzinga Radio his forecast for oil prices this year as well as insights on tensions in the Strait of Hormuz, the EU embargo on Iranian oil, upcoming earnings releases from major oil companies, and the PetroPlus bankruptcy in Europe. What is your base case for oil prices in the first half of 2012?

Fadel Gheit: We basically think there is going to be a trading range with muddle-through prices very close to the current level. Prices will be pulled up by concerns over supply, obviously, and will probably be pulled down if the global economy gets weaker. So, there are two different ways that oil prices can go, but in the near term, I think $100 is a safe bet.

Will China give in to the West over Iran, or will they continue to be the majority consumers of Iranian oil?

Fadel Gheit: China wants to cement relationships with some of these regimes that they feel they need because of their own economy. So, I'm not sure China is going to go along. They need Iranian oil. The Chinese premier was in Saudi Arabia a few days ago. Basically, they were discussing one thing and one thing only - oil supply. The Iranian government warned Saudi Arabia, Kuwait, and the UAE not to increase production to make up for any shortfall in Iranian shipments due to sanctions. I'm not sure Iran has any power to push Saudi Arabia to do what they want. It's going to be a hot summer. I hope cooler heads prevail, because we don't need another conflict. The world is already engulfed in flames. The whole neighborhood in the Middle East is obviously a very risky area right now. It's like a tinderbox - it could really blow up quickly.

What is your outlook for earnings in oil and gas over the next few weeks?

Fadel Gheit: The fourth quarter will be lower than the third quarter for a couple of reasons. First, on the refining and marketing side, profits deteriorated very rapidly, margins shrunk considerably, and obviously that impacted their earnings. Most of the companies will show very poor refining and marketing earnings - which doesn't really represent the bulk of earnings, but nevertheless, it will take earnings a notch lower. So, the quarter in general is going to be an "ok" quarter, but will be lower than Q2 and Q3.

What is your reaction to the PetroPlus bankruptcy announcement?

Fadel Gheit: The market has turned very negative in the third quarter. Companies with less financial flexibility, like PetroPlus, obviously found themselves in a very bad situation. So, I'm not totally surprised because even the stronger companies are suffering pretty badly. Most of the refiners could break even or have Q4 losses on the refining and marketing side of the business. It goes without saying that a company that is totally stretched, very weak balance sheet, all of the sudden having margins collapse against them - and they didn't have the advantage that most US companies have. All of the refiners in the US that use the WTI benchmark are a lot better off than the Europeans, who are using much more expensive crude. It was just a combination of many factors that pushed PetroPlus over the edge.

What are the implications for the European market as a whole?

Fadel Gheit: Europe has been sick for a while and is getting sicker. We consider the US to be in much better shape than Europe, and [yet] we are not doing too well. Demand is down significantly because of the lack of economic activity, and that is not likely to change anytime soon.

What should investors in the oil and gas space look for in the next few months?

Fadel Gheit: Number one are companies that have a cost advantage. No matter what happens to the global economy, the world needs oil. Companies will make less money if oil prices go down, demand goes down, and if there is no disruption in supply. Having said that, investors should look for companies that distinguish themselves somehow - through better efficiency, higher growth, a stronger balance sheet. Quality counts. You are going to see a flight to quality. When the market is apprehensive, people fly to quality.

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