We are changing our fair value estimate for BG Group (BG.) to £12 per share from £14 after reducing our mid-cycle price estimates for oil and natural gas. Our valuation methodology incorporates three years of strip prices, with terminal prices defined by these longer-term forecasts. We currently believe the appropriate mid-cycle prices for oil and natural gas are $75/barrel Brent, $69/barrel West Texas Intermediate, and $4 per thousand cubic feet Henry Hub.
Our new fair value estimate also includes reduced capital costs and operating expenses, based on our expectation for falling oil-service fees.
Our previous estimate for U.S. natural gas was $5.40/per thousand cubic feet. The reduction was primarily driven by three factors: services cost deflation driven by oil price declines, continued production growth in low-cost areas like the Marcellus Shale, and ongoing efficiency gains in higher-cost areas. Despite meaningful demand tailwinds – our forecast calls for U.S. natural gas demand to grow more than 25% through 2020 – we believe sufficient low-cost natural gas exists to meet these elevated demand levels at prices below our previous mid-cycle estimate.
With respect to our long-term oil price outlook, the fundamental issue that has changed relative to our previous mid-cycle per-barrel estimates of $100 Brent and $90 WTI, is the emergence of U.S. tight oil. Although U.S. production is showing in real time that quick supply responses are possible, any near-term slowdown – we project U.S. crude oil production will begin declining over the next quarter or two – does nothing to diminish the resource potential that is in place.
Given our belief that oil prices will increase from current levels, near-term declines in output will be short-lived and are likely to quickly reverse as producers respond to price signals.
BG has had its share of troubles, most notably failure to deliver on its growth targets and instability in Egypt. However, the long-term outlook remains positive. BG's fortunes should improve in 2015 as Queensland Curtis LNG (QCLNG) in Australia starts up and Brazilian production accelerates, reversing two years of declines.
Brazil remains BG's crown jewel, with net recoverable resources of six billion barrels of oil equivalent, an increase from initial estimates of three billion. More important, BG believes it can recover these additional barrels with little incremental capital thanks to the quality of the resource, therefore dramatically increasing their value.
