As the conflict between Russia and Ukraine continues to advance, the ramifications for the energy and raw material sectors are becoming evident. In particular, Germany depends on Russian gas by as much as 42% of it needs. Secondly, while in the initial phase of the sanction applications deliveries from Russia continued as previously, it appears now that trade patterns are starting to shift. According to research data, buyers of Russian oil deliveries are more and more reluctant to do so. As of now, almost all Russian registered tankers stand idle with no destination to unload.
With the supply-demand chain disrupted, risks that oil and gas prices are still firmly skewed higher, at least in the short term, become reality.
Prior to the crisis, petroleum companies budgeted an oil price of around USD 70/bbl. With prices now hoovering above USD 100/bbl, the sector generates ample free cash flows that can be allocated in the following three manners:
- Debt reduction: Normally this would be done, but oil-majors are not over-leveraged as of now,
- Capex: With the energy transitions at full speed, capex favoring rigs are not welcomed (at least politically),
- Share buybacks: Current dividend yields and share buyback yield to around 8%; we expect this to double in the coming year.
Investment implications US:
- We maintain a focus on high-quality energy companies that embrace capital discipline and increasing shareholder returns. The focus on energy security and energy transition over the next two decades should create attractive opportunities for energy companies.
- We prefer the exploration and production and integrated oil subsectors with direct exposure to rising commodity prices and modest growth in production over the refiners and oil field service subsectors.
Investment implications EU:
- Energy transition opportunity, which is sector negative, is a predominantly longer-term concern for the European energy sector.
- We prefer integrated operators that manage the full value chain, thereby in a position to benefit from full form rising prices.
Positives for the sector:
• Oil is priced above the level at which the average company can cover expenses.
• Supply has declined with lower production and OPEC compliance requirements.
• Diversified energy companies have strong balance sheets and access to capital.
• The ongoing recovery of the global economy bodes well for the return in demand for oil.
Negatives for the sector:
• Oil demand is still down significantly.
• Valuations are opaque.
• There is weak long-term stock price momentum.
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The current barrel price recovery occurs on the back of lower production capacities, since a large number of E&Ps have gone bankrupt or closed low-capacity rigs. |