Led by a fundamental shift in investors' long-term view on oil price, and a decadeof subpar returns and value creation by the E&P sector, there is increasingpressure on US E&Ps to show greater capital discipline, returns, and maybe evena path towards cash return to shareholders. Within, we examine both drivers andpotential forward looking scenarios, with the conclusion that: 1) over the next 5+years the sector can generate higher growth and FCF than the market suspects,even at $50/bbl, 2) there is precedent for similar transitions which have beenrewarded by investors, and 3) heavily discounted future FCF offers an attractivevalue relative to other industrial/cyclicals in the broader market. Positive: EOG,NBL (Upgrade to Buy), MRO.
The return of E&P and capex names. R&C prolonged peak cycle.
Project driven cash flow growth
After a dismal last few years, the strong start for E&Ps so far in 2018 feelsborderline disorienting (DB coverage +7.5% YTD vs. S&P 500 +4.8%). Andalthough we remain wary the current price of crude, and expect a pullback atsome point, we remain constructive on the group and expect 4Q earnings to be alargely positive event. Budgets are likely to suggest a reasonable commitment tocapital discipline, at least for now (ie. within cash flow at well below the currentprice), well performance remains robust, and positive revisions are likely to remaina tailwind (DBe FY18 +3% vs. Street). A slight offset: service inflation is likelyrunning ahead of Street expectations, while lag from development-focused shiftcould see volume growth lumpy and/or back half weighted. For 2018, we preferEOG, DVN and NBL. Into 4Q: PXD, EOG, and MRO.
We enter 2018 cautiously optimistic that there will be outperformance inEnergy equities following three years of underperformance since the oil pricecollapse. APAC energy companies have had their fair share of pain but webelieve the worst is behind us and businesses have been reconfigured to workeven in a c.USD40-50/bbl oil price environment. As the forward curve nowmarches convincingly into backwardation, there are increasing upside risks to oil,underpinned by strong demand growth from emerging APAC countries and theglobal rebalancing of crude markets. Under rising oil, there is pressure on Chinaand India to revive their declining oil production which is positive for both E&Pand, particularly, capex-related companies. Widespread adoption of gas throughaggressive coal to gas switching programs has led to a winter gas crisis in China.
We enter 2018feeling considerable enthusiasm on the potential for theEuropean oils sector both absolute and relative. No doubt our confidence ishelped by the much better feel to commodity markets and a price deck that, inour opinion, affords risk to the upside. Most significantly, however, our positivetone reflects our view that after three very challenging years the majorEuropean companies have repositioned their businesses to work in a $50/bblworld and that as the benefit of the cash flows from project starts accelerate,free cash is set for material expansion. In a world that shows very littlevaluation differentiation preferred names remain BP and Shell.
With front-month and near-term benchmark prices rising above $60/$65/bbl (WTI/Brent), the capital discipline mantra will be put to the test during budget season asincremental cash flow priority will take center stage. Based on our conversations,we expect most of the large-caps to largely "hold the line" on capex (for now) andstick to budgets based on $50-$55/bbl crude. We estimate an incremental ~$5bnof cash flow at the updated DB price deck ($56/$62 WTI/Brent FY18), and $4 Bnof FCF at the current strip (or $65/$60) and while we see some with the ability/interest to flex capital spending higher (MRO/EOG/APA/XEC/CXO), the majorityof our coverage pointed toward incremental cash flows being put toward thebalance sheet/outspend, as the back end of the oil curve remains in the mid $50swith the prospect of OPEC barrels coming back to the market in 2019, and a USonshore production profile biased to the upside in terms of 2018 growth, withestimates now re-approaching 900 mb/d. Given strength in the 2018/19 strip, welook for updates on hedging (sector 16%/3% hedged in 2018/19 at Q317) andits potential impact on activity levels. We see those with higher Brent leverage(OXY/COP/APA/MUR) as those to incrementally benefit from a widening Brent/WTI differential, while those with WCS leverage (DVN) will likely see short-termheadwinds.
We note the timing could not have come any better for Australian LNG exportersas the market turns to a seller's market from a buyer's market in 2018.
Macro themes – upside risk in oil, gas excess coming, downstream robust
澳门新永利国际平台登录， Operating efficiencies and capital discipline leading to higher returns.
Crude: OPEC extension should underpin price in a market that is alreadymoving towards balance and which, post a third year of modest projectsanctions is setting itself up for medium term squeeze. Natural gas and LNG:
Between 2009 and 2014, oil prices went from USD57/bbl to USD100/bbl but ROEsfor the sector actually fell from 14% to 11%. We believe the days of bloated costsand expensive M&A are now over. There is increasing evidence that a balancebetween growth and capital discipline can actually be achieved, which wouldconvince investors to return to the energy space. For starters, over the next fewyears cash returns to investors are set to return to those seen at the time of thepeak oil price levels in 2013 and 2014. FCF generation should also be in the bestshape it has been in its history, more than double the levels seen in 2009. Thisis all using the DB oil deck of USD53.4/54.5/56/bbl from 2017-2019, which isconservative compared with the Street and the current oil price of USD66/bbl. Onthe other hand, capex/DD&A essentially peaked in 2009 at 2.9x, falling to only1.0x in 2017, further proof of capital discipline in the sector in the years to come,and hence rising returns to shareholders.
In another 25mtpa supply build year will China sneeze? An ever moreimportant source of end market demand, its growth is needed if Europe is toavoid catching a nasty cold. Downstream: Low product inventories combinedwith moderate build in capacity suggest a market that should allow refiners toenjoy another cash generative year with IMO a looming underpin.
In this outlook report, we address seven investment themes and our regional picksacross sectors and countries.
Company cash jaws set to open; Rest in peace the Big Oil scrip
Three years on from the price collapse and the heavy lifting has been done. Bigoil works at $50/bbl with the much maligned scrip now officially consigned tothe coffin. Look to the future and there is much to encourage. Supported bythe continuing wave of project start-ups (+$13bn) we expect free cash flow toaggressively expand affording management the opportunity to both rewardshareholders and allocate capital to a re-worked set of investmentopportunities that our analysis suggests healthy double digit return. A secondyear of c5% volume expansion, the sector’s cash jaws look set to meaningfullyopen, sector CFFO rising by over 10% towards $130bn and with growingleverage to the improving commodity tone.
Preferred stocks: Shell (Buy 2700p) and BP (Buy 545p)
We may stand fairly accused of sounding like a broken record. But betweenvaluation, operating momentum and shareholder commitment we enter 2018as we ended 2017with a decided preference for the UK mega caps. A mix ofcash flow acceleration, most notably at BP, and total return potential ourexpectations for yield compression suggest real scope for continued healthycapital appreciation. Within Europe predictability and opportunity underpin ourpreference for Total (Buy ?51) although we recognize the greater FCFYleverage to price at ENI (Hold ?14.5) and the potential for performance ifconfidence in delivery can rise from its current nadir. Following earlier thanexpect scrip removal and reduced dilution we raise Repsol to Hold (?14.75) butleave Statoil (Hold NOK165) and GALP (Hold ?15.7) unchanged. Amongst thelarge E&Ps, we reiterate our Buy on Tullow (225p) where low capex intensivegrowth drives c.$500m p.a. FCF at DB deck to help repair the b/s. We thinkthat investors may be looking at the potential for both Lundin (Hold SEK190)and Aker BP (Hold NOK 182) to offer progressive dividend policies over thenext 5years, which we feel stretches traditional portfolio-based valuations.
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