Big oil is back. After enduring a near-death experience during the Covid crisis when demand plummeted and being distinctly off-trend as the sustainable investing wave engulfed Wall Street, cash-rich oil companies are again a sweet spot for fund managers.
Oil’s powerful rally and record-high gas prices have put the MSCI World Energy index on track for its best run since at least 1998, up more than 40 per cent so far in 2021.
And there may be more to come -- the International Energy Agency projects oil demand to recover to pre-pandemic levels in 2022 and the index trades at a 56 per cent valuation discount to the broader market, almost four times the long-run average.
The equity gains so far have also lagged the 60 per cent crude rally and analysts believe there could be catch-up potential from now on, even if crude stabilises.
Earnings optimism is near a 16-year peak. Oil firms in Europe and the US should see profits this year rise 720 per cent to 43 billion euros and 1,300 per cent to $68 billion respectively -- the highest of any sector, according to Refinitiv I/B/E/S.
The big question, though, is what management teams do with those
Unlike previous price booms, many oil firms appear reluctant to increase investment in upstream production. The IEA, instead, called this month for a surge of investment in renewable energy to meet future demand.
Kiran Ganesh, head of multi-asset at UBS Global Wealth Management, said the reluctance to invest in traditional energy sources was “a side effect of ESG (environmental, social and governance)” investing, which emphasises sustainability.
“Historically, when we saw oil price rises we have tended to see increases in investment. This time that response hasn’t come through because companies are talking more of redistributing to shareholders via dividends and buybacks,” he said.
“It’s exciting for investors, but it’s bad news if you are looking for commodity prices to moderate”.
Oil and gas investment could be as little as $365 billion this year, Morgan Stanley said quoting data provider Rystad Energy. That compares to $475 billion in 2019 and $740 billion in 2014.
European oil majors, including BP and Royal Dutch Shell, are spending billions of dollars to reduce their dependency on fossil fuels and grow their focus on renewables. But Morgan Stanley’s own analysis of 120 oil firms indicates total capex stagnating below 2019 levels even in 2023 and those figures include renewables investment, implying flat oil and gas capex and a peak in oil supply around 2024, they said.
BofA Securities’ October fund managers survey showed commodities had the biggest consensus overweight. Almost half of those polled said they expect oil prices to breach $100 a barrel.
Surging profits and shrinking capex have left oil companies with rich free cash flow piles and some are choosing to reward shareholders.