For decades, shares in oil and gas companies offered investors income, a hedge against inflation and exposure to the lifeblood of the global economy. In the last five years, this bull case has been challenged by a fundamental shift in supply dynamics. By and large, the supermajors have passed the test. But for long-term portfolios, much larger concerns lie ahead: the twin threats of regulatory change and competition from more alternative sources of energy. So does the sector have anything to offer potential investors?
Lower prices have been good for the industry: US production has permanently re-shaped the balance of the oil market. After the initial strain, the largest players now look leaner, more disciplined and focused, despite the lower price environment. A collective assumption that oil will stay capped at $60 a barrel should help to sharpen company investment decisions in an industry where the return on equity is notoriously volatile and poor.
The majors face a growth challenge: In the past, operators and investors have been guilty of pursuing growth for growth’s sake. The challenge now is to source high-margin development projects where costs can be contained and which can help to grow cash generation, over and above the top line and absolute production. This is easier said than done, and we expect that after a bit more de-leveraging, M&A could soon take precedence over exploration.
Investors should prioritise cash returns: Resources companies can be excellent cash generators when they put their minds to it. Increasingly, investors should focus on oil and gas stocks’ income case, rather than leveraged exposure to energy price fluctuations. Supermajors should no longer be rated for their resources, but their yield; cash – in the shape of dividends and buybacks – is once again king.
Long-term sector risks are profound: Oil demand may be currently growing, but it is expected to peak by 2030. Gas is already a greater priority for many companies, but buy-and-hold investors need to pay close attention to the ways management teams are planning for a lower-carbon world and the regulatory shifts which will accompany the transition. Again, this is likely to increase scrutiny on capital expenditure plans for long-life assets.
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