FTSE 350: Oil gotten gains

Cash generation now rules the roost. Aside from Cairn Energy (CNE), each of the FTSE 350’s oil and gas companies has seen a reduction in its resource bases since the end of 2013 (see chart), the last accounting period before Brent crude dropped (and stayed) below $100 (£72.13) a barrel. In each case, the headline corporate goals have been to deleverage, reduce costs and get cash flowing. And if that means shedding a whole lot of assets along the way, then so be it.

Such focus on short-term cash flow carries with it a curious parallel with US unconventional drillers, although London’s largest oil and gas stocks have little to no involvement in the shale industry. Both groups of producers also expect higher output in 2018, with the possible exception, among the London players, of Royal Dutch Shell (RDSB).

For Cairn, growth in the asset base has now finally been met with growth in production, even if this has been from a standing start. The group now has a title on output from the Kraken and Catcher fields, operated and majority-owned by EnQuest and Premier Oil respectively, and which on Peel Hunt’s numbers should provide Cairn with net cash flow of $85m this year, and $156m in 2019. Tullow Oil (TLW) also ended 2017 with production trending upward, and its floor for full-year output revised up 9 per cent. After completing seven major growth projects in 2017, BP (BP.) is also likely to pump more barrels in the year ahead. Even Nostrum Oil & Gas (NOG), which only recently slipped out of this year’s FTSE 350 cohort after a disappointing 2017, should see gas output climb substantially, providing the group can get its act together this time around (see box).

Whether any of this bodes well for shareholders depends on the oil price. And on that front, optimism is unnervingly strong. The consensus view, as measured by the net ‘long’ positions on crude futures contracts, is that producers are in a very good position, and that the market is much more finely balanced than it has been in some time. “The surplus has virtually gone,” opined Garr Ross, chief energy economist at S&P Global, in an interview at the end of December.

That inventories are falling around the world looks indisputable. However, the three topics up for debate are Russia’s commitment to supply cuts after its deal with Opec ends in June, the strength of momentum in recent demand growth, and the ability of US producers to close any deficit this creates. Of the three, we think investors should be most concerned about demand, although any number of sources of supply shocks (see Venezuela, Nigeria, the Middle East, etc) could tip the balance back in the producers’ favour.