Over the last decade, the energy sector has suffered from multiple downturns, and has consistently underperformed the market. The sector has also suffered with concerns around the implications of the energy transition. However, reduced capital investment across oil & gas and the economic recovery have led to booming commodity prices, and RBC’s equity research team expects this trend to persist. With depressed valuation multiples and subdued relative performance, now may be the time to revisit the sector. In fact, the sector may better positioned now than at any point over the last two decades, RBC argues.
Allow me to re-introduce myself
The energy sector has lost prominence in recent years with poorer share price performance and shrinking index weights. Despite earnings upgrades which have strongly outperformed the market in recent months, the sector’s valuation multiples remain depressed relative to history. With reduced investment across both oil and gas, commodity price strength is likely to persist as economic activity rebounds. Furthermore, following the initial shock of the COVID-19 pandemic, many companies have incorporated variable components to shareholder payout policies, which should leave equity holders with direct upside to commodity prices. RBC expects the Global Integrateds to return ~$107bn back to shareholders in 2022E, >50% more than the average over the last ten years. This comes on top of a ~$78bn net debt reduction in aggregate next year.
A shifting transition narrative
The conversations around the energy transition, of which the majors are at a very early stage, are evolving rapidly and greenwashing is a real issue in the industry. Nevertheless, for RBC, the majors have potential to present themselves as ‘part of the solution’ in key areas that require substantial scale such as carbon, capture & storage, and renewable fuels. Also, views of ‘Scope 3’ emissions as solely being a supply issue may become more nuanced over time. RBC’s view is that the transition, at least for the next decade, is likely to be less capital intensive than the market expects – which could further support investment cases across the sector.
Judging progress – the metrics have changed
RBC notes that whilst the sector was under-looked by investors, the majors embarked on a multi-year period of cost reduction and efficiency improvements. Also, a key shift operated in recent years - a move from looking at return ‘on’ capital, to return ‘of’ capital, means a much greater emphasis on shareholder returns through dividends and buybacks, as the industry spends less and shrinks. Looking forward, RBC believes a combination of TSR and net carbon intensity should become a key metric to assess the performance of a transitioning energy business. Utilised in combination, it would be clear 1) how well investors are being rewarded and 2) how quickly the business is decarbonising, it stressed.
