The energy sector has been outperforming other sectors among the S&P 500 companies this year, with a gain of 21.79 percent year to date. Now the question is whether or not the recent OPEC deal will further improve the prospects for the sector in 2017?
Doug Terreson, head of energy research at Evercore ISI and Institutional Investor’s top-rated analyst for integrated oil certainly believes it will. He expects oil companies to double their earnings in 2017 on the back of a sustained increase in crude oil prices and low oilfield service costs.
“We’re unrepentantly bullish here. Investors portfolios in our view should be overweight energy and this includes integrated oil, E&P and oilfield service stocks,” he told CNBC’s “Fast Money: Halftime Report” on Wednesday. “Our call this year has really been not to overthink it because with the oil price rising and costs declining, performance would probably be pretty good, and so far so good,” he said.
The bullishness is because OPEC not only struck a deal to cut production, it surprised the markets with a larger than expected cut. OPEC agreed to cut 1.2 million barrels a day and expects Russia and other non-OPEC nations to cut another 600,000 barrels a day of oil, bringing the total cut to 1.8 million barrels a day.
“This deal is significant. It sends a very strong message to the market and it should help the market find a balance,” said Simon Flowers, chief analyst at Wood Mackenzie. Flowers forecasts Brent to average $55-$60 a barrel in 2017, but cautioned this would “depend on OPEC being very careful to meet the terms of the agreement,” reports Reuters.
As a result of the deal, crude oil prices rallied along with a rally in companies from the oil sector. Crude has reached close to the current levels twice in the past year, but hasn’t been able to break out of it.
Hence, it brings a logical question to mind. Has crude bottomed out? The second question is, will we see the sustained rally in crude that is needed to justify a buy on oil companies?
“The main thing about this deal is there’s a lot less risk that oil prices go back to $40, or below that,” Desjardins senior economist Mathieu D’Anjou said, reports Business Financial Post .
Barring a black swan event, we can safely say that a bottom in crude oil is firmly in place. The investors should, however, not expect a runaway rally from the current levels.
Nevertheless, even if crude averages around $55 a barrel, investors can start accumulating oil companies for greater returns in 2017.
In the third quarter, the big five oil companies saw their cash flow from operations increase 67 percent over the second quarter and almost double from the depressed first quarter amount.
“The environment’s been tough but we’ve seen robust cash-flow delivery,” Brian Gilvary, chief financial officer of London-based BP, said Nov. 1 on a call with investors, reports Workboat.
Even at Brent crude prices average above $50 a barrel, the companies are confident they will generate healthy cash flows.
“Our overall financial picture is set to improve in a meaningful way as we move into 2017,” Patricia E. Yarrington, CFO of San Ramon, California-based Chevron, said Oct 28. “Our objective is to get cash balanced in 2017, assuming $50 Brent prices.”
Similarly, Shell is also confident to increase cash flows from $21 billion this year to mid-$30 billion next year. “I’m sure we can cover even the dividend with organic cash flow” in 2017 at $50 oil, CFO Simon Henry told investors.
The oil companies have successfully cut costs, and are now able to churn out good cash flows even at $50 a barrel levels. Hence, they look like a good bet for the next year; however, investors should keep an eye on the OPEC nations for their follow-through. OPEC members are known to exceed their production limits, if history is any evidence. If they cheat, oil will again tumble, and this time it might not react as favourably to OPEC promises.