The below Credit Suisse report talks about the Integrated Oil & Gas sector. The research analysts are Thomas Adolff, Ara Kosyan and Arjun Saini.
Sector Review
We lower our TPs for the European IOCs by 20-33%, driven by much lower near-term commodity price forecasts (oil, gas and refining margins). We take the Brent oil price ($/bbl) down to $42/$50/$60 in 2020/21/22 from $63/$65/$65 previously, and European gas prices ($/mmbtu) to $3.4/$4.4/$6.0 from $4.3/$5.0/$6.4 previously, both owing to weaker supply/demand dynamics. We assume Downstream to be almost as weak as 2019 (from our previous expectation of a strong year in 2020) owing to the demand shock. In terms of stocks, Total remains our preferred European Super Major – it has the most resilient business model, in our view, with the lowest cash flow break-even at ~$50/bbl and a strong balance sheet (reported gearing at ~21% at end-2019). Once the impact from the coronavirus fades, and Russia and Saudi Arabia still flood the market with oil, downstream-biased companies (e.g., Repsol where the dividend yield of 11-12% also looks compelling) look well positioned.
There are no winners from the Russia and Saudi action
Although the industry has been busy restructuring (and doing so successfully) in recent years, the last downturn (in 2015-17) left some wounds that remain unhealed. The ‘shock’ from last week’s event (with Russia walking away from the OPEC+ agreement and Saudi Arabia announcing it would flood the market) leaves the industry more exposed. Even before the effects of coronavirus and the severe impact this has had on global demand, downstream (refining and chemical) and (less so) gas, both of which played a supporting act in 2015-17, were struggling. Further, it is harder to take out costs – the easy wins have been made. The oil macro should mean revert at some point, but the shape and pace is uncertain.
Going solo is expensive
A broader alliance of producers managing supply benefits both consumers and producers because it reduces volatility and keeps prices in an acceptable range. While Saudi Arabia has a vast cash reserve base, it also has a high budget breakeven (>$80/bbl) with Aramco being the most important revenue source. Our original forecast was for the Saudi government to earn ~$220bn pa (over 2020-23) from Aramco (via taxes, royalties, dividends) at Brent ~$65/bbl. This could be as low as $90bn pa if Aramco floods the market with 12mbd and Brent reaches $30/bbl – assuming Saudi Aramco does not re-lever beyond its target gearing range (i.e., cuts its dividend).
Changes
Applying a regression to the market-implied CFROI®, we find the market is pricing in a long-term Brent price of ~$40/bbl. There is value, but also great uncertainty. We change our valuation methods for the Euro IOCs, whereby we normalize our forecast 2025E ROACE into perpetuity as opposed to fade up to a target ROACE. This, coupled with our macro changes, explains the TP changes of ~20-33% across the Euro Majors.
