Welcome to Morningstar. I'm Holly Black. With me is Allen Good.
He is an equity analyst at Morningstar. Hello.
Hi, how are you? So, Allen, you are focused on the oil sector
and it was just over a year ago that we were all surprised when the oil price went negative.
And that's obviously a big deal for oil companies. So, how have they coped since then?
Yeah. I mean the negative oil price was a bit of a technicality around storage issues and expiring
contracts. But I mean, I think the broader issue is that, yeah, oil prices did crash last year, an
issue when the pandemic hit, and you had basically a global lockdown. However, since then they have
mustered a steady recovery and now oil prices are nearly back at or above January 2019 levels. So,
really, the market has come around and fully recovered at least as the price goes.
What you saw over the last year though was what all companies typically do when oil prices crash,
or you have a down cycle, which is to certainly reduce costs, lay people off,
postpone or cancel projects. And in some cases, we saw major oil companies actually cut the dividend,
which is actually something quite a bit different than what we had seen in previous crisis.
So, the world is slowly but surely starting to return to normal. What does that mean
for the oil price and these companies? What are the opportunities and risks?
So, as I mentioned, oil prices have already begun to recover. We are at levels that we
saw in early 2020 before the pandemic hit, but we think prices can actually move higher
from here. We do expect demand to recover to pre-pandemic levels and grow from there
given nothing structurally has changed around oil demand. So, we think in the near term,
you could have a situation where demand growth far outpaces supply,
and that certainly could push prices much higher from where we are at today. Over the long term,
however, we still think that oil prices will average around somewhere around $60 per barrel,
which is the marginal cost of production. So, these oil companies, it really depends,
because we have seen several companies such as BP and Shell move more towards investing in low
carbon solutions or renewables (just sort of) from 15% to 20% of their budgets. So,
certainly, going forward, oil prices are going to be less important for their businesses. However,
that said, in the near term, oil prices still ultimately dictate the underlying financial health
and cash flow for oil and gas companies. So, with all that in mind,
what are your top stock picks in this sector? If you look at the strategies, if you look at
what I just previously mentioned around near-term oil and gas demand, even long-term oil demand
doesn't seem to be going away anytime soon. So, we think that investments in oil and gas continue to
make sense, despite some of the headlines you've seen around sustainability and carbon, et cetera.
And so, you combine that with where we think is valuation, we think Exxon (XOM) stands out.
Exxon has made some overtures to investors around capital discipline, about introducing carbon
reduction targets, about diverting some investment towards low-carbon solutions, particularly
carbon capture. You combine all of that with the valuation, which makes sense given that what we
think around a recovering oil and gas price and at about 20% discount to our fair value
it opens up a lot of opportunity we think for investors not to mention the strong cash yield.
Chevron (CVX) is another example. The valuation is less attractive, but we do think it's
a good play on recovering oil prices. It was another firm that didn't cut its dividend. So,
it has an attractive yield. If you are looking for a firm that has more of a mix of low carbon
along with oil and gas along with an attractive cash return to shareholders,
I'd recommend Total (TOT). It trades at about 15% discount to our fair value estimate,
very strong balance sheet, didn't cut its dividends, which yields relatively high and
it has a good mix of investment in oil and gas as well as renewables. So, I would highlight
those three companies as providing attractive valuation, an attractive capital allocation plan
along with a highly attractive dividend yield or cash return to shareholders.
Fantastic. Allen, thank you so much for your time. For Morningstar, I'm Holly Black.