Oil producers perform best in the “restraint” phase of the cycle, with Big Oil about to see a new golden age, Goldman Sachs said in a note dated last week.
The investment bank pointed to three phases of oil production: Expansion, contraction and restraint.
“There is a broad market perception that Oil Producers perform best in rising oil price environments, but historical evidence shows that producers actually fare poorly in the ‘Expansionary’ phases, as cost inflation and inefficiencies dilute returns,” it said. “Instead, we find that Big Oils perform best in the ‘Restraint’ phases of the cycle – defined by backwardation, cost deflation, and consolidation – when a high risk premium on long-term oil prices restrains investment and creates high barriers to entry.”
Goldman said the market was entering a new “restraint” phase, as concerns over long-term disruption from decarbonization drive up the risk premium on new investment. That means the long-term investment cycle turns favorable for a few large companies that can still self-finance new investment, it said.
“We see this as the start of a new Golden Age for Big Oil’s reborn Seven Sisters, but also a favourable environment for returns in the commodity, which stand to benefit from positive roll,” it said.
The Seven Sisters
The “Seven Sisters” are ExxonMobil, Chevron, RD Shell, BP, Total, ENI and Statoil, it said.
“These global majors are once again dominating complex, long lead time developments in non-OECD countries, locking in higher returns, better fiscal terms and a more reliable global oil services supply chain,” it said.
Goldman said with the new “Restraint” phase, Big Oil companies should see similar earnings growth as in the 1990s, amid consolidation and cost efficiencies. It also pointed to the chances for the stocks to re-rate, with current price-to-earnings ratios and dividend yield metrics suggesting around 30-50 percent upside to long-term multiple averages.
“This upside is also consistent with the oil sector going back towards the historical range of weight in the U.S. and European equity indices, which currently stands at less than half its historical average,” it said.
Goldman said it expected European Big OIls to have free cash flow yield of around 10 percent on aggregate this year, the highest in 20 years, on strong production growth as “Expansionary” phase projects come onstream, and amid improved efficiency and a strong LNG and oil downstream market.
Goldman tipped its top sector picks as Total, which is on its conviction list, RD Shell, ENI, Chevron and ConocoPhillips. It rates them all at Buy.