Five Things to Watch in European Oil in 2019

European oil and gas stocks are about to close what would have been their best year since 2014 — if only the last quarter had behaved.

Oil companies enjoyed a steady increase in crude prices for most of 2018, with the Brent and WTI benchmarks reaching four-year peaks on the 3^rd October.

But, in the final weeks of the year, the conversation has shifted from potential damage to the economy from oil-price gains to the timing for when the commodity will hit the floor. The regional sector’s main stock index is now set for its worst full-year decline since 2015.

Shares of oilfield services providers, such as TechnipFMC Plc, Subsea 7 SA and John Wood Group Plc dropped the most in the fourth quarter, as the companies need higher oil prices to sustain revenue. Big oil companies including Royal Dutch Shell Plc and Total SA were more buffered during the sell-off because they maintained capital-expenditure discipline.

Here is a round-up of some themes to watch for in 2019:

Price Volatility

Why did oil collapse? Fears of weaker macroeconomic growth, the China-US trade dispute, corporate waivers conceded by President Trump’s administration, new sanctions on Iran and booming American shale production all squeezed prices.

To stem the bleeding, the Organisation of Petroleum Exporting Countries and its partners agreed in early December to remove 1.2 million barrels a day from the market. After an initial gain in the industry’s shares, the slide resumed.

Brent crude at around US$60 a barrel is still comfortable for integrated oil companies, which have focused their efforts in the past years to reduce their break-even points.

The story is different for oilfield services operators.

“Spare capacity remains very high in that sector and it will take time to reduce it and to improve margins,” Oddo BHF analyst Ahmed Ben Salem said.

The worst performers on the Stoxx 600 Oil & Gas Index, TechnipFMC and Subsea 7, are about to close the year down more than 30 percent.

Capex Discipline

Higher volatility means oil majors “will continue to review if their economics work in a more bearish environment,” Christyan Malek, head of JPMorgan Chase & Company’s European, Middle East and Africa oil and gas research desk, said in November. “It will probably create paralysis around project sanctioning and continued discipline around capex, which is a good thing.”

Oddo’s Ben Salem predicted that integrated oil companies will grow even with their investment restraint, generating a nine percent free cash-flow yield at US$65 a barrel. Majors like Shell and Total will continue stock buyback programmes, while Eni SpA could start one, he said.

“From now to 2020 the visibility is very high, the market is already aware that the guidance will be respected as almost all the projects are under development,” while beyond that year “the pipeline is rich with high-quality projects,” Ben Salem said.

Ship-Fuel Conversion

With new International Maritime Organisation (IMO) limits on maritime vessels’ exhaust emissions coming into force in 2020, the oil industry is gearing up for disruption as shipping companies choose whether to convert engines to rules-compliant fuel, install scrubbers to continue using heavy fuel oil or switch to liquefied natural gas.

Repsol SA, Neste Oyj, BP Plc, Total and Saras SpA are best positioned to handle the changeover to so-called IMO 2020 regulations because of their refinery capacity for cleaner-burning products.

“We expect IMO 2020 to be even more of a driver of share price performance in 2019 as the impact starts to be felt in the second half,” UBS analysts wrote.

Energy Transition

The energy sector’s switch to technologies reducing carbon-dioxide emissions is the sword of Damocles dangling over oil companies. According to UBS analysts, the industry faces two challenges: deciding whether and how to participate in the increasing electrification of energy supply and to cut greenhouse-gas emissions, and pressure from shareholders basing investments on companies’ strategies for change.

For JPMorgan Cazenove analysts, Equinor, Repsol and Total are the best placed for the energy transition, based on their carbon footprint versus energy diversification, lower levels of gas flaring at upstream sites and the portfolio evolution until 2025.

Those companies’ capex projections through the end of the decade indicate their investment in “new energies” will remain at about five percent of spending excluding one-time effects such as acquisitions or disposals, the analysts wrote in November. “Reducing the carbon footprint will require more investment, quicker than many realise,” they said.

Shift to Gas

With the shift to cleaner energies, the big winners in the fossil-fuel industry are natural gas and LNG. As a result of the Paris climate agreement, electricity generation will tend to move to those fuels from coal. For countries without a pipeline to transport gas, LNG fills the gap.

“Demand will grow in LNG while companies continue their transformation” from producing oil and gas to offering energy from a range of sources, Oddo’s Ben Salem said. Shell and Total in particular will benefit from their strong presence in the Pacific enabling them to sell LNG to their customers in the area with lower transportation costs and more flexibility.

The shift to gas from coal will also play a key role at European utilities, while the energy transition more generally will be critical for the auto industry.

Source: Rigzone