Oil prices soared on Monday morning after OPEC+ decided on Sunday to stay the course on oil production cuts ahead of the implementation of a price cap of $60 on crude oil of Russian origin negotiated by the EU, the G7 and Australia. OPEC+ previously agreed to cut production by two million bpd, or about 2% of global demand, from November to the end of 2023.
Yet oil prices are down more than 30% from their 52-week highs while, curiously, the energy sector is just 4% off its peak. In fact, over the last two months, the first benchmark in the energy sector, the SPDR Energy Select Sector Fund (NYSEARCA: XLE), climbed 34% while average crude spot prices fell 18%. This is a notable divergence as the correlation between the two over the last five years is 77% and 69% over the last decade.
According to Bespoke Investment Group via The Wall Street Journal, the current split marks the first time since 2006 that the oil and gas sector has traded within 3% of a 52-week high, while the price of WTI has fallen more than 25% from its respective peak of 52 weeks. It is also only the fifth such divergence since 1990.
David Rosenberg, founder of an independent research company Rosenberg Research & Associates Inc, outlined 5 key reasons why energy stocks remain a buy as oil prices haven’t made significant gains over the past two months.
#1. Favorable reviews
Energy stocks remain cheap despite the huge rush. Not only has the sector significantly outperformed the market, but companies in this sector remain relatively cheap, undervalued and posting above-average projected earnings growth.
Rosenberg analyzed PE ratios per energy stock by looking at historical data since 1990 and found that on average, the sector historically ranks in only its 27th percentile. On the other hand, the S&P500 sits in its 71st percentile despite the massive sell-off that occurred earlier in the year.
Image source: Zacks Investment Research
Some of the cheapest oil and gas stocks right now include Ovintiv Inc. (NYSE: OVV) with a PE ratio of 6.09; City Resources, Inc. (NYSE: CIVI) with a PE ratio of 4.87, Enerplus Corporation (NYSE:ERF)(TSX:ERF) has a PE ratio of 5.80, Western Oil Company (NYSE: OXY) has a PE ratio of 7.09 while Canadian Natural Resources Limited (NYSE:CNQ) has a PE ratio of 6.79.
#2. Robust gains
Strong earnings from energy companies are a big reason why investors are still flocking to oil stocks.
The third quarter earnings season is almost over, but so far it’s looking better than expected. According FactSet Revenue Overviewfor the third quarter of 2022, 94% of S&P 500 companies reported results for the third quarter of 2022, of which 69% reported a positive EPS surprise and 71% reported a positive earnings surprise.
The energy sector recorded the highest profit growth of all eleven sectors at 137.3% against 2.2% on average by the S&P500. At the sub-sector level, all five sub-sectors in the sector saw year-over-year profit increases: Oil & Gas Refining & Marketing (302%), Integrated Oil & Gas (138% ), oil and gas exploration and production (107%), oil and gas equipment and services (91%) and oil and gas storage and transportation (21%). Energy is also the sector in which most companies beat Wall Street estimates at 81%. Positive revenue surprises reported by Marathon Petroleum ($47.2 billion vs $35.8 billion), Exxon Mobil ($112.1 billion vs $104.6 billion), Chevron ($66.6 billion $57.4 billion), Valero Energy ($42.3 billion versus $40.1 billion) and Phillips 66 ($43.4 billion versus $39.3 billion) were major contributors to the increase in the index’s revenue growth rate since September 30.
Even better, the outlook for the energy sector remains bright. According to a recent Moody’s Research Reportindustry earnings will broadly stabilize in 2023, although slightly below recent peak levels.
Analysts note that commodity prices have fallen from very high levels at the start of 2022, but predicted that prices are likely to remain cyclically high through 2023. This, combined with modest volume growth, will support a strong cash flow generation for oil and gas producers. . Moody’s estimates that U.S. energy sector EBITDA for 2022 will reach $623 billion, but will fall to $585 billion in 2023.
Analysts say weak capital spending, growing uncertainty about future supply expansion and the high geopolitical risk premium will, however, continue to support cyclically high oil prices. Meanwhile, strong US LNG export demand will continue to support high natural gas prices.
In other words, there’s simply no better place for people investing in the US stock market to park their money if they’re looking for serious earnings growth.. Moreover, the outlook for the sector remains bright.
While oil and gas prices have fallen from recent highs, they are still much higher than they have been for the past two years, hence the continued enthusiasm in oil markets. ‘energy. Indeed, the energy sector remains a strong favorite on Wall Street, with the Zacks Oils and Energy sector being the highest-ranked sector among the 16 Zacks-ranked sectors.
#3. Solid payouts to shareholders
Over the past two years, U.S. energy companies have changed their old playbook from using most of their cash flow for production growth to returning more cash to shareholders via dividends. and redemptions.
As a result, the combined dividend and buyout yield for the energy sector is now approaching 8%, which is high by historical standards. Rosenberg notes that similar highs occurred in 2020 and 2009, which preceded periods of strength. By comparison, the combined dividend and buyback yield for the S&P 500 is closer to 5%, which is one of the largest spreads ever in favor of the energy sector.
#4. Low inventory
Despite sluggish demand, U.S. inventory levels are at their lowest since mid-2000 despite the Biden administration’s attempt to depress prices by flooding markets with 180 million barrels of crude from the SPR. Rosenberg notes that other potential catalysts that could lead to additional upward pressure on prices include the Russian oil price cap, further escalation in the Russian-Ukrainian war, and China backing away from its Zero COVID policy. -19.
#5. Higher integrated “OPEC+ put”
Rosenberg points out that OPEC+ is now more comfortable trading oil above $90 a barrel, as opposed to the $60-$70 range it has accepted in recent years. Energy expert says this is because the cartel is less concerned about losing market share to U.S. shale producers since the latter have prioritized payouts to shareholders over growth aggressive production.
The new OPEC+ stance provides better oil price visibility and predictability, while prices in the $90/barrel range can support strong payouts via dividends and buybacks.
By Alex Kimani for Oilprice.com
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