Investor sentiment toward energy stocks will improve through 2020 as capital discipline exercised by U.S. producers is set to drive improved performance by sector companies, Goldman Sachs analysts said in a Jan. 2 research note.
Additional OPEC production cuts in the first quarter and a crude oil price outlook of $63 per barrel for Brent and $58.50/bbl for West Texas Intermediate will test producers' commitment to capital discipline. Still, as they strive to pay down debt and return more cash to shareholders, producers are expected to stay the course in 2020, the analysts said.
The Goldman Sachs analysts expect producers to generate $13 billion in aggregate free cash flow at the anticipated crude oil price. In turn, improvements in free cash flow, earnings and corporate returns in 2020 will improve energy stock performance relative to the S&P 500, the analysts said.
Energy stocks in the S&P 500 have moved to 5% of S&P earnings in 2019 from 13% in 2013, the analysts said. They expect earnings for the energy subsectors on market-cap-weighted bases to be up more than 25% in 2020.
The gains are primarily due to select integrated oil companies and refiners, the analysts said. "Refiners have historically traded with [free cash flow] growth, and we see compelling [free cash flow] generation power for our large cap refining coverage in 2020-2022," the Goldman Sachs analysts said.
The investment bank recommends that investors position in refiners Phillips 66, Valero Energy Corp. and Marathon Petroleum Corp. as well as U.S. oil majors Chevron Corp., ConocoPhillips Co. and Exxon Mobil Corp.
Longer-term factors, however, provide a risk to the expectation of improved energy equity sentiment in 2020, the analysts said.
Environmental, social and governance considerations and energy companies' role in decarbonization are increasingly crucial as the sector competes with others in the S&P 500. Investor concerns on longer-term oil demand and election-driven regulatory risk for the U.S. shale complex could also loom over energy equities through 2020, the analysts said.
Additionally, as U.S. shale matures, "individual stock picking based on core shale well inventory will become increasingly relevant," Goldman Sachs said.
U.S. shale production could be approaching its peak, Goldman Sachs said. Already, the inventory of drilled-but-uncompleted wells has fallen, and the market is nearing degradation in shale productivity gains.
Companies continue to invest in U.S. shale, remaining committed to organic and inorganic shale capital deployment. Still, as shale supply costs begin to rise, a shift toward global investment and capital from shale to other areas, including the international and offshore markets, is expected.
Energy companies that are better positioned to compete in the global markets will garner greater investment interest in 2020, the analysts said.
Oilfield services companies are poised to benefit from the international and offshore market recovery. For the second year, international and offshore spending by oilfield services companies will outpace U.S. land spending as international upstream spending will rise 5% to 6% with widespread activity growth. In contrast, exploration and production upstream spending in the U.S. will decline roughly 10%, the analysts said.
Oilfield services companies are also seeing the early stages of price increases for oilfield equipment and services as the companies show continued capital discipline while tool capacity tightens, the analysts said.
This bodes well for Schlumberger Ltd., Baker Hughes Co. and Halliburton Co., which generate 50% to 70% of their revenue from the international markets.
TechnipFMC PLC, Oceaneering International Inc. and National Oilwell Varco Inc. are market leaders in the offshore space, where Goldman Sachs anticipates increased offshore activity will drive higher demand for offshore-related projects and subsea tree orders.
"We expect to see an increased number of [final investment decisions] with deepwater economics improving significantly," the analysts said. Goldman Sachs expects to see a 10% to 16% increase in subsea spending between 2019 and 2021.