Oil: Saudi lollipop should soften energy company valuations – Financial Times

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OPEC+ has gone through periods of drought. But now it is oil that is affected. Production cuts by Saudi Arabia and Russia have managed to push oil prices up 27 percent to $95 a barrel since late June. With oil now approaching last year’s $100 per barrel average, consensus estimates for the energy sector appear outdated.

This race marks a return to form for the cartel. Not long ago, member producers balked at tighter production quotas, fearing a rapid supply response from U.S. shale producers. The new financial discipline demanded by investors in exploration and production – profits before growth – has given OPEC greater power.

A surprisingly resilient global economy has helped. Despite concerns about China’s economic weakness, its crude imports reached 11.5 million barrels per day in August, according to Jorge León of Rystad Energy. This is 2 MB/d more than at the same time last year. That kind of jump leaves China with the lion’s share of the expected growth in global demand for this year. The International Energy Agency estimates it at 2.2 Mb/d.

The world now produces less oil than it consumes. Report rapid clearance. Inventories around the world fell in August and are expected to continue to fall over the coming months.

The tightening of supply on the market could well continue next year. The exponential penetration of electric vehicles is expected to remove half a million barrels of oil from demand. Still, overall economic growth is expected to lead to a slight increase in consumption from this year’s 101.8 Mb/d.

Meanwhile, oil production must continue to shut down. Production from large conventional oil fields is declining at a rate of about 3 to 5 percent per year, no matter what. Few new projects are expected to emerge in 2024. The wild card here is Iran, where production has increased significantly despite sanctions.

The “Saudi lollipop” – a sweetener for the oil market – has caught analysts off-guard. Analysts expect European energy producers’ profits to fall by 23 percent in 2023 and another 6 percent next year, according to Bernstein Research. These should start to rise – and with them the share prices of European majors, such as Shell and Eni.

The sector’s low forward multiple of 7.4 times, despite record cash flow yields, could test investors’ resolve to avoid these carbon-intensive giants.