Updating Barclays Brent oil price forecast to $40/$55/$70 over the next three years does not alter our outlook for the challenged European E&P sector.
For 2016 the goal is survival while ensuring portfolios are positioned to benefit from an eventual oil price recovery. We continue to view sector valuations as attractive on a mediumterm horizon, but with the stocks pricing in a recovery to $59/bbl long-term some may argue a future oil price recovery is already priced in. We expect investors to continue preferring companies that combine balance sheet strength with low cost operations and some visibility on free cash flow and debt reduction. However, we remain conscious that deeply discounted debt-levered producers/developers offer the greatest exposure to an upwards shift in oil price sentiment.
Stock selection, DNO is our Top Pick: In our report ratings are unchanged but we introduced DNO (OW, NOK14 PT) as our new Top Pick for the sector, replacing Ophir Energy (OW, 130p PT). For full details see: DNO – Finding clarity in a $30/bbl world.
Tangible NAVs cut ~30% on average: The stocks most impacted by our lower oil price deck combine unhedged 2016-17 production with elevated debt levels and, in our view, more limited scope for further near-term cost reductions.
Costs coming down, but commitments being deferred: We see limited flexibility within 2016 capital budgets, but a more prolonged downturn leads us to defer unsanctioned activity further into the future. We thus anticipate a 22% year-on-year fall in aggregate capex during 2016 followed by a further 15-20% fall in 2017. Many operators continue to highlight attractive growth opportunities within their portfolios but farm-outs look set to be a prerequisite for projects to be sanctioned during 2016-17.
Balance sheets taking the strain: Sector debt levels remain elevated and a drag on investor sentiment. However, we continue to believe that, in general, high debt-levels remain a capital structure issue for the group rather than a liquidity issue. Successful project execution remains critical for debt-funded developers likely to need support from lenders for changes to covenant and repayment schedules. Management teams continue to emphasise self-help measures (cost efficiencies and reduced activity), which we believe can work over time alongside a recovery to $70/bbl by 2018.
Barclays Equity Research