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The opportunity in energy

Fook Hien Yap
Fook Hien Yap • 4 min read
The opportunity in energy
A Shell station in London. StanChart believes Europe’s energy sector offers a more attractive buying opportunity compared to US and China peers / Bloomberg
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The global energy equities sector offers some interesting opportunities for investors. The sector, which comprises mainly oil and gas producers, refiners and related services companies, has done well this year, rising over 10% as of end-April and comfortably outperforming global equities. 

Although momentum has softened in recent weeks, we continue to believe the sector can outperform the market benchmark over the next 6-12 months. In the shorter term, we believe Europe’s energy sector offers a relatively more attractive buying opportunity today as it has lagged its counterparts in the US and China year-to-date. Also, investor positioning appears less stretched in Europe. 

Oil price performing well
The strength in crude oil prices this year has been supportive of energy stocks. Demand for oil has been robust as transportation needs in emerging markets have been increasing and this could persist for longer. Oil producers and Opec+ have been disciplined in their output, curtailing global supply. 

Meanwhile, geopolitical tensions, particularly in the Middle East, have been driving oil price strength in the last few months. We expect these factors to support the oil price around current levels, which would be enough for energy sector equities to outperform, in our view. Consensus estimates are for global energy sector earnings to fall by over 10% in 2024, but with the current oil price exceeding the average for 2023, we see scope for 2024 earnings estimates for the sector to be revised higher. 

Strong cash flows and valuation
The large integrated oil companies dominate the energy sector indices in the US, Europe and China. These large companies are generating significant cash flows currently and remunerating shareholders generously. The combined dividend and share buyback yield for Europe’s energy sector is about 12%, the highest among all sectors. Valuation is similarly attractive, with the 12-month forward P/E for Europe’s energy sector at 8.0 times, a significant 36% discount to the average multiple over the last 10 years. The attractive yield and valuations underpin our view to buy Europe’s energy equity sector.

Inflation and geopolitical factors
Historically, the energy sector has also done well in an inflationary environment. This seems to be the environment we are currently in as US inflation data has been stronger than expected in the first quarter of this year, though the most recent data for April is indicating that inflation is slowing. We do expect disinflationary trends to resume this year but a stickier-than-expected inflation scenario cannot be ruled out. As a result, we believe investors would be well-positioned to hedge against this risk scenario with exposure to the energy sector.

See also: Winning the loser’s game

Geopolitical tensions in the Middle East are also helping to support oil prices. Our base case is that international efforts to contain tensions between Israel and Iran would be successful, but a broadening out of the conflict cannot be ruled out.

In addition, US presidential candidate Donald Trump has been a vocal supporter of the energy sector. In the run-up to the elections in November this year, Trump’s campaign promises in support of the sector may add further tailwind for energy companies. The importance of energy security has emerged as a strategic priority for Europe especially following the Russia-Ukraine conflict, which saw disruptions to the supply of gas to Western Europe. The strategic focus could tilt government policies worldwide in favour of national energy champions that can secure a stable source of supply.

The foremost risk to our positive view on the energy equities sector would be weaker-than-expected oil prices. This may come about from a supply glut or a collapse in demand due to a recession. Our base case is for an economic soft landing in the US over the next 12 months, keeping global growth and energy demand stable. In addition, any adverse regulations on the energy sector would impact the sector’s equities.

See also: Time to invest in Asia Pacific real estate market: M&G Real Estate says

On balance, we believe the risks are outweighed by potential rewards. Hence, in our globally diversified asset allocation, we have a tactical preference for energy sector equities. In particular, we see a buying opportunity in Europe’s energy sector.  

Fook Hien Yap is senior investment strategist at Standard Chartered Bank’s Wealth Solutions Global Chief Investment Office

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