European Energy Stocks Rally in Quarter as Oil Falls

by Sarah Jones | Bloomberg | October 23, 2006

Energy stocks are rising this quarter even as crude-oil prices fall and analysts expect earnings reports from BP Plc and Royal Dutch Shell Plc to show profits have peaked.

The industry’s shares are drawing investors after dropping to the lowest prices relative to the market since at least 1994, according to HSBC Holdings Plc. They declined in the first nine months of the year as stocks rose across the region.

“We have been topping up our holdings in oil stocks as we felt they’ve been overly sold off,” said Robert Talbut, chief investment officer at Royal London Asset Management in London, who oversees $46 billion. “Demand is likely to remain robust and earnings for oil companies will be reasonable.”

Energy stocks rose in the past two weeks, their longest winning streak since July, and were the third-best performers last week in the Dow Jones Stoxx 600 Index.

BP, Europe’s largest oil producer, will post third-quarter earnings tomorrow along with Norsk Hydro ASA, the biggest Nordic energy company, and Neste Oil Oyj, Finland’s only oil refiner. Shell, BP’s biggest European rival, will report two days later.

Profits fell about 8 percent at both BP and Shell, based on analysts’ estimates. Crude-oil futures tumbled 28 percent in New York from a record $78.40 a barrel, reached in July, as an end to fighting in Lebanon eased concern about Middle East supplies and the U.S. hurricane season left production intact.

Oil for November delivery fell 3 percent last week to $56.82 a barrel. OPEC, whose members produce 40 percent of the world’s crude, agreed to cut production by 1.2 million barrels a day to boost prices. The 4.4 percent reduction will take effect Nov. 1.

Today’s Retreat

The Stoxx Oil & Gas Index climbed 2.3 percent. Only basic- resource and health-care companies did better among 18 industry groups in the Stoxx 600, which added 0.4 percent for its fourth straight weekly gain. The Stoxx 50 rose 0.2 percent. The Euro Stoxx 50, tracking the euro region, was little changed.

For the fourth quarter, the oil and gas index rallied 4.7 percent as of Oct. 20 and the Stoxx 600 gained 3.6 percent. Norwegian companies have led the industry’s rise. Aker Kvaerner ASA, an oil-services and engineering company based in Lysaker, Norway, has risen 12 percent for the biggest gain.

The energy index retreated 0.6 percent today, leading declines in the market. Crude oil dropped on speculation that OPEC won’t cut production as much as its members planned.

The group was the second-worst performer from January through September, when its gauge slipped 0.8 percent as the Stoxx 600 climbed 10 percent. Only technology shares did worse.

Turning Around

Global fund managers worldwide turned away from energy stocks this month more than any other group, a survey by Merrill Lynch & Co. showed. The proportion holding fewer shares than are represented in benchmarks exceeded those that had so-called overweight positions for the first time since early 2002.

The group also replaced banks as the industry that European investors viewed as the least expensive. A net 26 percent said the shares were undervalued, up from 14 percent in September, according to the firm’s monthly survey.

Shares of companies in the Stoxx Oil & Gas Index trade at 9.8 times estimated earnings on average, below the Stoxx 600’s multiple of 13.9, FactSet’s data shows.

Energy stocks are 25 percent cheaper than the members of the FTSE All-World Europe Index, another pan-European benchmark, when compared against next year’s profit forecasts, according to HSBC. Analyst Paul Spedding reviewed data from Thomson Financial and found prices haven’t been lower on this basis since 1994.

‘Still Supportive’

Oil prices are “still supportive for the stocks to head higher,” said Michael Hughes, who oversees $36 billion as chief investment officer of Baring Asset Management in London. “These companies are going to be generating quite large profits for the foreseeable future.” Baring’s holding of energy shares exceeds the group’s weighting in benchmarks.

BP will report a third-quarter profit of $4.86 billion before any gains or losses on inventories, according to a Credit Suisse estimate. The company earned $6.12 billion in the second quarter and $5.26 billion in last year’s third quarter.

Shell earned $5.31 billion before inventory changes and one-time items, according to Credit Suisse. The estimate is less than the profits of $6.55 billion in the second quarter and $5.8 billion a year earlier.

Shares of London-based BP have risen 6.8 percent from this year’s low, set Sept. 25. Shell, based in The Hague, has risen 4.4 percent during the same period.

Slower Profit Growth

Earnings growth for oil and gas companies in the Stoxx 600 will plummet this year to 8.6 percent from 42 percent in 2005, according to analysts’ estimates compiled by FactSet Research Systems Inc. in London. In 2007, profit may rise 0.4 percent, the smallest gain among the 18 groups.

Lower oil prices aren’t the only reason for the expected slowdown. Delays or shutdowns at production centers in Alaska, Nigeria and the Gulf of Mexico have hurt profitability at major oil companies. Rising costs for labor and equipment and higher taxes in countries such as the U.K. have also contributed.

“The oil majors look cheap, but I can’t see a lot of upside,” said Willem Kadijk, a senior equity salesman at Kepler Equities in Amsterdam. “If the oil price was to double, most of the majors would not benefit.”

Crude oil will average $64 a barrel in New York next year, according to the median forecast of 29 analysts in a Bloomberg News survey at the end of September.

‘Room for Upgrades’

Worldwide demand for oil will probably climb 1.7 percent next year after rising 1.2 percent this year to 84.57 million barrels a day, according to the International Energy Agency.

Earnings growth estimates for oil companies have increased as well, according to FactSet. Three months ago, Stoxx 600 oil profits were projected to rise 8.2 percent in 2006 and decline 1.2 percent in 2007.

Some analysts didn’t factor in a higher oil price earlier this year, according to Jason Kenney, an oil equity analyst at ING Wholesale Bank in Edinburgh.

“If oil hovers around $60, that gives plenty of room for upgrades in 2007 earnings,” said Kenney, who raised European energy shares to “overweight” from “neutral” this month. “The sector still has a positive earnings outlook through to next year.”

Tim Guinness, who manages $2 billion in global energy stocks as chairman of Guinness Atkinson Asset Management in London, predicts the industry’s shares may climb another 10 percent by year-end.

“If oil remains in the $50 to $70 range, eventually energy share prices will rise to reflect that reality,” said Guinness, who also manages Investec Asset Management’s global energy fund.