James Butterfill

Executive Director – Head of Research and Investment Strategy

research@etfsecurities.com

Investments may go up or down in value and you may lose some or all of the amount invested. Past performance does not guarantee future results.

19 April 2017

ETF Securities Equity Research: Energy equities starting to look interesting

Summary

The Energy sector’s performance has lagged the recovery in oil prices

Energy sector valuations have already priced in a more

bearish outlook for oil despite some supports in the near-

term

On consensus forecasts, Energy now has the highest

dividend yield of any cyclical sector, and the highest EPS

growth over the next three years.

Energy balance sheets are now much healthier limiting

credit risks from a lower-for-longer oil price scenario.

Energy equities have lagged the recovery in oil prices

While oil prices corrected 13% in March and have since risen

8% to nearly their pre-correction levels, the interesting thing is

that oil-related equities have lagged and have risen only 2%

versus global equities.

Some near-term supports for the oil price

We are not bullish on the oil price – we continue to see it range

bound in the medium-term. Compliance issues among OPEC

are likely to cap the upside, while US shale production could

exert downside pressures. Nevertheless, there are some

counter-balancing supports in the near-term:

First, Oil positioning looks more balanced now. Since we

pointed out that speculative long positions in oil were at an

extreme at the end of February, they have since come down

and look more balanced, removing some downside risk for

further forced selling.

Second, we are entering a seasonally favourable time of the

year for oil prices – on average over the last 10 years, the oil

price has tended to rise from March to August. The closure of

refiners for maintenance during this period and the start of the

‘driving season’ in the US tend to be the main supports.

Third, global demand conditions continue to look robust even

in the face of rising supply risks from shale and OPEC

40

42

44

46

48

50

52

54

56

58

60

95

97

99

101

103

105

107

109

111

2016 2016 2016 2016 2016 2016 2016 2016 2017 2017 2017

Energy Sector has lagged the oil price recovery

Source: Bloomberg, ETF Securities as of close 18 April 2017

MSCI World Energy / MSCI World

Brent Crude (RHS)

200,000

300,000

400,000

500,000

600,000

700,000

800,000

900,000

1,000,000

Ap

r-16

Ma

y-1

6

Ju

n-1

6

Au

g-1

6

Se

p-1

6

Oct

-16

De

c-16

Ja

n-1

7

Feb

-17

Ma

r-17

CFTC Net Speculative Positioning

Source: Bloomberg, ETF Securities as of close 18 April 2017

WTI

Brent

-25

-20

-15

-10

-5

0

5

10

15

20

DE

C

NO

V

OC

T

SE

P

AU

G

JU

L

JU

N

MA

Y

AP

R

MA

R

FE

B

Average 10 yr Brent Crude price perf (%)

Source: Bloomberg, ETF Securities as of close 13 April 2017

10 yr avg

2017

Yo

Y %

2 ETF Securities Research 2016

producers.

Energy sector valuations have already priced in a more bearish outlook for oil

Based on a range of valuation metrics, energy equities have

already priced in a lower-for-longer outlook for oil. The Price-

to-Book and Dividend Yield ratios relative to the wider market

are both trading one standard deviation cheap to their long-term

average. The Energy sector has the highest forecasted dividend

yield (3.6%) among cyclical sectors and higher than the overall

market (2.6%).

Valuations compared to other reflationary beneficiaries such as

Materials and Industrials are close to an all-time extreme. The

MSCI World Energy sector is trading on a 20% discount to the

Materials sector and 40% to Industrials on Price-to-Book.

Energy should benefit if the rotation in value / reflationary

beneficiaries continues.

The sector looks less attractive on P/E as earnings are still

recovering. However, on a 3-year outlook, the Energy Sector is

forecasted have the strongest EPS growth of any sector on

consensus projections.

Energy Sector balance sheets healthier now

What is worthy to note is that the Energy sector credit risk is

much lower than 3 years ago: the recent dip in oil prices has not

caused high yield energy spreads to blow out because global oil

companies have been through a period of unprecedented cost

and capex cuts. According to IHS Markit, upstream capital

expenditure and operational costs in North America have fallen

by 50% in 2015 and 35% in 2016, their fastest rate for the last 30

years. This has helped the sector’s projected FCF yield to move

back into positive territory for the first time in three years and

should help solidify companies’ dividend pay-out policies going

forward.

What are the risks?

One of the biggest risks to oil prices in the medium-term is

deteriorating compliance among OPEC members. The cartel is

only 83% of the way to cutting the 1.2mn barrels proposed last

year. Extending the deal could be difficult given that non-OPEC

countries are doing far worse on compliance. We should get an

update at the next OPEC meeting on 25th May.

45

47

49

51

53

55

57

59

61

30

40

50

60

70

80

90

100

110

120

2010 2010 2011 2012 2012 2013 2013 2014 2014 2015 2016 2016

Global demand indicators remain firm

Source: Bloomberg, ETF Securities as of close 18 April 2017

ISM Manuf (LHS)

Brent Crude (RHS)

0.6

0.7

0.8

0.9

1

1.1

1.2

1.3

1.4

1.5

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Energy sector trading 1 st dev cheap to global equities on P/BV

Source: Bloomberg, ETF Securities as of close 18 April 2017

Energy P/BV Rel

+1 St Dev

Avg

-1 St Dev

-10 -5 0 5 10 15 20 25 30 35

Energy

Materials

info Tech

MSCI World

Cons Staps

Telecoms

Health Care

Real Estate

Cons Disc

Financials

Utilities

Industrials

Energy has the higest forecasted EPS growth over the next 3 years

Source: Bloomberg, ETF Securities as of close 17 April 2017

3yr EPS CAGR

-4

-2

0

2

4

6

8

10

12

14

16

18

2007 2008 2009 2010 2010 2011 2012 2013 2013 2014 2015 2016 2016

Energy company balance sheets have started to repair

Source: Bloomberg, ETF Securities as of close 17 April 2017

MSCI World Energy 12m Fwd FCF Yld

3 ETF Securities Research 2016

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