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Major oil firms like Shell are entering ‘sweet spot’ - UBS

"We could be entering the sweet spot for the integrated sector with oil prices recovering, the downstream strong and spending under control,” Rigby said in a note.
Shell oil and gas operations
Shell is the 'top pick' for UBS

Integrated oil companies may be entering a ‘sweet spot’, that’s according to UBS analyst Jon Rigby, who rates Royal Dutch Shell Plc (LON:RDSB) as the ‘top pick’ among the London-listed oilers.

“We argue that we could be entering the sweet spot for the integrated sector with oil prices recovering, the downstream strong and spending under control,” Rigby said in a note.

Shell is described as the “clearest play” on the reset in the integrated oil and gas sector.

A painful but necessary reset

“The beginning of Shell's reset was painful (but necessary) as the market reacted negatively to the purchase of BG. Our view was this misunderstood the weakening competitive position of the legacy Shell portfolio and the quality of the acquisition.

“Pleasingly, the recently held Shell Management Days highlighted the value that this deal has brought (in particular the upgraded FCF target for Integrated Gas) and the catalyst it represented to wider restructuring of the group which is not fully appreciated by the market, in our view.”

With a broader assessment of the sector, Rigby added: “Our outlook suggests a continued constructive view on the sub-sector in absolute terms.

Positive shift in sentiment

“We also sense a positive shift in sentiment among investors in the past 6 months as share price performance has stabilised and oil prices recovered. Such shifts in sentiment can be ephemeral, however.

“2014-16 was obviously a chastening experience for the sector. The warning signs were there before the oil price collapsed as control over-investment levels and cash returns was lost.

“Companies have undertaken a significant reset of their operational and financial models. Indeed, 2017 saw an important cross-over – in 2H17 oil prices rose above the implied cash neutrality of the sector.

“We calculate cash neutrality - the oil price needed to generate the cashflows necessary to fund organic capex and the dividend.”

A sector derisked

Rigby added: “This is quite clearly a major step forward and the sector has significantly de-risked in the eyes of investors.

“It also goes a considerable way to restoring credibility to the management of the sector and we think (hope) that this hard-won credibility will be only reluctantly risked in the next stage of the cycle, implying an appropriately conservative response to improved financial conditions.”

“Indeed, we think there is a persuasive argument that the 2018 conditions represent the sweet spot for investors in the Integrated sector.”

He reckons the sector will now be capable of generating ‘meaningful’ free cashflow, although he added that the recent financial scars have yet to heal and as such some of the new funds may be used to unwind the ‘sins of the past’.

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Royal Dutch Shell Plc Timeline

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