Would a Norwegian exit hurt oil stocks?

Thought of the day

The Stoxx Europe 600 Oil and Gas Index fell as much as 0.5% on 17 November after Norway’s USD 1tr sovereign wealth fund, the world’s largest equity investor, said it’s considering dropping its investments in oil and gas stocks. The proposed move would diversify the Norges Bank Investment Management’s portfolio and protect against a fall in crude prices.

Given the fund’s exposure to Norway’s domestic energy sector, the desire to diversify is understandable, but we believe energy stocks remain attractive:

  • Energy stocks look undervalued. On a price-to-book valuation at 1.2x, the Eurozone energy sector is trading near its 10-year low of 0.9x, and it is the second-lowest of all sectors. The valuation of US energy firms is near a 40-year low, both on a price-to-book and a relative cyclically adjusted price-earnings basis.
  • The impact of low oil prices is largely discounted, in our view, and crude prices have recovered strongly recently, with Brent up 38% since its June lows. Cash flows and returns on capital, including return on equity, should improve, aided by drastic cuts in capex and favorable year-on-year comparisons.
  • Energy stocks provide protection against an escalation in geopolitical risks in the Middle East, which have come back into focus with rising tension between Iran and Saudi Arabia, and the latter’s crackdown on alleged corruption in the Kingdom.

While Norges Bank Investment Management has valid reasons for considering divesting its holdings of overseas energy stocks, this doesn’t undermine the investment case for the sector. We prefer energy stocks in both Europe and the US.

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