Since the beginning of the year, the stock of ExxonMobil (XOM) has lost significant ground, down near 10% on the year. This is in contrast to British Petroleum (BP), which is near breakeven, and Shell (RDS-A), which is up close to 10% year to date. While the stock sector beta is a challenge to calculate based on these three diverging stocks, with oil trading near $50 per barrel, Moody’s analysis points to slowing if steady oil and gas sector EBITDA growth in 2018 after strong year over year growth basis June. Even with oil and gas sector earnings stabilizing, however, there is a slight caution flag apparent, leaving investors to wonder if the energy sector will be a drag on overall stock prices.

(Click on image to enlarge)

(Click on image to enlarge)

Net earnings growth in the oil and gas sector is expected to slow to the mid-single digits, according to a September 25 report from Moody’s. Analysts Elena Nadtotchi, Peter Speer, Steven Wood and Anke Richter pointed to an average price of oil near $50 in 2018 – near where it is trading at present.

The generally stable if muted forward-looking outlook is due to Moody's expectation of strength in downstream operations in "resilient refining margins" and anticipated strong performance in trading and chemical divisions. "We have assumed that downstream earnings will remain flat in our 2018 forecast for the sector as a whole. On a company-specific basis, we have factored in an increased focus on delivering growth in downstream earnings through investment in new chemicals capacity for Shell and BP, and through further efficiency gains for BP and Repsol." (REPYF)

The lackluster if stable price movement in a key underlying asset, oil, is what is expected to keep earnings “broadly flat.” Moody’s had been positive on the oil and gas sector since 2017.

(Click on image to enlarge)

The flat earnings projections come in the wake of a 28% increase in reported EBITDA year over year basis June 2017. Firms such as ExxonMobil, Shell and Statoil ASA are expected to be in a position to pay full dividends in 2017, while BP is expected to be in a position to do the same in 2018. Moody’s thinks that overall European firms will remain cautious about reinstating cash dividends, however.

Higher returns to shareholders, including scaling up cash payments of dividends in line ratings guidance. That said, performance could be muted going forward.

Even with positive oil and gas sector earnings, Moody’s expects the investment environment to “remain challenging” as 2018 capital levels are expected to remain at low levels. The projects that receive an investment will be large-scale, high-margin new projects. If oil drops in price, however, there could be a move to find lower cost supply. Moody's outlines the variables:

We would change the sector's outlook to positive if we projected that its EBITDA would rise sustainably above 5% annualised over the next 12-18 months, supported by higher oil prices sustainably above $55/bbl that allowed the sector to generate free cash flow (FCF) after cash dividends. Lower oil prices trending to a $40/bbl level and our expectation of a 5%-or-greater decline in EBITDA for the sector would lead us to change the outlook to negative. We expect that a lower rate of decline in costs and slower production growth will leave the earnings growth rate more sensitive to changes in oil prices.

If such a lower priced oil market environment does take hold, firms like Shell, BP, Chevron (CVX) and ExxonMobil are likely to find points of differentiation that help them compete effectively.

With oil priced near $50 per barrel, firms such as Shell and Italy’s ENI (E) have been looking to divest their existing production portfolio while balancing such activity with new portfolio acquisitions.

Shell completed many divestments in its $30 billion portfolio, a plan that was announced after the firm acquired BG Energy in 2016. There are $15 billion in completed deals and another $9 billion in expected in 2017

Moody’s expects additional oil and gas sector divestments and acquisitions next year, with energy producers focusing on “upstream portfolios on higher margin, growth reservoirs and to secure positions in long-term strategic assets with limited new capital outlay.”

(Click on image to enlarge)