Can big oil turn it around in 2014?

Big oil has been largely out of favour with investors for some time now but could a potential shift to re-focus on investors and improve cashflow see the oil majors return to favour?

The energy sector has lagged global equities in recent times, with data from FE Analytics revealing that the MSCI Energy index returned 0.71 over one year versus 11.57 for the MSCI World index.

The energy sector is also a net underweight position within portfolios, according to the latest Bank of America Merrill Lynch global fund manager survey.

Many of the large integrated oil companies’ performance issues have stemmed from a preoccupation with capex and growth on new projects at the same time as costs have inflated and extraction has become more expensive.

The latest difficult for the energy sector arrived when Shell surprised markets with an unexpected profit warning in mid-January.

However some industry experts believe that Shell may look to take steps to tackle some of the issues currently surrounding the wider industry.

Old Mutual Global Investors head of UK equities Richard Buxton has opted to take advantage of “cheap and deeply unloved” Shell by “gently” adding exposure to his £1bn Old Mutual UK Alpha fund.

Buxton also points out that Shell could be set for a re-rating if its new chief executive officer Ben Van Beurden is able to implement his plans concerning capex and cashflow.

He says: “The market hopes that the new CEO will raise money from disposals of peripheral projects and reduce capex to improve cashflow.

“If he does, this could be a catalyst for a rerating, although it is unlikely that he will slash capex by as much as the market wants.”

Buxton also continues to favour Shell as a “secure” stock that can provide important balance in a more cyclical portfolio.

“The yield is good and the company has not cut its dividend in many decades, so I regard it as secure. In a portfolio which is heavily exposed to financial and cyclical companies, [Royal Dutch Shell] is a useful counterbalance – as exemplified by today, where in a weak market its shares are unchanged,” he adds.

Charles Stanley is also continuing to recommend Shell following the profit warning on the belief that the oil giant will sell-off projects under Beurden’s leadership.

He says: “We expect a major step-up in divestments in 2014. Shell’s cash flow target was $175bn-$200bn over 2012-2015 but it could be discarded if large disposals are made.”

Artemis global manager Jacob de Tusch-Lec goes further to say that this realignment could actually take place more broadly across big oil companies, following the positive reception of similar steps previously taken within the mining sector.

“In the mining sector BHP and Rio are now actually generating free cash-flow because they are not just spending on new capex,” says De Tusch-Lec.

“The integrated oil companies have had experienced very high cost inflation over the last decade but they could go down the same route as the mining companies soon because they have seen how well their message was received by the market in the latter part of last year.”

Although careful to stress that these are only tentative signs within the wider energy sector, the manager of the £525.5m Artemis Global Income fund believes that the oil giants have the potential to become the “contrarian value story of 2014”.

“While I am not advocating a massive rotation into these integrated oil majors, I do appreciate that the equity market is putting rather low valuations on these companies and that the equity market is ’up with events’,” he adds.

”And hence the energy sector continues to stand out as a contrarian value story for 2014, albeit it is important not to be too early … as things will take a long time to turn.”