European oil majors are poised to scramble as oversupply is found

Oil stocks rallied two years ago with a vengeance as investors sought to capture some of the record profits the industry reaped from Europe’s gas squeeze and fears of an oil glut driven by sanctions. Russia.

Two years on, the allure is also fading, at least according to some banks, as an oil oversupply hangs over the market and demand growth remains below bullish expectations. In fact, one bank thinks that European Big Oil is exhausted.

Last month, Morgan Stanley cut its price target for crude oil, citing rising supply and slowing demand growth. The bank also cut its share price targets for major European oil companies without exception. TotalEnergies, Shell, BP, Equinor and Repsol were all revised down, with only Eni exempt from the bank’s forecast.

Those forecasters had a solid basis for their revisions: None of the factors that typically drive energy stocks higher were present at this time. Among those factors, as reported by the Financial Times, were expectations of higher inflation, higher interest rates, rising oil prices and a generally subdued stock market.

“Going through the checklist, we find that none of these are in place at this time. In fact, most of these factors point in the opposite direction,” Morgan Stanley analysts wrote in a note predicting the immediate future of European supermajors.

Interestingly, Morgan Stanley cites higher interest rates as favorable to higher energy stock prices, when they are opposed to another driver for higher stock prices, namely rising oil prices. When interest rates are high, oil prices tend to come under pressure and vice versa. But another factor that Morgan Stanley cited as a reason for pessimism about the energy sector was the discrepancy between oil demand and oil supply.

The bank said in a previous report that the oil market will move into oversupply in 2025 amid higher output from both OPEC+ and other producers, namely the United States and Brazil. Morgan Stanley, by the way, is not the only bank predicting a surplus. Goldman Sachs also recently forecast a surplus, citing high global inventories, weak Chinese demand and rising US production.

If all these developments are indeed underway, it is bad news for the European supermajors. They’ve just recently overhauled their strategies, reprioritizing their core business over the so-called ESG investing experiments of the past few years, as they’ve tried to get a piece of the crossover action and suffered losses because of it.

Here’s the problem, though: The factors that Morgan Stanley lists as precursors to a breakout in oil and gas stocks aren’t fact. There are suggestions and possibilities. And it may never materialize.

Let’s take Morgan’s expectations for a surplus oil market in 2025. The specific numbers are demand growth of 1.2 million barrels per day and supply growth of 2.6 million barrels per day, both from OPEC producers and outside of OPEC. Like others, Morgan Stanley assumes that US production will continue to rise at previous rates and that OPEC will begin to reduce its cuts at whatever price point Brent crude trades. These are some substantial assumptions, especially in light of OPEC’s insistence that it would only begin reducing cuts when market conditions are right. Brent below $80 does not seem to match OPEC’s perception of fair market conditions.

OPEC cuts aside, what about production? U.S. drillers served up surprise after surprise, reporting higher-than-expected output in terms of drilling efficiency, posting an unexpected output growth rate of about 1 million bpd for last year despite a lower rig count. However, to assume that this will continue regardless of where oil prices go would be a bold one. Because, in addition to the efficiency of drilling, US oil producers have focused on ensuring some level of shareholder return at the expense of drilling just for fun.

Then there is demand. All price forecasts, be it Brent crude or Shell shares, are heavily based on Chinese demand data and forecasts. The data suggest oil demand in the world’s biggest importer of the commodity is losing steam after two decades of strong growth. This naturally weighs on prices – and supply.

Reuters’ John Kemp reported last month that OECD oil stocks were 120 million barrels, or 4 percent, below their ten-year average at the end of June this year. That was up from a shortfall of 74 million barrels at the end of March. In other words, the world, or at least the OECD part of it, was sinking into stocks to meet its demand for oil. These are a far cry from the surplus predicted by Morgan Stanley for next year. Moreover, OPEC+ is in no rush to reduce production cuts.

European supermajors saw their shares underperform similar US peers. However, the consensus as to why had nothing to do with oil supply and demand. It had to do with much tighter regulation in Europe and the obligation to invest in non-core activities in the alternative energy segment of the industry. Those investments have not turned out well – despite optimistic forecasts from analysts that this was the way to go and that the supermajors had done the right thing. Big Oil’s bets on its core business, on the other hand, have generally paid off regardless of the banks’ forecasts.

By Irina Slav for Oilprice.com

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