EUR 1140.00 For Business Accounts Only

UK E&P sector

In this note we revise our oil price deck, roll forward our NAV discount origins to end 2017, and update models for spot fx rates and operational updates. The net effect is to reduce PTs by 21% on average. However, our revised PTs still show considerable upside relative to the current share prices, and we believe the sector can still create value in a Lower for Longer oil price world. We retain Cairn Energy as our top pick. We also upgrade Faroe Petroleum to BUY, given an attractive valuation and defensive story.

Lower for Longer: In this note we cut our Brent oil price forecasts from $54/bbl in 2017 to $51/bbl (-6%), from $60/bbl to $55/bbl in 2018 (-8%), from $70/bbl to $60/bbl in 2019 (-14%), and from $70/bbl to $65/bbl in 2020+ (-7%). Whilst we struggle to see many short term ultra-bullish factors for the oil price, we do think longer term the lack of investment should support prices.

Investor sentiment negative but we see potential: We sense that many investors have continued to avoid the sector, given a bearish view on oil prices and the sense that E&Ps cannot fare well in a lower oil price world. Whilst we agree there are definite challenges, we believe a shift to more focused strategies (eg decommissioning, play opening exploration), significant cost cutting, increased collaboration, innovative M&A deals and technology solutions will help to unlock value in the sector. As always, we think rigorous stock selection is key.

Recommendations: Within our coverage universe, our RENAV’s fall 24% on average under our new oil price deck. Our top pick remains Cairn Energy, given an attractive valuation, quality acreage off Senegal, and potential material upside if International Arbitration is successful. We also continue to have a BUY recommendation on Tullow Oil, which could potentially see several overhangs (eg refinancing risk, ITLOS) removed in Q317 and possibly some long awaited M&A in 2018 (TEN, Kenya). We upgrade our recommendation on Faroe from HOLD to BUY given low oil price gearing and an overall solid story. We remain with our HOLD on EnQuest, where we are somewhat cautious given its leverage and gearing to the oil price, where value erodes quite quickly at oil prices much below $50/bbl.