Energy sector: decarbonisation to continue, for big oils in particular

Highlights:

• The energy sector is currently characterised by lower MSCI Environmental and Governance scores relative to the average Iboxx. Energy’s total CO2 emissions and Carbon Intensity are the third highest after Materials and Utili-ties.
• Looking forward to the next 3 years, the decarbonisation trend (Scope S1+S2, direct Emissions and Indirect from Electricity Purchased & Used) of -11% for the Energy names in 2019-2024 lies above that of EU sector average (-8%, source: MSCI).
• The “big oils” are in a much better position than the Energy sector average. More importantly, their 2019-2024 decarbonisation trend at -20% is superior.
• Furthermore, we expect credit KPIs to hold well, estimating a manageable decarbonisation, allowing needed capex and dividends and further declines in Net debt and Net debt-to-Ebitda ratios, thanks also to higher cost efficiency.
• Longer term (10-30 years), S3 (other Indirect emissions, related to products sold to clients) will be a challenge but the mix change towards renewables via big investments will help.
• Transition risks are palatable, and the firms’ current targets still imply a trajectory slightly above 2°C. Pressure to adhere to more stringent goals – (2°C) – would imply a higher capex and negative cash flows. The good news from early simulation is that, after an initial period, the available cash flow could then increase over the long run more robustly than in the base scenario.
• Higher credit spreads vs. the Iboxx index and an extreme degree of relative equity undervaluation (cheapest sec-tor on adjusted market multiples) should appeal to investors. This come at a time when the oil price is forecasted to remain in the 80 to 85US$/bbl range, with risks clearly skewed to the upside. The sector’s relative equity per-formance also shows the highest correlation to inflation, a high one to yields and an average one to volatility (VIX).
• Relatively low E scores (Esg) and ECB greening will be headwinds, which will slow the mean reversion of cheap valuations.
• Following the 2021 ally, we maintain a slight OW on the energy equity sector (small given the short-term over-bought signals from our quant models), while sticking to a Neutral position in the Credit space.

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