Amid the global energy crisis, many consumers and businesses were hit hard by soaring energy prices in 2022. But for the oil and gas industry, it was a year of record profits. The broader market logged historically disappointing results last year, with the S&P 500 generating a total return (price change plus dividends) of -18.1%. By contrast the Wisdom Tree Brent Crude Oil ETF, generated a total return of more than 32%. Oil stocks followed up an incredible 2022 with dismal returns through the first three months of the new year. But a surprise production cut on the part of OPEC+ and its allies might be just the catalyst the best oil stocks need to return to their market-beating ways.

In its latest forecast, the International Energy Agency (IEA) said China will account for most of 2023 demand growth. “World oil demand will climb by 2 mb/d in 2023 to a record 101.9 mb/d. Reflecting the widening disparity between regions, non-OECD countries, buoyed by a resurgent China, will account for 90% of growth,” it said.

Our oil market balances were already set to tighten in the second half of 2023, with the potential for a substantial supply deficit to emerge. The latest cuts risk exacerbating those strains, pushing both crude and product prices higher.

Many investors have turned their backs on oil stocks in recent years, preferring instead to invest their money in cleaner energy for the future. Looking at the longer-term, renewable energy stocks may prove to be the wiser choice, as the future of our planet depends on the success of this industry, and it continues to increase its market share each year.

However, that does not necessarily mean that top oil stocks have nothing to offer in the meantime.

While the world may have begun transitioning to greener energy, the truth is that we are still reliant on fossil fuels, such as crude oil, for much of our energy consumption. As well as being a major source of fuel, crude oil is also used in the production of various other goods, such as fertilisers and plastics.

Contrary to popular opinion, integrated oil companies are part of the energy transition solution, not part of the problem.According to the International Energy Agency (IEA), between 2010 and 2019, coal-to-gas switching saved around 500 million tonnes of carbon dioxide – an effect equivalent to putting an extra 200 million electric vehicles running on zero-carbon electricity on the road over the same period.

Pressure on oil and gas producers to adapt their operations to fit into a net-zero world has grown, from both policymakers and the investment community. But a supply crisis and price spikes have illustrated the danger of moving away from these fuels without a sufficient corresponding uptake of cleaner alternatives.

As the race to net zero accelerates, low-carbon solutions (LCS) are quickly becoming the primary new growth opportunity for companies that historically have focused on oil and gas (O&G) production.

Low carbon solutions (LCS) are products, services and technologies that have a limited carbon footprint and can serve as alternative energy sources or tools for decarbonizing operations and consumption. These offerings fall into six categories: hydrogen and ammonia; carbon capture, utilization, and storage (CCUS); bioenergy; green mobility and battery electric storage; decarbonization technologies; and renewable power.

The opportunity has not escaped O&G companies, which are increasingly developing LCS to diversify their operations and ensure future revenue generation.

Oil and gas players that enter new energy markets typically have a competitive advantage because risk exposures across oil and gas and power can offset each other. When energy consumption remains fairly stable, reduced consumption of fossil fuels translates into increased consumption of power or hydrogen, and vice versa.

Many oil and gas companies are well positioned to become leaders in the energy transition. This is not only because of their global scale, the risk appetite of their investors, their large balance sheet and cash positions, and their long-standing relationships with energy customers and stakeholders, but also because of their unique capabilities related to offshore projects and hydrogen and sustainable-fuel production and transport.

The war in Ukraine has emphasised the importance of both energy security and diversifying into new sustainable energy sources. Despite its lowly valuation TotalEnergies [€55.40] has been a consistent performer operationally in recent years and is at the forefront of the major energy groups in terms of transitioning to a post-carbon fuel world. It also has the ability to generate significant free cashflow, even at lower oil and gas prices, which can be returned to shareholders. With OPEC+ continuing to adhere to production cuts and the embargo on Russian oil, together with a gas price which remains high by historic standards despite recent sharp declines, 2023 should be another year of strong profitability and cashflow generation for TotalEnergies. The company is accelerating the growth of its investments in renewables and electricity, bringing them to $3 billion per year, or nearly 25% of its investments over the period 2021-2025. It trades on an undemanding p/e of 5.8x and offers a dividend yield of 5.18% and our PT of €72.

BP [£16.38] was the first oil major to commit significant capital to renewable projects, such as wind and solar, from 1980 onwards. Formerly known as the British Petroleum Company, it rebranded to Beyond Petroleum in 2001 with a look towards other energy sources beyond oil. BP plans to cut its oil and gas output by 40% by 2030 and spend $5 billion a year on low-carbon projects, to become one of the world’s biggest green energy producers. The oil and gas company wants to reach 50 gigawatts of renewable energy in its portfolio by 2030. It is trading on a P/E of 5.9x and a dividend yield of 4.2% and consensus PT of €20.71.

Anglo-Dutch oil giant Shell [£23.94] is investing up to $3.5bn per year in renewables and energy solutions. The energy major outlined extra cash for biofuels, electric car charging and renewables. It is focused on strengthening its balance sheet and returning cash to shareholders while gradually investing more in the energy transition.Shell is targeting a reduction in absolute emissions from their operations and the energy they use to run them by 50% by 2030, compared with 2016 on a net basis. By the end of 2022, they had made a reduction of 30%. Shell trades on a forward P/E of 7.2x and yields 3.56%. Consensus PT is £30.80.

Balancing risk exposures across your portfolio can improve the risk/return profile, compared with non-diversified portfolios. Players that invest in only one source of energy are typically exposed to higher levels of risk (because 100 percent of the portfolio may be affected by a market event). Those with diversified portfolios, however, can not only reduce their overall risk exposure but also tend to be able to improve project returns.

This article was featured in the Sunday Times on 28/05/2023