MoneyTalks: Decarbonization is trending, but Monash Investors’ Simon Shields says one shouldn’t discount “old world” energy stocks

MoneyTalks is Stockheads Regular drill-downs into the stocks investors are currently watching. We tap into our extensive roster of experts to learn what’s hot, their top picks, and what they’re on the lookout for.

Today, Monash Investors portfolio manager Simon Shields talks about his favorite stock picks for 2022.

What’s hot right now?

Monash Investors is currently paying particular attention to the energy sector, where the world is investing enormous sums in renewable energy while disincentivizing investments in hydrocarbons.

“Companies’ stock prices are volatile during transition periods, which can present investors with opportunities for mispricing,” Shields said.

“For example, the energy sector of the S&P 500 is up 63% over the past 12 months.

“Nevertheless, the weighting of the entire energy sector in the S&P 500 is about 4%, up from 13% in 2011.

“In some context, Apple and Microsoft each sit about 5-7% in the S&P 500.”

Shields says decarbonization is a key macro trend going forward, and Monash is keen to support sensible opportunities in this area, but cautions that oil’s continued role as a fuel is often underestimated while on the planet Supply-side production capacity remains tight in the face of chronic underinvestment in new oil projects.

“As we re-enter a world where money isn’t free and the Federal Reserve is removing liquidity from the market, the energy sector has attractive attributes,” Shields said.

“Notable features include strong cash flow generation, earnings stability and management teams that prioritize returns for shareholders.

“We expect these returns to shareholders will increasingly come in the form of share buybacks and dividends.”

Decarbonization is on trend, but don’t neglect ‘old world’ energy.

Within the decarbonization megatrend, Shield sees many interesting developments, including carbon capture programs, wider adoption of regulated carbon credits, and emerging low-emission replacement technologies such as carbon Calix (ASX:CXL).

“However, let’s look at the ‘old world’ energy sector for a moment,” he said.

“Given the current macro backdrop, one might be surprised to see oil prices well above their pre-COVID levels.

“Elevated concerns about a global recession, rising cost of living and ongoing lockdowns in China are putting strong downward pressure on oil demand.”

On the supply side, the US government has released an average of 0.7 million barrels of oil per day from its Strategic Petroleum Reserve (SPR) since April 2022.

For comparison, the IEA estimates that annual growth in global oil demand for 2022 is 2.1 million barrels per day – meaning the SPR has unlocked about a third of that additional demand per day.

The SPR releases have reduced SPR’s finite oil reserves by 40% (a level not seen since 1984), which Shields says is unsustainable but has had a significant impact on oil prices.

“For commodities, the rule of thumb is that ‘the cure for high prices is higher prices,’ because producers respond to higher prices with more supply, thereby driving prices down,” he said.

“Nevertheless, due to a muted response from oil majors to increase supply, oil prices remain surprisingly stubborn above pre-COVID levels and we expect this to remain so.”

Sheilds added that structural underinvestment will persist in the oil and gas industry, and that’s a positive for oil prices “because otherwise supply growth can’t keep pace with demand growth.”

“Between environmental activism/restrictions, ‘lawfare’, lender reluctance, institutions’ ESG focus, threats of super taxes on profits, renewable energy subsidies and social shaming of directors, the perverse incentives are overwhelming.”

Santos is the first choice

Shields’ number one choice in this sector is Santos (ASX:STO), the giant Australian oil and gas producer, which completed its merger with Oil Search in late 2021.

His argument includes the experienced and respected management team, which is using the company’s strong cash flow generation – $2.7 billion this year through the end of September – to invest in expanding its core assets and other growth opportunities, including offshore oil production in Western, invest Australia.

“The Company is also completing partial sales of some of its assets (Alaska and Papua New Guinea) and using the proceeds to return capital to shareholders,” Shields said.

“It is on track to complete a $350 million buyback by year-end for another buyback program in 2023.”

In September, Santos announced that Kumul Petroleum Holdings Limited (Kumul) would acquire a 5% interest in PNG LNG for an asset value of US$1.4 billion.

Production in 2023 is expected to be in the range of 91-98mmboe impacted by the end of field life at Bayu-Undan, the timing of the completion of the expected sale of a 5% interest in PNG LNG and including domestic gas production in Western Australia.

“[The company is also] The goal is carbon neutral status by 2040, with significant emission reductions and carbon offsets planned for 2030,” Shields added.

STO share price today:

Woodside has improving fundamentals

Another choice is Woodside (ASX:WDS) which Shields says is improving fundamentals and production volume, and has recently beaten analyst expectations for both production volume from Australian assets and better realized LNG prices.

“Management is also conducting a strategic review of the Company’s asset portfolio to streamline production and prioritize exploration work,” he said.

“The company remains committed to returning capital to shareholders through dividends with a payout ratio of 50-80% of net income.”

In the September quarter, the producer delivered record production of 51.2 MMboe (557 Mboe/day), a 52% increase over Q2 2022 — and record revenue of $5,858 million, a 70% increase over Q2 2022.

Woodside also raised its full-year 2022 production guidance to 153-157 MMboe.

WDS share price today:

Karoon generates strong cash flows

Karoon (ASX:KAR) is Shields’ Last Pick, an Australian oil exploration company that has transformed itself from a troubled past into a pure-play oil producer with the purchase of its Brazilian projects.

Oil production for the September quarter of 2022 was 1.29 million barrels (MMbbl), up 19% sequentially, and oil sales revenue from the lifted charges was $140.2 million.

“However, the company retains some individual asset risk,” Shields said.

“[They’re] Generating strong cash flows with potential to increase production from a number of existing oil wells and to ramp up two wells currently under development.

“Its net cash balance sheet is growing strongly and provides management with an opportunity to acquire another asset.”

Karoon is also aiming for net-zero emissions by 2035 through carbon offset purchases and has made it into the in particular ASX200 Club in the September Quarter.

KAR share price today:

The views, information or opinions expressed in the interviews contained in this article are solely those of the interviewee and do not represent the views of Stockhead.

Stockhead does not endorse, endorse or otherwise assume responsibility for the financial product advice contained in this article.

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