Oil companies have delivered bumper results on both sides of the Atlantic. Yet the premium at which US companies trade compared with their peers in Europe has widened. The reason? European oils are stuck between a hydrocarbon and a hard place.
The peer group, which includes BP, Shell, Total, Repsol, Eni and Equinor, among others, now trades at 3.3 times forward cash flow according to analysis by Bernstein. Transatlantic oil groups are on more than twice that. In part, that is because the US market overall commands a higher multiple. That was one reason why Shell considered listing in the US. Even so, valuations have diverged sharply over the past year.
One reason why US oils have outperformed is that they tend to be exposed to less risky domestic shale production. Moreover, European companies are starting to take bets outside their traditional patch.
Much has been made of the fact that these businesses have a lower return profile than traditional oil and gas. Yet that should not, of itself, entail a valuation discount. Operationally, they are straightforward. And they carry none of the societal risk that deter investors from investing in oil and gas. By rights, they should also have a lower cost of capital.
The trouble is that investors cannot gain exposure to such projects without getting lumbered with the traditional business as well. Those with environmental mandates are reluctant to do so. As European majors transition, they risk being saddled with the cost of capital of an oil company and the returns of a renewables utility.
Over the long term, that will change. Renewables will make up an increasing share of the business, especially if the majors turn to M&A to build their portfolios up. But the majors will not get rewarded for their energy transition efforts until they become very sizeable. In the meantime, they are unlikely to get much recognition for their transformation.
