Energy sector may prove expensive even if results beat estimates

[July 24, 2015]   By Sinead Carew

(Reuters) - The battered energy sector may begin to brighten a little as companies report second-quarter results, but barring a big increase in the price of oil, the sector won't be able to sustain even current share prices going forward, analysts and investors say.

Oil prices have fallen at a much steeper clip than energy shares in the 13 months since June 23, 2014 - when oil prices hit a nine-month peak - keeping valuations high even as share prices have plunged. The S&P energy sector <.SPNY> has fallen about 30 percent since then while oil prices have fallen 50 percent.

With the energy sector's second-quarter earnings seen doing better than the prevailing consensus forecast for a decline of almost 59 percent from the year-ago quarter, according to a Thomson Reuters analysis, shares could get a benefit. The S&P energy sector's price to earnings ratio is around 23 compared with 17 for the S&P 500.

But the S&P energy subsector of exploration and production companies <.SPLRCOILP> is at its most expensive on a price-earnings basis since Reuters started tracking the data in 1995. Consensus estimates for oil producer earnings this year imply an average crude oil price of $65.19 a barrel in 2016, says Fadel Gheit, an analyst with Oppenheimer & Co.

Oil recently has been selling for around $48 a barrel, and oil futures trading is pointing at a 2016 average price of around $54.

Gheit says roughly half of U.S. oil producers could run into financial trouble unless oil surpasses $70 a barrel.

"The outlook for energy shares looks somewhat challenging for now as the oil price implied in the shares is higher than current spot prices," said Stephen Clark, senior vice president, portfolio manager, Standard Life Investments, in Boston, a long investor which is mostly on the sidelines for oil. "There is already some degree of oil price recovery baked in."

The energy sector overall is expected to report earnings 3.5 percent better than consensus estimates, according to Thomson Reuters data, which puts more weight on forecasts from analysts with the most accurate track record. But there may be some negative surprises as well.

In next week's reports Chevron Corp <CVX.N>, Exxon Mobil <XOM.N> and Murphy Oil <MUR.N> are seen beating consensus estimates while ConocoPhillips <COP.N>, Range Resources <RRC.N> and Occidental Petroleum <OXY.N> could miss consensus, according to Thomson Reuters data.

To be sure, commodities traders and analysts may both be underestimating future oil prices. Investors have been encouraged by signs of strong demand in the summer driving season and cuts to capital expenditures by many energy firms, allowing more room for profitability on those sales.

"There could be a trade higher for both oil prices and the energy stocks later this year driven by falling U.S. production and generally healthy demand," said Tim Parker, oil analyst and portfolio manager at T. Rowe Price.

"I’m less confident in the coming years with the cross currents of Iran and the potential for global economic slowing."

Exploration and production share prices remain especially costly. Even after falling 25 percent since April, the subsector's P/E sits at about 100 - dramatically higher than the S&P 500. The previous peak for the subsector was under 70 in 1995.

"It will be a day of reckoning as we get closer to the end of this year and people realize that average prices are not likely to match current expectations," said Gheit.

"I'm not willing to make bets that there'll be disruption of oil flow from the Middle East or elsewhere that will give us $70 oil."

(Reporting by Sinead Carew; Additional reporting by Rodrigo Campos, Saqib Ahmed and Catherine Ngai in New York, Noel Randewich in San Francisco; Editing by Linda Stern and Leslie Adler)

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