Oil & gas valuations remain attractive but earnings revisions pose a risk, Morgan Stanley says

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Morgan Stanley analysts said in a research note Monday that relative valuations in the oil and gas sector remain attractive.

The analysts told investors that exploration and production stocks have fallen 17% so far in 2023, outpacing a 14% slide in crude prices, with most of the declines occurring in the past few weeks. This was alongside rising instability in the banking sector, the prospect of tighter lending conditions, and a weakening economic outlook.

“While buying similar dips over the past two years has generally been the right strategy, rising recession odds increase the risks over the coming quarters,” the analysts noted.

“That said, much of the oil market demand growth in 2023 hinges on China’s reopening and rising mobility across Asia — trends which are still on track. Furthermore, low inventories, limited OPEC+ spare capacity, slowing shale growth, and constrained global oil & gas investment make this cycle look different than others in recent history.”

Although they believe valuations are still attractive, the analysts think further earnings revisions are still a risk.

“Oil risk-reward still skews positively, but the range of outcomes is wide,” they wrote. “Demand is still recovering from China reopening, rising aviation, and a potential reversal of price-driven demand weakness in some regions (including the US, where summer driving season is on pace to start with 30% lower gasoline prices y/y).”