A Citi Research report on the oil and gas industry published earlier this week argues all of the pieces are in place for a turnaround in the sector. Citi analysts Alistair R. Syme and colleagues suggest that an improving global economy and an “emphasis on profitability, cost-control and careful portfolio development” by companies in the Oil and Gas sector will lead to a significant improvement in sector-wide return on equity over the next year or two.

Oil and gas sector

Improved investment and operations leading to better returns

According to the report, most of the slew of bad investments and poorly executed projects dating back to 2008 by oil and gas companies have been divested or written off. “…we think truly marginal investment has already been cut and what is left has strong value potential (our proprietary 200 project cost-curve concludes the industry can deliver an average IRR of 17% on new investment). Can the industry now deliver on these project economics? We point to significant investment in delivery–more front-end engineering man-hours, greater supply chain capacity (a 7-fold increase in invested capital) and a shift to modularization (e.g. pre-salt Brazil, North American shale) as positive signs.”

Oil and gas sector

Citi’s picks in the Oil And Gas Sector

Syme et al. expect oil and gas sector ROE to improve by 20% in 2014 (from 10% to 12%) and argue that could lead to significant share price appreciation. “With good project execution we think the industry can grow book value c. 7% CAGR to 2018 and see ROE improve to 12%. Trading at 1.1x end-2017 book the sector is perhaps not deep value, but it is certainly a more investible proposition than has been on offer in the last five years. We see a number of companies where we think the delivery outcome can be better than what the market currently views – we identify BG Group plc (LON:BG) (OTCMKTS:BRGYY), Cenovus Energy Inc (NYSE:CVE) (TSE:CVE), Chesapeake Energy Corporation (NYSE:CHK), Statoil ASA(ADR) (NYSE:STO) and Total SA (ADR) (NYSE:TOT) as key names.”

The report highlights BG as the top “pre-salt Brazil” play, and that “the growth-delivery issues that have plagued BG Group plc (LON:BG) (OTCMKTS:BRGYY)’s recent past are now largely behind it.”

Cenovus Energy Inc (NYSE:CVE) (TSE:CVE) and Chesapeake Energy Corporation (NYSE:CHK) are Citi’s top North American onshore recommendations as both are set to deliver above-average ROE.

Total SA (ADR) (NYSE:TOT) is Citi’s top pick among international oil majors as the company is leading the way with strategies to improve project outcomes.

Last but not least, Citi suggests Statoil ASA(ADR) (NYSE:STO) as the name to consider among Russian oil companies as the company is close to completing two large LNG projects.