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Oil: Top 3 energy stocks as sector transitions to renewables

As conflicts in the Middle East continue, oil prices (BZ=F, CL=F) near 3-week highs. As investors look to balance their portfolios, the energy sector may seem daunting to buy into.

HSBC Oil & Gas Research Director Kim Fustier joins Yahoo Finance to discuss the state of the energy market and what plays investors should look out for if buying into the energy sector.

Fustier chooses BP (BP), Chevron (CVX), and Shell (SHEL) as her top 3 picks, explaining how these companies are positioned for the ongoing transition away from fossil fuels:
"Despite continued pressure from ESG [Environmental, Social, and Corporate Governance] investors, particularly in Europe, the European majors including BP and Shell recognize that. So they have to strike the right balance really, between being forward leading, investing into clean energy but also making sure they've got viable businesses and continue to invest in oil and gas. That's exactly why you've seen both BP and Shell tilting back towards growth in oil and gas at least in the medium term for the next two, three, four years, and then at the same time pulling back from renewables, but not abandoning the renewables altogether..."

For more expert insight and the latest market action, click here to watch this full episode of Yahoo Finance Live.

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Editor's note: This article was written by Nicholas Jacobino

Video transcript

- While oil prices remain high and, as mentioned, staying close to three-week highs on rising demand from Asia and the continued conflict between Israel and Hamas in the Middle East. And big names like BP, Chevron, and Shell have all reported their second highest annual profit in a decade on increased production. Let's bring in Kim Fustier, HSBC oil Gas Research director, to discuss how to navigate the energy space. Kim, it's good to talk to you today. Are there additional tailwinds here that could push the profits higher, or is this as good as it gets?

KIM FUSTIER: Thanks for having me on the show. I think, as always, oil and gas prices will be really key to the sector outlook. If you look at consensus for Brent this year, it's already about $82, which is bang in line with spot prices. So right now, we can't count on earnings upgrades to lift the sector higher.

In the near term, we do think oil prices can be supported around current levels or even rise if there's further escalation in the Middle East. That said, let's not forget that OPEC has ample spare capacity, over 5 million barrels a day, and that should cap the upside maybe around 85 or $90.

In the second half of the year, in fact, we expect oil prices to slide back under $80 when OPEC and Saudi Arabia bring volumes back to the market. I think I should also mention another downside risk for the sector, which is natural gas prices. Prices in Europe have fallen back to almost normal levels just two years after the 2022 energy crisis and that's really surprised us. Also, in the US, natural gas prices have cratered recently because of warm weather.

But if you take a step back, in this environment, it's still a very solid macro environment for the oil and gas companies. And they're still able to return a 10% total distribution yield, including dividends and buybacks. Balance sheets are in pretty good shape, so companies are able to absorb short-term macro volatility.

- And so Kim, with that in mind then, who are your top picks? Your top three picks here in the oil sector.

KIM FUSTIER: The energy sector as a whole is cheap and unloved and so we would expect the sector to rerate if the companies are able to demonstrate good performance quarter after quarter. Our top three picks are BP, Shell, and Chevron. So, for BP and Shell, we think there are good rate of change stories. They've got new leadership teams.

BP surprised positively at Q4 results by giving much more visibility and stability in its quarterly buyback program. Shell is also executing better and becoming more consistent. And then Chevron, we think, is a good growth story where its organic growth has been further boosted by the Hess acquisition, and it trades at a decent discount to Exxon.

- Kim, the broader narrative within the industry has really been about this transition or whether, in fact, there will be a significant transition away from fossil fuels. You named BP as one of your picks there. I mean, this is one of those companies that has been more aggressive in that transition into clean energy under previous leadership with Bernard Looney. Is that diversification important as you assess where these companies are going to proceed, at least in the medium term? How significant a headwind or tailwind does that provide?

KIM FUSTIER: I think if we take a step back, global oil and gas demand is still growing. We can see that in the statistics. And so, despite continued pressure from ESG investors, particularly in Europe, the European majors, including BP and Shell, recognize that. And so they have to strike the right balance, really, between being forward leaning, investing into clean energy but also making sure that they've got viable businesses and continuing to invest in oil and gas.

And that's exactly why you've seen both BP and Shell tilting back towards growth in oil and gas, at least in the medium term for the next two, three, four years and then at the same time pulling back from renewables but not abandoning the renewables altogether. Renewables still represents something like 20% of BPs and Shell's capital investment programs. So, that is still definitely something that investors need to continue to care about.