Investing.com -- Morgan Stanley in a note dated Monday revised its outlook for key European oil and gas stocks, cutting ratings and price targets amid concerns about weakening demand.
The analysts point to a softening macroeconomic environment, which is expected to drag on both oil and gas prices over the coming years.
This comes as Morgan Stanley forecasts that Brent crude will stabilize at around $75 per barrel, while European gas prices are expected to decline to about $7.0 per million cubic feet by 2026.
These projections reflect the challenges facing the industry as supply exceeds demand, particularly in Europe, where gas prices currently hover at about $11/mmcf.
In the exploration and production (E&P) sector, Aker BP (OL:AKRBP), Energean (LON:ENOG), and Ithaca Energy (LON:ITH) were among the companies most affected by these changes. Aker BP (NYSE:BP), once seen as a solid performer in the space, has now been downgraded to "underweight."
Morgan Stanley analysts cite declining near-term production and high capital expenditure requirements as key reasons behind the revision.
The company’s free cash flow yield is forecasted to average only 6% between 2025 and 2026, a relatively low figure compared to its peers.
Worse yet, in a bear-case scenario where Brent crude falls to $60 per barrel, Aker BP’s free cash flow could turn negative, casting further doubt on its near-term financial performance.
The stock's price target has been slashed to NOK 240, down from NOK 307, reflecting these risks.
Energean, another major player in the sector, has been moved to an "equal-weight" rating. Morgan Stanley reduced its price target from 1,430p to 1,100p, citing higher geopolitical and asset concentration risks.
The company’s focus on offshore Israel, particularly the Karish and Katlan fields, makes it vulnerable to geopolitical tensions. The planned sale of Energean’s Egyptian and Italian assets, while seen as strategic, further heightens its concentration risk, limiting the diversification that typically helps buffer companies against regional issues.
Despite these challenges, Energean’s strong cash flow and dividend yields, supported by long-term contracts that protect it from commodity price volatility, offer some upside. However, the elevated risk profile has prompted a more cautious stance.
Ithaca Energy has also felt the impact of Morgan Stanley’s more bearish outlook. The company’s price target has been reduced to 127p from 150p, and it too has been marked as "equal-weight."
While Ithaca is expected to generate solid free cash flow in the near term, there are looming uncertainties tied to the UK’s fiscal regime. Frequent amendments to the UK’s energy profits levy, along with the government’s ongoing review of capital allowances, add layers of risk to Ithaca’s operations.
In Morgan Stanley’s view, these factors make it difficult for the company to fully capitalize on its production potential, especially given its exposure to UK-focused projects.
Despite the overall gloom, not all European oil and gas stocks have been downgraded. Harbour Energy (LON:HBR) and Var Energi (OL:VAR) remain bright spots in Morgan Stanley’s analysis, with both companies retaining "overweight" ratings due to their resilient cash flow profiles and attractive dividend yields.
Harbour Energy, which recently completed a significant transformation with the acquisition of Wintershall Dea’s assets, has emerged as one of the firm’s top picks.
With a diversified portfolio spanning multiple countries, including Norway, the UK, and Argentina, Harbour Energy is forecast to deliver an impressive free cash flow yield of 16% per annum between 2025 and 2027.
In addition, the company’s hedging strategies, particularly in gas, provide a cushion against potential declines in commodity prices, ensuring that cash flows remain strong even in bearish scenarios.
Investors can also expect substantial returns, as the company is set to distribute an 8% dividend yield, complemented by a 5% share buyback program, further enhancing shareholder value.
Var Energi, another preferred stock, is poised to benefit from its near-term production growth, driven by the Johan Castberg and Balder X projects.
Production is expected to rise by 33% over the next 15 months, ensuring strong cash flow despite the broader weakness in oil and gas markets.
Morgan Stanley forecasts a free cash flow yield of 16% on average for Var Energi in 2025-2026, with a robust dividend yield of around 14%.
Even under a bear-case scenario, where oil prices fall to $60 per barrel, Var Energi’s free cash flow yield would still stand at a resilient 11%, backed by the company’s low-cost production and strong balance sheet.
As the brokerage lowers its price targets for several major players, the focus shifts to companies with strong near-term cash flows and diversified portfolios, such as Harbour Energy and Var Energi, which are well-positioned to navigate the difficult landscape.
For companies like Aker BP, Energean, and Ithaca Energy, however, the path forward appears more fraught, as production challenges, fiscal risks, and geopolitical exposure cloud their prospects.