Norwegian energy giant Equinor (EQNR 0.62%) was the best-performing oil major in 2020. It was a minor victory, though, as Equinor produced a total return of -13.6%. Still, it performed much better than its peers, as well as the broader energy sector, which suffered a -32.5% return in 2020.
Like most oil companies, its performance was heavily impacted by the COVID-19 pandemic, which crippled oil and gas prices for most of last year. Looking ahead, Equinor has some of the lowest production costs in the industry -- which should help it navigate lower price environments while still capitalizing on upside. Here's why Equinor has what it takes to continue outperforming other oil majors, and one day turn into one of the world's leading offshore wind energy operators.
A tight ship
Equinor produced 2.07 million barrels of oil equivalent per day (boe/d) in 2020, roughly the same as it produced in 2019. This is no small number, and in fact, is over half as much as ExxonMobil (one of the world's largest oil companies) produced last year. About 45% of Equinor's 2020 production was gas and 55% was liquids, giving it a bit more of a natural gas focus than what's typically seen from other integrated majors.
Despite being a big oil and gas company, Equinor isn't too interested in growing production over the coming years. In fact, it only expects to grow production by 2% in 2021 and 2022, and then around 3% per year from 2020 to 2026. Equinor has a relatively low amount of oil and gas reserves. According to SEC figures, it has just over seven years left of reserves. These figures are based on what's economically recoverable at trailing-twelve-month (ttm) prices. However, Equinor estimates it has over 24 years' worth of total reserves, many of which would be economically recoverable at today's higher oil prices.
To understand Equinor's low growth rate and limited reserves, it's important to realize that the company has spent the last 50 years as the leading offshore producer in the North Sea. 70% owned by the Norwegian government and formed in the early 1970s, Equinor's entire reason for existence was to develop the North Sea's oil and gas reserves. It did that. And now, its oilfields are mature and becoming increasingly harder to drill.
North Sea production is likely in the 8th or 9th inning of its development, and Equinor knows it. In response, it has decreased costs, lowered spending, and improved profits. Specifically, it plans on spending 15% less than its pre-pandemic guidance and says it can achieve 2021 free cash flow (FCF) of $6 billion at an average Brent oil price of $50 per barrel. Brent prices are currently over $65 per barrel, and if they stay there, Equinor could easily generate the most FCF in its history. But commodity prices are volatile, so it's best not to take higher oil prices for granted. Here's where Equinor's ace in the hole comes in -- its incredibly low breakeven point.
The company notes that it can be FCF positive at just $30 per barrel. The new projects it is pursuing along the Norweigian Continental Shelf can have a breakeven as low as $10 per barrel. Equinor may not be growing its oil and gas business, but the company has a very good chance of earning plenty of cash even in weak environments. Equinor's oil and gas business doesn't have a good long-term future. But it's reassuring to know that it is relatively safe and could do quite well in the short- and medium-term.
Wind energy investments
A good chunk of Equinor's long-term investments are going toward wind energy. And its timing couldn't better. Renewable energy costs are coming down. In many cases, onshore wind and solar are now cost-competitive with fossil fuels. Offshore wind is a lesser-known, much newer industry. It isn't as profitable as onshore wind, making the playing field less competitive. But Equinor thinks the growth potential could be huge, especially for companies that get involved in the early stages.
Equinor is well-positioned to integrate wind energy into its portfolio. The Norwegian Continental Shelf is long and shallow, which is ideal for offshore wind. Equinor's new CEO is adamant about renewable energy investments. Norway as a country is implementing strict emissions reductions, which matters because it's Equinor's largest shareholder. As an offshore oil and gas operator, Equinor has the right background to handle large-scale offshore wind energy projects that take years of planning and funding before they pay off.
What to watch
Equinor is one of the best-positioned energy stocks because it combines the short- and medium-term upside of higher oil prices with a dedicated long-term transition to wind energy. And because its transition is born out of necessity and aligns with Norway's energy policy, Equinor's renewable investments appear to be much more legitimate than other oil majors that may just be paying lip service.
After slashing spending in 2020 and taking a multi-billion dollar loss, Equinor is poised to return to profitability and support its growing renewable portfolio. In the short term, investors should see if Equinor can truly breakeven at the low levels it claims, as well as monitor its FCF generation. If Brent oil prices average over $60 a barrel in 2021, then Equinor could well exceed its $6 billion FCF goal. Anything less than that should welcome skepticism.
The best thing Equinor can do over the medium term is remain on schedule with its wind energy projects. Over the long term, as in five years from now, investors should start to examine the profitability of Equinor's offshore wind energy projects. If all goes according to plan, Equinor will certainly have a head start over the competition, and stand to benefit as renewable costs continue to fall.