By Christopher M. Matthews and Sarah McFarlane
Does investing in oil and gas companies still make sense? Money
manager Jacinto Hernandez has doubts.
The partner at Capital Group Cos. liquidated $1 billion in oil
and gas stocks as Covid-19 spread around the globe in February,
according to regulatory filings. Mr. Hernandez said he suspected
the expansion of the new coronavirus in Italy was about to crush
global demand for gasoline, diesel and jet fuel -- and with it, any
near-term thesis for investing in oil companies.
Adam Waterous, a Canadian private-equity investor, looked at the
same circumstances and came to the opposite conclusion: This was
the time to buy. Demand will eventually bounce back, he said, and
when it does, prices will spike sometime later this decade. He
backed up that conviction in July when his Waterous Energy Fund
purchased a big stake in an oil sands company.
"There is absolutely a stigma about investing in oil and gas,"
Mr. Waterous said. "It hasn't been a sexy industry for a
while."
The question of whether to invest in oil and gas has become a
polarizing issue in the world of money management. Even before the
pandemic sapped the world's thirst for fuel, the future of the
fossil-fuel industry was already under threat due to the rise of
electric cars, the proliferation of renewable energy and growing
consciousness about the long-term impact of climate change.
The biggest oil companies increasingly disagree on what the
future holds. Exxon Mobil Corp. continues to invest in increasing
oil production and has said it believes oil demand will increase
for years to come. BP PLC, by contrast, believes demand may already
have peaked and plans to reduce its oil and gas production by 40%
over the next decade as it pivots to green energy.
What makes the situation even more challenging for investors are
new questions about the direction of oil prices, which no longer
follow the fairly predictable cycle of boom and bust that governed
the industry for much of the past century. Prices traditionally
fell when supply exceeded demand, and rose when reduced investment
in new drilling resulted in shortages. In the past decade,
America's widespread adoption of hydraulic fracturing disrupted
that historic pattern, resulting in a flood of new oil that could
be produced quickly. That tamped down price spikes and eroded
profits.
Brent oil, the global benchmark, last topped $100 a barrel six
years ago. This April, the pandemic briefly led U.S. oil prices to
fall into negative territory for the first time ever. So much oil
backed up in storage that investors literally paid people to take
it off their hands. When prices recovered, oil companies didn't
benefit as they might have in the past. Since the end of April,
U.S. oil prices have more than doubled but a stock index of U.S
producers is up only about 21%. Brent crude prices topped $50 a
barrel Thursday for the first time since early March, part of a
broad market rally fueled by investors' anticipation for a 2021
economic resurgence.
The quandary investors now face is this: Will global oil demand
recover before electric vehicles, renewable power, and
environmental regulations permanently dent the market for fossil
fuels?
Reduced ambitions
There are signs that demand may not recover permanently. The
International Energy Agency expects that global oil demand will
peak sometime in the 2030s even as the world churns through around
90 to 100 million barrels of oil a day for the next two decades.
Next year, capital expenditures in renewable power supply are
expected to overtake oil and gas for the first time in history,
according to Goldman Sachs Group Inc.
Investors are one of the main forces driving this
transformation, according to Goldman. Climate change-related
shareholder resolutions have nearly doubled since 2011, the bank
said, with the largest share of them, about 30%, directed at oil
and gas companies. This fall Exxon temporarily lost its crown as
America's most valuable energy company to NextEra Energy Inc. -- a
Florida utility that has become a green giant with aggressive wind
and solar farm investments.
The challenge facing traditional oil and gas companies is how to
make money as the industry changes. The minimum rate of return
required to finance long-term oil projects has increased to as much
as 20%, according to Goldman, compared with as little as 3% for
renewable projects. That gap suggests investors are factoring in
higher regulatory costs for carbon producers, according to
Goldman.
The squeeze on capital has led to a dramatic pullback in
spending. This month, both Exxon and Chevron Corp. sharply reduced
their capital expenditure plans by billions of dollars a year
through 2025.
Even if oil prices go up due to a decrease in oil and gas
supply, as analysts predict, companies are unlikely to sign off on
new mega projects due to long-term fears about energy demand.
Raymond James estimates oil project investment will never fully
recover to pre-virus levels.
Two sides of the same coin
Some investors aren't waiting around to find out how things turn
out. Those who are paid to mirror the broader market have all but
abandoned the industry due to changes in the composition of the
S&P 500. Energy stocks have fallen to less than 3% of the
S&P 500 and Exxon was dropped from the Dow Jones Industrial
Average in August.
For investors who still have an appetite to own Western oil
companies, two divergent corporate options are emerging. The first,
pursued mostly by U.S. oil companies, is premised on sustained,
though relatively reduced, investment in oil and gas production to
capture an uptick in commodity prices later this decade. Exxon and
Chevron primarily aim to address climate change by reducing the
carbon intensity of fossil fuels through technologies like carbon
capture -- which reuses emissions or stores them underground. Both
say maintaining their dividend is a priority.
"[W]e conclude that the needs of society will drive more energy
use in the years ahead -- and an ongoing need for the products we
produce," Exxon Chief Executive Darren Woods wrote in a note to
employees in October.
The second option, predominantly pursued by European oil
companies, involves a dramatic corporate shift to investing in
renewable energy, based, in part, on a belief that oil demand may
plateau sooner than expected. BP and Royal Dutch Shell PLC have
pledged to reach net-zero carbon emissions, using oil proceeds to
fund billions of dollars of investment in renewable energy. Both
have cut their dividends to free up cash. BP plans to shrink its
fossil fuel production over time.
"The more we understand about the impact of Covid--19...the more
convinced we are that the path we have chosen and the destination
we have set are the right ones for BP," BP Chief Executive Bernard
Looney said in a note to employees in August. "And we intend to
move quickly -- within a decade, we expect to be a very different
kind of energy company."
So far, neither strategy is popular among investors. Since May,
Exxon's shares are roughly flat, and BP's are down about 5%. No
oil-and-gas company has figured out how to make money in a low
carbon-energy world, according to Peter Bryant, a managing partner
at business consultant Clareo.
"Exxon and BP are two sides of the same coin," Mr. Bryant said.
"Investors don't like either."
While many investors support green investment, they are
unconvinced major oil companies can make the new business
profitable. According to a Boston Consulting Group survey of 150
investors, 86% believe clean energy investments could help
oil-and-gas companies, but only 25% of them said oil and gas stocks
will become a larger part of their portfolio in the next
decade.
A five-alarm fire
One activist investor, Jeff Ubben of Inclusive Capital Partners,
is buying the European transition story. He invested $75 million in
BP in March and set a five-year goal to make money from the
investment.
He is currently raising more for his fund. "If I am successful
in raising the money I will put $1 billion into a big oil company,"
said Mr. Ubben.
Mr. Ubben said he believes major oil companies should have
excess cash to spend on clean energy by cutting costs, spending and
dividends. The firm bought BP shares after 50-year-old Mr. Looney
became chief executive in February and said the British
conglomerate would reduce its dependence on oil.
Mr. Ubben's firm has made several other low-carbon energy and
technology investments, including electric-truck startup Nikola
Corp. and electricity producer AES Corp. While he said he doesn't
believe the virus will accelerate the clean energy transition, Mr.
Ubben does think it will increase divestment from oil and gas
companies. To counteract that, he said the companies should use
their cash flows to transform the business instead of increasing
dividends or buying back stock.
Why would you return money to shareholders, he said, "if you
want to be an energy company of the future?"
Not all investors share this view. After Shell cut its dividend
for the first time since World War II in April, the asset
management division of Virginia-based broker-dealer Davenport &
Company LLC sold its position in the oil giant.
"We thought they could continue paying that dividend so that
just took us a bit by surprise," said Bradford Seagraves, research
analyst at Davenport. "The income component was certainly an
important consideration for us."
Shell increased its dividend by a small amount in October after
cutting it by two-thirds, telling investors it could cover both the
payout and its investments in renewable energy.
The high dividend yields of Chevron and Exxon are attractive
especially to individual investors who may rely on the payouts as a
source of income, said Noah Barrett, an analyst at Janus Henderson
Investors.
But the companies have to be able to cover the dividends from
their cash flows for them to be sustainable, said Mr. Barrett.
Exxon has had to borrow to cover its dividend this year, which
costs it about $15 billion annually. Chevron hasn't had to take on
substantial amounts of debt during the pandemic or borrow to cover
its dividend.
"If I'm a retail investor I still care about the share price,"
Mr. Barrett said, who works for a Janus fund that owns Chevron
shares. "The monthly check is nice, but the value of my holding is
still going down."
The industry will need to return cash to investors quickly to
convince them to shrug off long-term concerns about the value of
their holdings, said Capital's Mr. Hernandez, the money manager who
sold $1 billion in oil and gas stocks earlier this year. "We don't
really know what the demand is going to be" for years to come, Mr.
Hernandez said.
Those warnings don't faze Mr. Waterous, who previously headed
investment banking at the Bank of Nova Scotia before founding
Waterous Energy Fund in 2017. He said he believes investor
disaffection with the industry is divorced from its supply and
demand fundamentals, and that is why he pounced this spring after
prices turned negative.
Within days, his team had put out proposals to acquisition
targets. His fund purchased 45% of oil sands company Osum
Production for about $111 million -- one of the few private equity
oil deals thus far in 2020. In November, the fund launched a
takeover bid to buy an additional 40% of Osum's shares for about
$99 million.
"It became a five-alarm fire," he said."It became 'oh my God,
we've got to do this right away.'"
Write to Christopher M. Matthews at christopher.matthews@wsj.com
and Sarah McFarlane at sarah.mcfarlane@wsj.com
(END) Dow Jones Newswires
December 11, 2020 15:10 ET (20:10 GMT)
Copyright (c) 2020 Dow Jones & Company, Inc.
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