Strange alliance of investors and environmentalists keeps oil stocks afloat

Oil stocks are booming right now, which is not surprising amid the economic recovery. What is more surprising is that the boom in oil stocks could likely continue for years beyond the pandemic recovery phase.

“I think we are in a multi-year bull market in oil,” said Eric Nuttall, a prominent energy investment manager and partner at Ninepoint Partners LP.

You might think that efforts to decarbonise the global economy would turn oil into a declining industry with poor long-term prospects. However, the transition to renewables will likely take decades.

That leaves plenty of time for investments in oil stocks to pay off generously, says Nuttall, senior portfolio manager of Ninepoint Energy Fund, Canada’s largest oil and gas industry mutual fund by asset size.

Limited supply

As the world continues to use oil, its supply is surprisingly limited. Due to an unusual combination of environmentalist and shareholder pressures, oil companies exercise unusual restraint when investing in production, despite high prices.

“I see an environment in which sufficient investment is no longer permitted, whether because of environmental pressures or pressure from shareholders who want companies to prioritize returns over spending,” Nuttall said.

While no one can predict what will happen with much certainty, if supply is tight while demand remains strong for an extended period, prices should remain relatively high as long as these conditions prevail. If so, oil company profits and stock prices should be doing well.

Even though the prices of many Canadian oil stocks have already doubled this year, valuations are still “ridiculously cheap,” says Nuttall. In many cases, current valuations are only a fraction of typical historical levels. According to one valuation measure – the company’s value relative to operating cash flow – Canadian oil stocks are currently trading at a ratio of 2.0 to 3.5 times, up from a typical historical figure of 7. , 0 to 9.0 times, says Nuttall.

Oil prices collapsed at the start of the pandemic, then recovered gradually but sharply. US benchmark prices hit over $ 80 (all US figures) per barrel at the end of October, the highest level since 2014. They have since stabilized, in part due to the reaction to the variant’s announcement. Omicron, but oil prices hovered just under $ 70 a barrel. barrel for most of last week, a relatively high level sufficient for healthy earnings.

As the recovery in oil prices took hold earlier this year, companies initially focused on paying down debt and repairing the damage to their finances. With finances now in better shape, Canadian oil companies are focusing more on share buybacks and sizable dividend increases. Among the notable examples, Suncor Energy Inc. recently doubled its dividend, fully reinstating a cut made at the start of the pandemic. “Investors are just getting a taste of these hefty dividends,” says Nuttall.

Surprising allies

Supporting the outlook for the oil industry is an unusual alliance of value-oriented investors and environmentalists, both of whom, for different reasons, are pushing to restrict investment in oil production. With oil being a depleting resource, oil companies must continue to invest massive sums in exploration and development just to maintain existing production levels, let alone increase them.

Environmentalists seek to reduce carbon emissions from oil in any way possible, whether by limiting supply or impacting demand, but the transition from oil to low-emission energy sources will be gradual and problematic. It will be some time before everyone drives electric vehicles, which will require not only a massive transformation of the auto industry, but also a decarbonization and expansion of the global power generation capacity, now heavily dependent on coal and carbon-intensive natural gas.

The world will therefore still need oil for a few more years. The International Energy Agency’s World Energy Outlook released in October predicts that even if all climate commitments from all countries around the world were met in full and on time, oil production in 2030 would still be slightly above. peak before the 2019 pandemic. It was only in the 2030s that the IEA saw oil production drop significantly below 2019 levels on the very basis of these aggressive assumptions.

A less aggressive projection of the IEA based on the policies that governments actually put in place would result in significantly higher oil production in 2030 compared to 2019, followed by a subsequent cap.

Yet the growing array of environmental regulations, emission caps and carbon taxes combine to discourage oil companies from investing in production. Environmentalists are also pressuring banks and institutional investors to divert industry financing activity in favor of renewable energy. This makes it more difficult for oil companies to find financing at a reasonable cost.

At the same time, value investors have increased their grip on the management of oil companies. The high prices of the last oil cycle led to massive investments in additional production, especially in the American shale. But the resulting surge in global production overwhelmed demand, pushing prices down in 2014, followed by nearly seven lean years. So, investors, after being burned, are now putting pressure on management to reduce investment in production, despite the high prices.

Oil companies around the world, including major US shale producers and “supermajors” like BP PLC and Royal Dutch Shell PLC have mostly embraced this new discipline. BP goes so far as to sell a large part of its fossil assets to finance a transition to renewable energies. In many cases, companies are not investing enough to keep production at current levels. Royal Dutch Shell expects oil production to decline by one to two percent per year until 2030. This plan is unaffected by the recent surge in oil prices. “From my perspective, (the price hike) doesn’t mean anything,” a Shell executive told The Economist.

When company management tries to turn the tide, it faces intense pressure from investors. This year, a hedge fund called Engine No. 1 led a revolt among ExxonMobil Corp. investors. opposing the company’s expansionist policies. With the support of large institutional investors like BlackRock and Vanguard, they have succeeded in replacing three directors on the board, reducing the likelihood that Exxon Mobil will proceed with new large projects.

The coalition of oil-producing countries known as “OPEC Plus” (OPEC members plus allies like Russia) represents a potential wildcard for global supply, but their recent disciplined behavior in favor of higher prices suggests that they are unlikely to overwhelm the market for additional oil in the foreseeable future. They drastically cut oil supplies at the start of the pandemic to help stop prices from falling. Since then, they have gradually replenished the oil supply in a disciplined manner that has always allowed for price increases.

New emissions commitments

The Canadian oil industry’s recent climate change commitments will force it to spend large sums of money to reduce emissions instead of handing it over to shareholders.

Canada’s oil sands, a large part of domestic production, have been shunned by environmentally focused investors even more than mainstream oil companies because of particularly high carbon emissions. However, in October, Canada’s top five oil sands producers pledged to achieve net zero emissions from oil production by 2050, with milestones in between in 2030 and 2040. Plans include a capture network carbon that would collect sequestered carbon dioxide from 20 oil sands facilities and ship it by carbon pipeline to a storage facility in Cold Lake, Alta.

For environmentalists, this does not come close to solving the environmental problems of the Canadian oil industry, but it is a big step in the right direction. “It’s very positive that the companies have all made net zero commitments,” says Chris Severson-Baker, Alberta regional director for the Pembina Institute, a clean energy think tank.

Yet the long timeframe for reaching net zero means it “doesn’t mean much in the short term,” says Chris Severson-Baker, director of the Pembina Institute, a clean energy think tank. And looking at the plans in detail category by category, “that’s too optimistic.” Additionally, oil sands production still generates higher emissions than conventional oil, while conventional oil producers also strive to reduce emissions from a lower emissions base, he says. “I don’t see much relief for the oil sands industry from the external pressure. ”

So while the world is likely to need oil for a long time, it is not clear whether Canadian producers will be able to maintain their current share of global production in the face of environmental pressure. To achieve this, the Canadian industry will likely need to continue to step up efforts to clean up emissions – and if companies can continue to make healthy profits, it may well provide them with the means to do so while keeping shareholders happy with buybacks. and dividends. .

(Oil stocks are risky investments. Do your own due diligence and / or consult a financial advisor before investing in them.)

David Aston, a freelance columnist for The Star, is a personal finance and investment journalist. He holds the Chartered Financial Analyst designation and is a Chartered Professional Accountant. Contact him by email: [email protected]

Steve R. Hansen