The energy markets are currently going through a seismic shift only rivaled by the global energy crisis of the 1970s. Commodity analysts at Standard Chartered have pointed out that the oil majors in particular are facing one of their greatest tests due to a host of conflicting objectives, some of which are mutually exclusive while others demand tradeoffs of some sort:
- Incessant calls especially by western governments to expand oil and gas output in a bid to lower consumer prices.
- To act as a revenue source for government finances when needed.
- Accelerate the energy transition and net zero objectives.
- Promote energy security in all its forms.
According to StanChart, the reaction to recent quarterly results of oil majors “would include an impression that majors are failing to increase output”.
The reaction also seems to suggest that the wider sentiment is that Big Oil is also lacking in its contributions to the energy transition, while at the same time not paying a fair amount of tax. Instead, the reaction is that Big Oil prefers “to buy back their own shares or increase dividends rather than to be dynamic or innovative”.
Standard Chartered views some of this “synthesis” as “unfair”, but because it is so prevalent, it demands that Big Oil proceed with greater awareness.
The commodity experts have a valid point. We are halfway through the earnings season, and the energy sector has once again emerged as the market’s best performer with earnings growth clocking in at 57.7%, multiples higher than the S&P 500 average of 4.3%. Five Big Oil companies have returned their Q4 2023 scorecards, with Exxon Mobil (NYSE: XOM), Chevron Corp. (NYSE: CVX), BP Plc (NYSE: BP), Shell Plc (NYSE: SHEL) and TotalEnergies (NYSE: TTE) raking in combined profits of $196.3 billion, more than the annual economic output of 156 countries. The Biden administration is clearly not pleased with the turn of events:
“You may have noticed that Big Oil just reported record profits. Last year, they made $200 billion in the midst of a global energy crisis. It’s outrageous,” U.S. President Joe Biden said in his State of the Union address on Tuesday. The president’s polemic appears justified considering that Big Oil is hardly using much of its windfall profits to expand production, preferring instead to distribute their excess cash to shareholders in the form of dividends and buybacks.
Source: Standard Chartered
High oil and gas prices have translated into high fuel prices for consumers, drawing the ire of the public and governments everywhere and sparking populist moves in response.
Back in October, President Biden threatened to slap a windfall profits tax on American oil and gas companies if they fail to use their "outrageous" bonanza to expand oil supplies in a bid to lower fuel prices. A windfall tax is a one-time surtax levied on a company or industry when unusual economic conditions result in large and unexpected profits. However, Biden is yet to follow through on his threat but instead American companies have to face a different beast: buyback tax.
As part of the new Inflation Reduction Act that President Biden signed in August is a new 1% tax on corporate share buybacks. Oil and gas companies will bear the brunt of the new tax because they have dramatically increased buybacks as a favored way to return excess cash to shareholders.
“My message to the American energy companies is this: You should not be using your profits to buy back stock or for dividends. Not now, not while a war is raging,” Biden said in October.
Biden has scolded U.S. oil producers claiming they fail to appreciate the free-market capitalism windfall made possible by American democracy nor sympathy for their retail customers. In 2022, U.S. oil company share buybacks increased 1,043%, dwarfing the 64% increase for S&P 500 while dividends were up 33%, more than three times the rise for all the companies in the index. Total free cash flow of the 23 companies in the S&P 500 Energy Index increased 2.3 times to $201 billion, with free cash for Exxon Corp. (NYSE: XOM) and Chevron Corp. (NYSE: CVX) increasing 150% to $60 billion and $36 billion. Meanwhile, Valero Energy Corp.’s (NYSE: VAL) free cash flow grew five-fold to $9 billion from the previous four quarters.
Other western nations have followed suit: the European Union, the UK and India have already introduced windfall taxes on oil and gas companies while others such as the Netherlands, Norway are currently considering them.
On September 30, 2022, the Council of the European Union agreed to impose a "temporary solidarity contribution" on energy companies that realize "above a 20% increase of the average yearly taxable profits since 2018”. This tax will be levied on top of whatever taxes these companies already owe in their individual countries.
And this might just be the beginning: according to a recent Wood Mackenzie report, while 2022 was the year in which the idea of the windfall tax and the villainization of Big Oil reached a new peak, this year will likely see more momentum if oil prices remain high. If prices drop, windfall taxes could be eliminated; however, Wood Mackenzie views this as “unlikely”, noting at the same time that some windfall taxes have expiration dates and clauses for modification based on oil prices.
StanChart has warned that Big Oil’s new playbook entailing maximizing the short-term share price by holding back investment and minimizing risk-taking is hardly an ideal long-term strategy. Luckily, western governments might eventually get their wish: according to Wood Mackenzie’s ‘Oil and gas exploration 2022 edition, exploration well numbers in 2022 were less than half the numbers during pre-pandemic years, yet the total volume of 20 billion barrels of oil equivalent (Boe) matched the average in the 2013 – 2019 period, creating at least $S33 billion of value. Wood Mac says that oil and gas companies are getting better at exploiting low-cost, lower-carbon but high-yield assets, meaning they are in a better position to grow production and meet emissions goals while also rewarding shareholders.
By Alex Kimani for Oilprice.com
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