Here’s for an orderly transition
The COP 28 climate summit recently adjourned called for “transition away from fossil fuels … in a just, orderly and equitable manner … so as to achieve net zero by 2050 in keeping with the science.” A sentence clearly written by lawyers and politicians with a touching belief that soothing words substitute for reality. We would argue, first, that nature’s reaction to excessive fossil fuel emissions (severe drought, storms, ice melt, forest fires, rising water level) has not been just, orderly or equitable— so why ignore reality? Second, that implementation of new technologies will not move at an orderly pace, but will be determined by cost of production and customer preference. (You might recall Eastman Kodak’s attempt to phase in digital photography while retaining the cash flow from its legacy film photography business. Eastman Kodak quickly went bankrupt.) Third, given the slow decarbonization progress to date, it might be prudent to move the 2050 goal to something closer. (A tourist noting a relaxed attitude to the timing of a major anniversary celebration —17 years late— asked an Irish bard if there was a Gaelic equivalent to “mañana” to which he replied, “No, we don’t have a word with that sense of urgency.”) Related: U.S. Drillers Cut Drilling Activity Amid Stabilizing Oil Prices
As investors, we worry that COP 28’s slow walk to decarbonization as well as the hope that a second Trump administration would further delay action, will foster complacency in the fossil fuel industry. We also worry that oil executives might believe their own propaganda, which is another matter. But we are also concerned by the notion, recently repeated in an NPR report, that oil companies do not invest in renewables because renewables offer lower returns than oil.
No doubt they do, on paper, but in actuality, over the past decade renewable investments have made bigger profits for shareholders than oil investments. High returns on paper don’t mean much if they can’t be translated into shareholder value. So here’s an update of numbers that show the total return earned (common stock dividends plus capital appreciation, or interest plus capital appreciation) for the past 10 years (through Dec. 15, 2023), in nominal and real terms, in % per year:
|S&P Clean Energy
|S&P Global Oil
|S&P Corporate Bond
Based on historic precedent, the average stock should outperform bonds by 2.5 to 4 percentage points. The S&P 500 did way better than that, the clean energy stocks outperformed slightly and the oil stocks did woefully badly. Oil companies earned less than half their cost of shareholder capital, we estimate. No doubt they had higher hurdle rates for investment, but whatever they invested effectively lost money for shareholders. Incidentally, historically, US companies have produced lower total return for shareholders than would have been expected from reinvestment of funds. Why? One influential study suggested that the corporations frittered away funds on bad investments, paid too much when making acquisitions and handed out too many dilutive stock options to senior employees. So, to the extent that oil companies might be guilty of those deficiencies, no big deal, it’s just they might have been guiltier than most, based on the results
So back to investment strategy. Oil companies have three choices: (1) maintain the status quo (on the belief that COP 28 is just a toothless PR exercise so ignore it), (2) take their cash out of the oil business slowly on the belief they have time for a leisurely exit (COP 28’s multi-decadal time frame is realistic), (3) or exit the oil business more rapidly now at high prices (there is no way that the COP 28 conferees can control the timing of events and it will take only one giant climate disaster or technological breakthrough to send the market spinning). Those are the real investment issues, not whether another merger or two will add to economies of scale, or whether the next administration will offer better tax advantages for drilling policy. Every investment announcement fits into one of those three categories and tells us more about the company’s overall direction than about the deal itself. It might even be helpful if the managements told us how they thought that the investment fit into one of those three buckets. That certainly would help to clear the air.
By Leonard Hyman and William Tilles for Oilprice.com
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