The moral dilemma: Should I invest in big oil?
Big oil has had an incredibly profitable quarter. In the last week, Exxon Mobil (US: XOM) and Chevron (US: CVX) - the two big players in the US have reported combined net profits of almost $31bn. Their peers in the UK, Shell (LON: SHEL) and BP (LON: BP.) have posted similarly lucrative income: $9.5bn and $8bn respectively.
Investors are benefiting from these profits. Alongside its results, Shell announced a 15% hike to its dividend and a $4bn share buyback programme, which will reduce the number of shares in issue and thus boost the profit per share. BP plans to buy back another $2.5bn shares in the final quarter of 2022, taking its full buyback programme for the year to $10bn. Exxon Mobil’s share price is up 73% in the year-to-date (in a US market which has fallen hard) and Chevron’s is up 50%.
But these numbers also raise some thorny questions. Should the oil and gas majors be raking in such high profits at a time of exorbitant inflation which may leave many Brits with cold homes this winter? Should their profits be reinvested for the good of their investors or the green energy revolution? And is the sector profiteering from troubles in Eastern Europe?
The latter point was raised by President Joe Biden on Monday. “Their profits are a windfall of war — a windfall from the brutal conflict that is ravaging Ukraine and hurting tens of millions of people around the globe,” he said at a conference in Washington. And if these companies don’t start lowering prices his solution is higher taxes: “if they don’t [lower prices for consumers], they’re going to pay a higher tax on their excess profits and face other restrictions.”
But a windfall tax is not always the solution - as the differing tax profiles of BP and Shell have shown in their recent results. In the UK, the Energy Profits Levy is a 25% tax on profits made extracting (but not refining or selling) oil and gas. It should, theoretically, tax both BP and Shell for the oil they drill out of the North Sea. But a rebate on investment in fossil fuel extraction means the companies can apply for tax savings. Thus, Shell will not pay any tax on the oil it has extracted this year because it has also invested significantly in new oil fields. By contrast, BP will pay about $2.5bn in taxes this year. The company told the Financial Times that $2 in every $3 made in the North Sea is going to the government.
Is the industry profiteering? It’s hard to deny that the oil and gas majors are net beneficiaries of the war in Europe - which has disrupted global supply chains, thus sending the price of fossil fuels higher. But the age old adage in the industry is that the cure for high prices is high prices. Historically when supply chain disruptions have sent the price of fossil fuels higher, companies invest heavily in order to profit from the higher prices. That investment increases supply so that the prices come down. Supply, rather than demand, cures the problem.
This happened as recently as 2014 during the US shale boom. But not in 2022. Last year the industry spent just $305bn on exploration and yet, according to the International Energy Agency, companies need to spend about $466bn annually from 2022 to 2030 to meet the world’s oil needs. If supply continues to undercut demand, prices will just keep rising.
And so, for oil executives this ‘no spend’ policy is good for business. Without having to invest excessively in new fields, companies are making higher profits thanks to price rises which are out of their control. Profiteering? Perhaps. But this is the fallout from climate activists, governments and investors asking companies to slow their exploration projects. In the words of Bloomberg’s energy columnist Javier Blas: “We told big oil not to invest. Don’t complain now.”
But where oil executives struggle to find the upper hand in the moral dilemma is their approach to investing in green initiatives. In the five years to 2021, Shell invested a total of just $3.2bn in renewable energy, compared to $84bn on oil and gas exploration in the same period. It’s dragged its feet far more than BP, which has poured money into a wide range of renewable projects which are currently producing energy. By contrast, Shell’s more muted investment has been in long-term projects which seek to change the way renewable energy is harvested and used. It wants to make money from supplying energy directly to businesses, for example through its electric vehicle plug-in points.
For most investors at a time of economic crisis, the ultimate question really is ‘will this stock make me money’. And the answer for the companies in the energy sector is surely ‘yes’, at least in the short term. Prices are unlikely to come down until governments change the conversation around more drilling and given the fragile political environment in both the US and UK, this is unlikely any time soon. Healthy cash flows look likely to hold up at the oil majors and in that time investors can continue to expect healthy dividends.
But beyond the short-term benefits being enjoyed by the sector, this could be a fragile time to invest in oil. This week Roland has analysed the case for investing in cyclical stocks (those that are tied to the economic cycle) and found that oil may be approaching its peak. High forecast profits mean price to earnings ratios are about half of cyclically adjusted average over the long term - which for a long-term investor isn’t the best time to buy.
There is therefore no clear answer to the big oil dilemma. For short term investors who can sidestep the moral problems of a lack of investment in green initiatives, BP and Shell both look like good opportunities. But as a long-term investor hunting for businesses which are investing in the technologies of the future, I am looking elsewhere.
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Excellent comment on tax burden of UK based oil companies and their historical performance. Also great analysis from Megan. Unfortunately the eco-warriors, Ed Miliband, Ed Davey and Caroline Lucas plus most of the media outlets do not understand what they are talking about. BP (LON:BP.) as Megan notes are investing heavily in renewable energy. Most recently they bought a US based Biofuel business for $4.1bn and previous investments include solar (BP Lightsource), Wind (licences and wind farms in US & UK) and an EV charging infrastructure (BP Pulse). In addition they are active in industrial hydrogen development projects working with European partners. BP (LON:BP.) are increasing the proportion of their capital expenditure in renewables every year with a target of 50%+ by 2030. The current 'windfall' is surely contributing to this investment. Nevertheless they are attacked from all sides. The eco-warriors want them out of oil altogether (ridiculously - immediately) yet at the same time certain analysts in the investment community focus on them overpaying for renewable investments! Add to that the insistent cries for a windfall tax from all and sundry must be extremely disheartening for management and employees. I just hope they have a thick skin and can continue to contribute to the move toward net zero though as has been pointed out this under investment in oil & gas has contributed to the high prices of today. Adding more tax to the mix will not help energy security or result in lower prices going forward.
Excellent post Megan.
On the ethical/moral story I struggle a bit with many of the arguments out there.
1. Until we are close to complete non-dependence on oil it makes little sense to regulate our own companies to death and buy our oil from unregulated foreign companies. IMO both Shell and BP are moving in the right direction and should be treated more sympathetically.
2. Many so called ESG companies are indirectly linked to Oil. Green washing is not a myth.
3. Gas is an ideal intermediary energy source as we wean yourself off fossil fuels. It so also an elegant solution for managing the peaks and troughs in renewables.
4. As a shareholder in both BP and Shell I didn't hear anyone insisting that we should be helping the Oil and gas players (and me) out as they were haemorrhaging money and cancelling dividends a couple of years back.
Disclosure - I am actively involved in a major wilding project and a (voluntary) advisor for an environmental challenger - so please don't take my (slightly grumpy) observations as falling into "the world doesn't have a problem category".
On the investment front I get the technologies of the future idea but if that means jam tomorrow then I start to get very nervous - like a few of us, I have been badly bitten on recent investments in this space.
It is an emotive subject. Personally I have a simple rule, I don't Invest if a company does more harm than good. There is no need, lots of other opportunities out there.
Big oil, any fossil fuel extracting company, tobacco etc, I steer well clear.
Hi Forbsy, have a look at the ETF "XES". Pure asymmetry here if you believe that we will need more oil and gas in the future. If XES goes back to its 2015 value then that would be a circa 5 fold increase from here i.e. massive upside potential.
The stupidity of the Uk government hoodwinked by the green blob is amazing not to mention the cozying up to St Greta, I dispair. We all know that in the UK the sun hardly ever shines for long and the wind is also unreliable and we need natural gas and nuclear as backup. Here we are surrounded by gas fields not to mention beneath our feet and what do we do? We import the stuff . We lose jobs at home ruin the balance of payments and then borrow money and jack up taxes to pay for it all.
Exactly. If you look around, you're likely to find that half of the items in your room are a by-product of oil. It's just that most people don't realise it. Most probably, even the sole of the shoes you wear. People need to look carefully at the components used to make a wind turbine or an electric car: cobalt (from the Congo, most probably mined by children), copper (often extracted by injecting sulphuric acid into the ground), rare earth metals (which primarily come from China), Lithium,... the list goes on and on. In the meantime, some of the cleanest natural gas companies are carbon-negative.
The same people will complain when their electricity bill rises a few hundred percent and then beg the government to pay for it.
Anyway - it's been a very nice day for oil and oil companies!
FYI: I'm not against copper, Lithium, Cobalt or rare earth metals. I invest in those as well.
He presumably doesn't eat food (pesticides, fertilizer, diesel machinery et al are all of course required for modern food production), nor does he apparently brush his teeth with toothpaste:-) Our entire economy & way of life is merely a function of surplus (fossil fuel) energy, few people seem to grasp this.
I'm not sure why everyone is coming down quite so heavily on NewInvestor1972. He is just explaining his own approach. He isn't trying to dictate what others must do. I'm cool with that.
Where I might disagree with NewInvestor1972 is the evaluation of where a company is doing 'more harm than good'. I think that is a very difficult assessment to make, especially when we are engaged in the extremely tricky process of transitioning to a low carbon economy and where a broad political consensus must be maintained for change to be acceptable. Not everything we do not like causes more harm than good in that difficult context. Keeping the lights on and the wheels turning while we try to build greener ways of powering them is essential to sucessful change. And 'dirty' fossil fuels are going to be needed for some decades to come as an integral part of that (30 years or thereabouts is, I believe, effectively the short-term in economic and technical reality).
I invest in big oil and the like with a clear conscience because I know that they are, paradoxically, essential to the green revolution.
Thanks Davi, they are all the usual arguments though and I fully expected them. Only 1% of oil is used in bi-products. I drive a petrol car but the next one will be electric.
One recommendation, watch big oil v the world, with your kids and then tell them you invest in Exxon.
We are addicted to oil as that's what big oil wanted, we need to wean ourselves off of it quicker and leave fossil fuels in the bowels of history.
Great article though., Nice balance What are people's thoughts on OPEC reducing capacity "to stabilise prices" when surely for the good of the Western world in the current energy crisis, caused by our reliance on oil, they should increase.
This is a great analysis Megan, a good balance of facts, figures and looking at the circumstances beyond them. It doesn't quite answer the question in the title though, even though you come to a long term investment conclusion in the last sentence.
Moral dilemmas are only really solved by working out how comfortable you are looking that person in the mirror in the eye, when you are shaving (Or doing your make up). Moral dilemmas are solved by emotion and the individuals capacity for (Dis)comfort. This is why the "Lines in the sand" that one person draws will often be different to another's, or even contradict themselves. When I inherited my Dad's portfolio I sold his Entain (Gambling business) shares, likewise I'd never invest in oil, motor industry or aviation. However I'm comfortable investing in defence giant SAAB (Who divested their car and waggon businesses many years ago and no longer build civil aircraft: but presumably continue some kind of operation to support aircraft still in service), as well as Uranium stockholder Yellow cake. For people with differing moral objections these choices may be inexplicable or- to them- hypocritical as we tend to project our own values onto others.
I hope I haven't belaboured this point; peppering it with personal examples and barely mentioning oil, but a lot of investing is influenced by irrational factors, some of which we can ascribe to emotion. Part of it is why share prices often fail to reflect the actual value of the business itself and so emotion and values are dimensions to be mindful of when investing.
NewInvestor1972 You say "Only 1% of oil is used in bi-products." Let's say a company builds a facility to make plastic from oil. Plastic is the primary end product. It is not a bi-product. Oil is used to make so many things. I don't believe that only 1% of oil is used to make end products. Please can you define what you mean by a bi-product? And please can you substantiate "Only 1% of oil is used in bi-products." because to me it does not appear to be a credible claim.
Windfall Tax - the choice really isn't just Windfall Tax yes or no. For Govts, it is Windfall Tax vs other taxes (to let me spend what I think I need to spend - a political question). Done well, a Windfall Tax should not deter existing investment (Shell planned to XX before any Windfall Tax and will certainly still do that since that investment is still at least as profitable as I planned; the Windfall Tax will only deter the marginal extra investment that would have otherwise have been made in response to the high price).
On renewables - so much backward looking analysis. Cobalt is rapidly been designed out of the big new battery products. The cost/benefit is constantly improving on both vehicle and grid scale batteries, and the CPEX / financing cost is typically low (since they can be built and payback quickly much quicker than fossil fuel or nuclear plants . So for NEW Capex, they are typically cheaper as the Govt's own BEIS data shows. It does depend on assumptions for a carbon tax but since the costs of climate change are very high (I look out over a new 140Mn sea defence scheme!) and could be existensial/major quality of life influencable, this seems a legitimate inclusion anyway! (Its no wonder 25 year old care about the planet more than 65yearolds - it isnt just moving right with age, they will have to live in a hotter world with all the consequences)
However, it is also true oil & gas are not replaceable short term. I cycle/eat veggie......but as pointed out have a car/use plastics etc. I have therefore invested in Shell in the crisis a few years ago but am looking to exit over the next 6 months since the future is elsewhere.
For another 20 years, a lot of oil still will be consumed but it will translate to less and less profit for (Western) oil majors as their politics will impose costs that national oil companies in repressive regimes will not. But is fundamentally economics that will kill the North Sea and other oil & gas production sites.
On that basis, Oil is a trade not a hold.
Totally agree ... oil (with coal) is a terrific swing trade.
Be aware, however ... I think a full swing of this pendulum will take at least 20 - 25 years. There's definitely a 'trade' here ... if you have the usual big cojones and much more than usual lasting power.
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Yes but foreign governments around the world could start putting up taxes too - I know Biden would be keen. So I think there are risks to consider here, beyond the UK assets.