Big Oil remains big business
Hydrocarbons will be needed to reach net-zero, so an energy fund is a core holding, says Max King
The World Meteorological Organisation, an agency of the United Nations, has sounded a “red alert” on climate change, stating that 2023 was the hottest year since statistics began, with temperature records broken “and in some cases smashed”. They see “a high probability that 2024 will break the record of 2023”.
In the UK, a warm winter, and consequently reduced consumption, has kept energy bills down. If this is the result of global warming, then, consumers will believe, this cloud has a very bright silver lining. Meanwhile, abundant rainfall makes it very unlikely that there will be water shortages in the summer.
Global supplies of liquefied natural gas have proved abundant and look set to rise further, despite the blocking of the Russian gas pipelines to the West. In the US, the spot price of gas has dropped to $2 per mcf (1,000 cubic feet), down by nearly 80% since the summer of 2022. Meanwhile, the oil price, at $83 per barrel for US benchmark futures, West Texas Intermediate, is at similar levels to just before the Russian invasion of Ukraine.
This might appear to be bad news for investors in the sector. But energy has been a solid performer, with the MSCI World Energy index returning 5% in dollars over one year and 77% over three. In any case, the benefit of high prices is soon confiscated by taxes in the host country, so the sector’s fortunes are only loosely connected to energy prices. Returns for energy companies, like for any other, are determined by good investment, efficient operation and the application of technology rather than by commodity prices.
But if fossil fuels, as many believe, will be superseded by renewable energy, then the business of fossil-fuel firms will vanish. But when? Twenty years ago, the industry worried about “peak oil”, the point at which global oil production became sufficiently constrained by the exhaustion of reserves to start to decline. Now the concern is “peak demand”, but that looks some way off. Even when (if?) demand does start to fall, hydrocarbons will be big business for a long time.
A new lifestyle
The International Energy Agency (IEA) expects demand for oil to grow by 1.4 million barrels a day (1.4%) in 2024, in line with the average since 1990, despite European consumption declining steadily. Demand for gas increased by 0.5% in 2023, despite consumption in Europe falling by 7% to its lowest level since 1995. The IEA expects global demand to expand by 2.5% in 2024. Europe may be reducing its dependence on hydrocarbons, but the rest of the world isn’t.
The belief of the net-zero crowd is that the rest of the world will follow Europe’s downward path of consumption. But even if that is the case, it is unlikely to go nearly as fast as their ambitious targets for a reduction in carbon emissions imply.
As Mile Lakin, managing director of energy advisers Envoi says, “energy transition will take time. Talk and promises about net-zero deadlines are great and a real incentive, but only if there is a realistic energytransition plan to a achieve them and [a] willingness of – and incentives for – the world’s population to adopt a
“Europe is reducing its dependence on hydrocarbons, but the rest of the world isn’t”
completely new lifestyle”. The growth in renewables has been impressive, but has required significant subsidies and supportive capital markets. Governments no longer have money to burn; consumers resent high energy prices and investors are demanding higher and more certain returns on capital to invest.
The problem of the intermittency of solar and wind energy has yet to be solved; nuclear-power generation is capital intensive, politically awkward and slow to build out; and storage solutions are of short duration and expensive.
“The world does need to use less fossil fuel, recycle more and become more energy-efficient,” says Lakin, not least to increase energy self-sufficiency and make supply more resilient to geopolitical shocks. It is not a coincidence that the governments of major energyproducing countries are among the world’s most aggressive, corrupt and autocratic – it is the inflow of unearned revenues from hydrocarbons that makes them so.
“The writing has been on the wall for over seven years that energy can’t ‘transition’ seamlessly without new sources of oil and increasingly gas. The world is still reliant upon hydrocarbons for 80% of its energy,” says Lakin, “yet since the last commodity price crash in 2015-2016, a fraction of the exploration needed to guarantee supply has occurred [owing] to the lack of funding.” The reluctance or refusal of many institutions to invest in the sector has made the companies riskaverse and unwilling to invest.
“The investment community’s current eschewal of exploration and production (E&P) now appears equally short-sighted and only likely to increase, not decrease, emissions. It is not too late to instigate a realistic approach to a new cycle of exploration, with environmental and social governance (ESG) compliance, to help restore global supplies over the next five,” says Lakin. Yet that will not be an easy task. “After nearly six years of almost zero E&P investment and subsequent loss of experienced geoscience and
engineering teams, few established E&P companies can now grow their exploration capability sufficiently fast, if at all. New exploration techniques and technologies such as AI may be needed to advance and improve success rates and cycle time.”
Lakin has some interesting thoughts on the most promising areas for exploration, including East Africa, offshore Namibia, the Guianas, the Caribbean and Eastern Australia. Some of these areas will make companies and their investors rich. Some, for reasons of geology, politics or poor execution, could be money pits. Trying to pick the winners is a task best left to the experts.
What to buy now
Investing through a dedicated energy fund makes obvious sense, but many managers charged into energytransition funds when the theme was all the rage. These funds, focusing on renewable energy, have been poor performers. More promising are the traditional energy funds managed by Schroders, BGF Investment Management and Guinness, which continue to offer both value and opportunity.
The Guinness Global Energy Fund, for example, managed by Jonathan Waghorn, Will Riley and Tim Guinness, trades on a 2024 price/earnings ratio of 9.2, a dividend yield of 4.5% and an underlying free cash-flow yield of around 11%, according to the managers.
A quarter of the portfolio is invested in the “super majors” (Shell, BP, Exxon Mobil, Chevron and Total); a further 30% in integrated producers; 24% in E&P, 9% in equipment and services companies and 5% in both refining and marketing, and storage and transportation. There are 35 holdings, with the ten largest accounting for 47% of the portfolio.
Although the benefit of higher oil prices to the energy sector is only short term, it does provide a counterweight for investors to the adverse consequences for markets generally. And if oil prices are weak, the sector will probably languish, but the rest of the market will probably go up. So investment in the energy sector helps mitigate risk for your portfolio as well as being likely to provide attractive long-term returns.
From current depressed prices, renewable energy companies and “new energy” funds may also be a good investment, but a traditional energy fund is more than just a contrarian investment and should be a core constituent of any portfolio.
“Investing in the sector mitigates risk for your portfolio in addition to promising healthy longterm returns”