Oil and gas industry is riding high, for now
Little of its profit is being invested for fossil fuels’ smaller role later
Another quarter of record profits. Another quarter of rising stock prices. Another quarter of happy investors.
The oil and gas industry, riding the highest prices in nearly a decade, has its swagger back — once again the indispensable player in a world desperate for energy. After years on the defensive as a fading industry that could no longer deliver for shareholders, the oil and gas sector is capitalizing on its advantage, showering investors with returns, pressing its policy agenda in Washington and rebuffing the entreaties of President Joe Biden to significantly increase production to ease high prices.
But, analysts say, oil companies should enjoy the moment. As executives bask in the glow of short-term profits — much of them driven by Russia’s war against Ukraine — the industry faces the same long-term challenges that have been threatening its future in recent years. Despite generating some $1.4 trillion in free cash this year, companies have invested precious little of it to position themselves for the ongoing transition in which fossil fuels play a smaller role in the world’s energy mix.
Oil companies may have little choice but to favor the short term as they try to win over and hold skeptical investors with generous payouts. But the strategy has long-term implications for Texas, where the future may depend on whether the critical energy industry can make the transition to a low-carbon environment. Despite eye-popping profits, analysts said, U.S. oil and gas companies have done little to develop or invest in a sustainable, longterm business strategy.
“They didn’t have one before Ukraine,” said Tom Sanzillo, director of the Cleveland-based nonprofit Institute for Energy Economics and Financial Analysis, which advocates for a sustainable energy industry. “And unless we expect these kinds of geopolitical manipulations to continue — whether it’s a war or something else after it that makes for artificially high prices — I don’t know that they have anything but a short-term gain here.”
Short term gains, indeed. For the third quarter, San Antonio refiner Valero Energy Corp. said its profits jumped 400 percent from a year ago, to $2.8 billion. Houston independent oil company Conocophillips reported that profits surged 90 percent from a year earlier, to $4.5 billion. Exxon Mobil had its best quarter ever — earning nearly $20 billion in three months — and said it distributed $8.2 billion to shareholders while spending $5.7 billion on long-term investments. Bloomberg data shows that this year, Exxon, Chevron, Shell and French energy major Totalenergies will distribute about $100 billion in profits to shareholders while reinvesting only $80 billion into their core businesses.
But as companies race to pay shareholders, analysts said, the businesses are left with little flexibility to steer investments elsewhere.
“They have committed to this new financial model,” said Bill Gilmer, director of the Institute for Regional Forecasting at the University of Houston. “And this new financial model says, ‘We (companies) are going to have to maintain pristine balance sheets. And we’re going to have to, from this point forward, reward investors by diverting 30 to 40 percent of all of our free cash flows to dividends.’”
Past and future
It wasn’t always this way, Gilmer said. In the past, investors were attracted to oil companies because of the prospect of long-term growth. While the companies provided shareholder returns, they also were expected to reinvest profits to grow the business.
The shale boom changed that model. As investors pumped billions of dollars into new drilling projects requiring more technology and equipment, companies focused on growth and quickly ramping up production. But the bonanza that investors and companies expected didn’t materialize.
The high costs of shale drilling — producers need oil at $65 a barrel to break even, according to Gilmer — limited profits. And when a global oil glut sent prices crashing from more than $100 a barrel in 2014 to less than $30 in early 2016, losses mounted. From 2015 through 2021, more than 600 energy companies, carrying more than $320 billion in debt, filed for bankruptcy, according to the Dallasbased law firm Haynes and Boone. Growth lost its luster. As prices stayed low through the rest of the decade, fewer investors were willing to send money to the oil patch. In 2014, the energy sector was valued at just over 10 percent of the S&P 500. By 2020, when the pandemic drove the second major oil bust in five years, energy accounted for less than 3 percent of the S&P’S value.
This recent history has all but forced oil companies to focus on shortterm profits and deliver them to shareholders as crude prices this year reached their highest levels in more than a decade. The strategy, however, is shaped by the future as well as the past.
Climate change and policies to address it have created uncertainty about the industry’s future and more hurdles for investors. With some projections estimating that oil demand could peak as soon as the end of the decade, investors have grown skeptical of the prospects for fossil fuels. Even with the recent surge in profits and stock values, energy still accounts for only 4.5 percent of the value of the S&P 500, less than half of the industry’s share in 2014 and a far cry from the 28 percent in the 1980s.
That leaves oil companies with little choice but to keep investors happy in the short term.
What this focus on short-term profits means for Houston is less growth, Gilmer said. Despite high oil prices, local employment in the upstream oil and gas industry has fallen by more than one-third since 2014, to 157,000 from 240,000.
The jobs aren’t returning because high oil prices no longer mean the industry drills more oil, Gilmer said. It’s not financing, environmental activists or government regulations stopping oil companies — it’s investor pressure. Investors would rather companies stick to production schedules and rake in the cash instead of increasing output, which could lower consumer costs and add jobs but also eats into investor payouts.
Drag on economy
As the industry follows this path, Gilmer said, it will become a drag on the local economy, which usually grows about 2 percent a year. Gilmer expects that over the next few years, growth will slow to about 1.6 percent because of changes in the energy sector.
At the same time, fossil fuel alternatives are becoming more affordable and attractive to investors, and the transition to cleaner energy may come faster than previously expected. In 2021, global investment in low-carbon technologies reached $755 billion, a nearly 27 percent increase from $595 billion in 2020 and nearly triple the $264 billion spent in 2011, according to Bloomberg data.
The International Energy Agency, an intergovernmental energy research organization, estimates that 13 percent of all new cars sold this year will be electric, up from 9 percent in 2021. The IEA reported that the share of renewables in global electricity generation reached 28.7 percent in 2021, up from 19.8 percent in 2010. Government policies such as the recently passed Inflation Reduction Act, which includes billions of dollars in incentives for clean energy, are helping speed the transition.
Todd Staples, president of the industry group Texas Oil & Gas Association, rejected analyst claims that the industry is focused on short-term gains at the expense of a sustainable long-term strategy. He called such assessments “misguided” and blamed political rhetoric about climate change and phasing out fossil fuels as hurtful to investment and growth in the industry.
Most publicly traded oil and gas companies have committed to lowering emissions and developing technology to aid the energy transition. Nearly every company, however, expects to increase oil and gas production in coming years. Last year, the industry invested around $10 billion in clean energy, according to the IEA, representing less than 4 percent of capital investments. IEA expects this to grow to 5 percent this year.
Hugh Daigle, associate professor in the petroleum and geosystems engineering department at the University of Texas at Austin, said some oil companies will try to branch into new forms of energy, and some will go all in on producing the oil and gas the world is expected to use even as economies shift to clean energy.
For example, European companies such as BP are moving into renewable technologies. U.S. public companies mostly prefer sticking with fossil fuels while investing in technologies such as carbon capture, which removes carbon dioxide from industrial emissions or the atmosphere. Private companies mostly remain focused on oil and gas production.
“It’s not a zero sum game, I don’t think one path is going to win out over the other,” Daigle said. “The industry is at an interesting point where there’s multiple paths forward — and the reason for that is because of the energy transition and the diversification of energy sources.”
Sanzillo of the Institute for Energy Economics and Financial Analysis is not as sanguine. He said the industry’s focus on short-term profits to the neglect of long-term investment reflects a sector that recognizes that its prospects are declining.
“Russia and the other countries and the oil companies know their days are numbered,” he said. “And the way you get money now is to squeeze every last nickel you can get out of the barrel of oil. That’s what’s going on here.”