Oil Investors are not only eyeing Big Profits Only
The current situation on the oil and gas markets force investors to rethink their strategies.
For years, the oil industry attracted investors with substantial - and regular - returns. Even as oil prices fell, Big Oil found ways to keep paying dividends even if it had to cut them, which only happened in extreme cases. Now it's becoming increasingly clear that dividends - and profits - are no longer king. Today's investors want different things from their oil investments. To be perfectly fair, returns are still important. They just aren't the only reason for an investor to buy into or stick with an oil company.
The sustainability of an oil company is also receiving increasing attention. But more on that later. Even if returns were investors' only priority today, they would be dissatisfied. In 2006, the average return on capital employed in upstream operations among major oil companies was more than 27 percent, according to a recent study by the Boston Consulting Group. In 2019, this average was no more than 3.5 percent. That was before the pandemic drove oil prices up and forced spending cuts. The study showed that the oil industry's earnings had become much less resilient to price movements, as the study showed. The difference is too great to be dismissed as random.
Indeed, the study's authors note that one significant change in the industry between 2006 and 2019 was a shift in companies' upstream asset portfolios. Until about 2006, according to BCG in its report, up to 80 percent of Big Oil's portfolio consisted of conventional oil and gas assets. Since then, they have flowed into things like deep sea and shale. And while investors have been hearing production costs drop in both deep sea and shale for years, this has not been the case with all deep sea fields or all shale rocks. Unconventional exploration and production in the deep sea are still much more expensive overall than shallow water and conventional oil wells.
In the case of the deep sea, this is due to purely physical challenges such as, as the name suggests, depth. With slate, it's because of the capital intensity of fracking. One focus was placed on the fast turnaround time of fracking wells: They require considerably less time than conventional wells to generate income from the investments made. But unlike conventional boreholes, they have a much shorter lifespan. In short, the promise of unconventional oil and deep-sea oil has fallen far short of what was promised when measured by investment returns. Oil investors have been dissatisfied with Big Oil for some time now, since the trend towards ecological, sustainable and social governance accelerated. More and more people looking for a company to buy their way into now want to know that this company's business is environmentally sound.
It's not just for altruistic reasons. Investors are told that climate change is an existential threat to many companies, and the more environmentally responsible a company is, the greater its chances of survival. Obviously, oil companies are in a delicate position, to say the least, when it comes to environmental stewardship. But the situation is not as delicate as many might imagine. The global demand for energy is growing, and despite the pandemic, it will continue to grow for the observable future. And that means that oil and gas are still needed. "On the one hand, the energy transition is real and will be in the future," Bob Maguire, CEO of the Carlyle Group, told the Energy Intelligence Forum, as quoted by Argus Media.
"On the other hand, there are 280 million cars on the US roads today, 279 million of which run on oil, and the average life of a vehicle is 12 years. Oil and gas will continue to be needed, but they would have to be produced differently to meet the changing sentiment of investors towards the industry. According to a study by the Boston Capital Group, 65 percent of oil investors want companies to prioritize ESG factors over profits, even if it negatively impacts those profits. As many as 83 percent say Big Oil should invest in low-carbon alternatives to their core business. An even larger majority of 86 percent believe that investments by oil companies in clean energy technologies would make them more attractive to investors. That should give a pretty clear picture of where big oil needs to go.