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Investing in big oil

Going ‘Beyond Petroleum’

Duncan_Macinnes
Duncan MacInnes
Investment Director

This month’s chart shows the energy sector has fallen from 16% of the S&P 500 just 13 years ago, to below 3% as of today. If you looked back to the early 1980s you would have seen it was more than 20%. 

If you add up all of the listed oil majors (BP, Royal Dutch Shell, ExxonMobil, Chevron etc) you get a market cap less than 40% of Apple’s $2.5tn.1 It looks decidedly like a one way track, reflecting an irreversible change to investor sentiment, indicative of a future no longer powered by fossil fuels.

And yet the integrated oil majors make up more than 6% of Ruffer portfolios. We often receive questions from clients about the rationale and justification for these investments.

Top down, the energy sector is attractive as a play on higher economic growth and as an inflation hedge. But there is a compelling story of industry evolution too.

This industry has been under pressure to limit capital expenditure into new oil production over the last five years. This has had the effect of tightening supply.

However, global oil demand is growing and forecast to grow for at least another five years. The world consumes 100 million barrels of oil per day.2 As emerging market countries become wealthier, their demand for energy intensive things like cars, international travel and air conditioning is rising.

Tight supply and rising demand are a recipe for rising prices. As the Greek shipping adage goes, “98 ships and 101 cargoes, boom. 98 cargoes and 101 ships, bust.”

However, asset managers don’t want to be seen to own these stocks as the inevitability of the green transition, and the awkward questions from clients, has left them uninvestable for many.

An example from 2000: BP Amoco was derided for their premature rebrand to ‘Beyond Petroleum’, but today it is starting to ring true. Across the industry, there is a metamorphosis happening in plain sight, but nobody wants to see it. That is the opportunity.

In broad brush terms, at current prices, BP is an $92bn company with an additional $38bn of debt. At $75 per barrel of oil, BP produces at least $15bn in free cash flow, which is being returned to shareholders via a 5% dividend yield, a further 6% buyback plus paying down debt. A 16% return is interesting – you get your money back in less than six years.3

But what if I told you this was after spending $4-5bn a year on investing in renewables? If BP continue to invest at this rate, in five years, they will have invested a capital base of more than $20bn of renewable energy assets. They may be one of the biggest renewables companies in the world – will the equity still be uninvestable?

Returns on renewable projects are currently lower than oil and gas assets, but given their sustainability and their long lives, they are valued highly by the market. They are also utility-like in their predictability and the counterparty is, in effect, sovereign governments who underwrite the electricity price to de-risk the investments. By 2030, BP aims to generate 50 gigawatts (GW) of renewable power.4 In today’s market, that alone could be worth more than $100bn.

The reality is we live in a world that still needs oil and gas, even as we tackle climate change – just look at the extraordinary surge in gas prices in the news this week. There are supercharged gains to be made by engaging with companies and holding their hand on the journey from pariah to good citizen. The most money is made when things go from terrible to just about ok.

When Mr Market begins to appreciate oil majors are uniquely placed to be a deep-pocketed part of the solution, we expect a reappraisal of the value of the equity. The market values BP and peers like they won’t exist in the not-too-distant future. By 2025, we should have proof they will be with us long Beyond Petroleum.

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  1. Bloomberg
  2. International Energy Agency
  3. Ruffer estimates, Bloomberg
  4. bp.com

Chart source: Factset

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London
80 Victoria Street
London SW1E 5JL
Edinburgh
31 Charlotte Square
Edinburgh EH2 4ET
Paris
103 boulevard Haussmann
75008 Paris, France