The Oil Majors in a Time of Transition: Stratagems and Spoils

“The man that hath no music in himself,

Nor is not mov’d with concord of sweet sounds,

Is fit for treasons, stratagems, and spoils.”

The Merchant of Venice (1605), Act V Scene 1, by William Shakespeare (1564-1616).

Profitable But Unpopular

The oil majors know that their core products – oil and natural gas – are the primary causes of global warming, and that, therefore, they are likely to be phased out altogether sometime between now and the end of this century. So, in one sense, they are like the fraternity of blacksmiths in the 1890s who foresaw that, with the rise of motorised transport, demand for horseshoes would dwindle over time to (almost) nothing.

But they also know that, for now, the global economy has a ravenous demand for their products and is prepared to pay through the nose for them. And they are more than willing to provide the product at market prices, thus resulting of late, given current market conditions, in supernormal (or obscene, depending on your point of view) profits.

Centrica reported 2022 operating profits of £3.3bn last week – up from £948m in 2021. BP made £27.7bn last year and Shell $39.9bn (£33bn). In fact, last year the six largest western oil companies made more money than ever before: over $200bn collectively, and mostly just from pumping ‘black gold’ out of the ground.

But at least blacksmiths, back in the day, were generally regarded as a bunch of decent fellows – indeed pillars of the community, if not accorded the social status of ‘the professions’. Now, the oil majors are not just doomed but almost universally reviled, especially by the young, as the malevolent agents of climate catastrophe. Their standing in public opinion is even worse than those repugnant tobacco companies (some of which, unbelievably, continue to exist).

Psychologically, this is a not a comfortable space to inhabit, so perhaps we should keep an open mind about the likes of BP’s chief executive Bernard Looney and Centrica’s Chris O’Shea. But it is appropriate for investors to consider how they evaluate a business sector which is (a) massively cash generative, (b) doomed and (c) despised. Further, it is necessary to analyse the corporate strategy of businesses that will not exist 80 years hence. Or will they? Sure, they are all pitching themselves as diversified energy companies these days with photos of windmills on the covers of their annual reports. But seasoned analysts know that diversification strategies often fail.

Much of the not-for-profit world has decided that we should send the oil sector to Coventry. Thus, the Royal Opera House, long a recipient of BP’s largesse, has told that London-based oil major that not only does it not want its money, but that it doesn’t want to be associated with it − even though BP has been using its profits from hydrocarbons to invest in renewables and hydrogen for over a decade.

The UK government, desperate for cash, has decided that energy companies are easy targets for rich pickings − hence the windfall taxes on their profits. And more could be on the way. Labour, according to Shadow Chancellor Rachel Reeves MP, would evidently squeeze the energy majors even harder. Energy companies already pay 40 percent corporation tax plus the additional 25 percent imposed by Rishi Sunak when he was still chancellor. This has since been raised to 35 percent by Jeremy Hunt. Any additional such taxes will gravely disincentivise new investment in offshore drilling capacity in the North Sea. If that is want Labour actively wants, they should say so.

But while it is true that domestic energy prices – along with food prices – have been the main drivers of the national cost-of-living crisis (and not just in this country), it would be foolish to blame producers of hydrocarbons for energy prices. The price of their outputs is set on the international wholesale markets. During the coronavirus pandemic those prices plummeted: they have had to take the rough with the smooth. And when they make profits, they pay handsome benefits to retail and institutional investors, hence they are must-have holdings for pension funds.

Green Shoots

BP is planning to build massive solar and wind arrays in Mauritania in the north African Maghreb and in Oman. Some of the power generated will be used to electrolyse water and thus to produce hydrogen. Hydrogen can be converted into ammonia by combining it with nitrogen. This could then be transported as a liquid in tankers to Europe and beyond. This kind of infrastructure investment will require big financial backing and trusted engineering and technical skills.

It is true that BP – and other oil majors – have signalled a decision to decelerate their exit from fossil fuels in recent months. If they go completely green too early they know that that would actually hamper the transition from fossil fuels to renewables and nuclear energy. How does one manufacture blades for wind turbines without energy partially generated from fossil fuels? The Just Stop Oil people don’t seem to have grasped this.

At least BP is self-aware. Its 2023 Energy Outlook report reckons that peak oil production occurred in 2019 and that it will be downhill from hereon in. It’s an approach that is more transparent than that of ExxonMobil, let alone Russia’s Rosneft. The Royal Opera House and others should reflect on what they wish for. If BP were rendered inactive, the slack would often be taken up by producers around the world who have neither windmills on the covers of their annual reports nor senior ESG (environmental, social and governance) officers on six-figure salaries. And we would become much more dependent on the kindness of strangers, some of whom, apparently, don’t like us.

In a world where energy companies in liberal democracies are forced out of business by climate extremists, we would become dependent on bad actors. Saudi Arabia would resume its status as the arbiter of the global oil price. One thing we have learnt since Russia’s invasion of Ukraine is that we cannot be beholden for our energy needs on states which do not wish us well.

Thus, after years of maligning oil companies, last year leaders from Berlin to Washington called upon the oil majors to boost output, to secure the shortfall of supplies resulting from sanctions against Russia. Those companies that were best able to increase production were most handsomely rewarded by investors.

ExxonMobil, which has resisted the decarbonisation agenda most vehemently, increased production – and its shares rallied by over 50 percent in 2022. It declared profits of $55.7bn (£45bn) for last year.

BP two weeks ago signalled that it would slow down the pace of reducing oil and gas output – and its share price rallied by 10 percent, reaching its highest level for three years. BP’s share price hitherto had been dampened by Looney’s plans to reduce oil and gas production by 40 percent and to build 50 GW of renewable capacity by 2030. Now, the target to reduce oil and gas production is 25 percent by 2030, as compared with 2019 levels. At the same time BP will invest £8bn in “transition businesses” by 2030 – that is, biofuels, EV charging stations, renewables and hydrogen. Three years into his tenure as chief executive, Looney has decided that he wants to maximise profits rather than virtue.

Shell made record profits but left its capital-spending plans unchanged. It spent $3.5bn on renewable projects last year – just 14 percent of total capex. It will spend about the same in 2023.

Shale-gas producers like Chevron were amongst the best performers on the S&P 500 last year. The company declared profits of $35.5bn for 2022 and is planning to hand back an extraordinary $75bn to shareholders in share buybacks. Yet it will spend just $2bn on renewables this year out of a total capex budget of $14bn. The fact is that, for the oil majors, investment in renewables just does not generate the same return on capital for now as the expansion of existing fossil-fuel wells.

The Oil Majors and the Hydrogen Economy

Currently, about three quarters of UK homes are heated by gas boilers. These will over time be replaced by heat exchangers (whether air source or ground source) and, feasibly, by hydrogen boilers. The National Grid is making planes to pump hydrogen through the gas-pipe network by 2025. But the transition to a hydrogen-powered economy is threatened in the UK by the rise of protectionism and the pursuit of energy security in both the US and the EU.

President Biden’s Inflation Reduction Act (IRA) specifically targets green energy and the creation of ‘green’ jobs. It does not impose tariffs, instead offering a budgeted $369bn of subsidies for new infrastructure and capital investment in renewable energy – but only if all the money is spent in the US.

Ford is cutting 1,300 British jobs in order to focus on EV production in the US. The fear is that energy companies will do likewise. The EU also has launched its own €806.9bn Next Generation EU plan which aims to create a greener, more digital and resilient Europe.

Two weeks ago, I warned here that the UK may have missed the boat on the mass production of EVs, given the failure to develop battery gigafactories. We currently have just one. Just as concerning is that the UK is falling behind in the development of a flourishing hydrogen economy. The Energy Security Bill which might foster investment in the hydrogen sector is still wending its way through parliament, and will hopefully address this.

To generate one kilogram of green hydrogen – ie electrolysing water with electricity generated by renewables – costs about $5-6 according to Longspur Capital. Extracting hydrogen from methane would be cheaper – but that would require carbon-capture technology which is still untested. Biden’s IRA, which, as I said two weeks ago, doesn’t have much to do with inflation, offers a subsidy of up to $3 per kilo for hydrogen production.

Johnson Matthey is a British company which produces membranes for electrolysers which break down water into hydrogen and oxygen. It also makes catalysts for steam reformers which extract hydrogen from methane. It would make sense for Johnson Matthey to team up with the likes of BP.

They Knew All Along…

An academic paper published last month suggests that the activists were right. Exxon’s scientists had predicted that burning fossil fuel would have a greenhouse effect which would cause global warming. They knew as much as university academics and government scientists did in the 1980s. And yet they continued to extract hydrocarbons and suppressed the science.

Nathaniel Rich, in his book Losing Earth: The Decade We Could Have Stopped Climate Change, argues that we could have “solved” climate change in the 1980s if this scientific knowledge had been publicly available. Instead, climate denialism set in. In fact, the correlation between the concentration of CO2 in the atmosphere and global ambient temperatures goes back to the work of the Swedish scientist, Svante Arrhenius (1859-1927).

There are numerous class actions underway in the US which point the finger of culpability at the US oil majors and demand reparations (that word again!) for “climate damages”. The attorney general for the state of Massachusetts has alleged that Exxon possessed “long-standing internal scientific knowledge of the causes and consequences of climate change” and thereafter engaged in “public deception”.

Exxon set up its own internal carbon-dioxide research division in the late 1970s. James Hansen of the NASA Goddard Institute for Space Studies testified before Congress that global warming was in progress as early as 1988. And yet the US – along with the UK, Japan and the Soviet Union − refused to sign a commitment to freeze CO2 emissions at the November 1989 Noordwijk Climate Conference of 68 countries.

The historical insouciance of the oil sector now haunts it like a phantom. There will be consequences.

Is There Such a Thing as Ethical Investment in Hydrocarbons?

If investors are concerned about climate change and the environment they should focus on the good guys within the oil sector such as BP, Shell, Equinor, Total, Enel and Repsol who are consciously managing the transition The bad guys are too numerous to mention.

When Theresa May committed the UK to a net-zero carbon economy by 2050 in May 2019 – one of her last acts as prime minister – the assumption was that we would continue to live in a peaceful, cooperative global order in which trade in energy would continue unimpeded. The UK, it was asserted, as a power that industrialised early, should set an example. BP for one bought into the narrative that the ethical strategy was to run down its core product. Now, energy security is paramount, and the real cost of renewable energy – as I discussed here two months ago – is much better understood.

The energy paradox − which eco-fundamentalists just don’t get – is that without a sure supply of reasonably priced hydrocarbons for at least three more decades, the transition to the ultra-low-carbon economy (zero carbon is a chimera) will not happen. And then there is the conversation about climate-change mitigation and geoengineering which I would like to explore here soon.

It’s a funny old world – as the uber-realist Margaret Thatcher once said.

Afterword: one year of war in Ukraine

At last year’s Master Investor Show, Jim Mellon told a packed house that there was only one thing certain about Russia’s war on Ukraine: that no one knew how it would pan out. We are now one year into the most dangerous security situation since the second world war – the first major interstate war in Europe since the defeat of Hitler – and it is still unclear how the carnage will end. According to some estimates, a quarter of a million people have been killed so far and many more wounded.

Three things stand out that we can all agree on, in my opinion.

First, the Ukrainian nation, under the leadership of Volodymyr Zelensky has resisted Vladimir Putin’s aggression with extraordinary courage, resilience and determination – this in itself evidences the absurdity of Putin’s claim that Ukraine is a “fake nation”. Second, the Russian war machine has failed in almost all of its objectives and is not the mighty force many of us had supposed. Russian military tactics, leadership, weaponry and soldiership have been second rate. That does not mean that Putin does not possess the means to grind Ukraine down slowly – but the expected Blitzkrieg never happened. Third, Western solidarity has held up – contrary to the expectations of the pessimists. I liked Biden’s words in his Warsaw speech on Tuesday (21 February): “Putin expected the Finlandization of NATO; instead, he got the NATO-isation of Finland”.

Biden is having an unexpectedly good war, and his visit to Kyiv on Monday (20 February) was a display of Western resolve and personal courage. Men of his age do not normally venture into war zones. His steadfast position that Russia must not be allowed to win stands in contrast to the stance of many influential Republicans – including Governor DeSantis, who could be the next Republican candidate for the presidency.

For all that, Russia could still win. Though what winning might look like is still unclear. Any peace on Russia’s terms will be claimed as a win by the Kremlin. Russia expert and former White House advisor Fiona Hill (no relation) wrote this week that “Absolute victory over Russia isn’t possible”.

We don’t really know what the Russian people at large really think about it all. I haven’t spoken to any of my Russian friends for a year now – though one sent me pleasant Christmas wishes on WhatsApp, which I reciprocated. But rumours that there are plots afoot against Putin and/or that the Russian president is terminally ill are, in my judgement, wishful thinking.

Moreover, we can now see that the West made some egregious mistakes which emboldened Putin to resort to war. First, NATO’s response to Putin’s land grab in Crimea in 2014 was pusillanimous. He got away with it – and his popularity increased at home. Second, the Minsk Agreements, brokered by France and Germany (hapless Hollande and myopic Merkel), allowed Putin to destabilise the Donbass. Third, Biden’s catastrophic decision to withdraw from Afghanistan in August 2021 signalled that the US and its lieutenants were in retreat, as I observed at the time. Fourth, NATO never even planned for a war in which Ukraine would effectively resist. Notoriously, Zelensky was offered a passage to exile. Famously, he replied: “I need ammunition, not a ride”. Fifth, the supply of armaments to Ukraine by Western powers, while game-changing, has been beset by the dragging of feet.

What is clear is that we are in a new age of geopolitical disequilibrium. Even a peace deal would not restore the status quo ante bellum. But then I have been banging on about rising geopolitical risk and its consequences here for years.

Listed companies cited in this article which merit analysis:

• BP (LON:BP)
• Shell (LON:RDS)
• Centrica (LON:CAN)
• Exxon Mobil Corp. (NYSE:XOM)
• Chevron (NYSE:CVX)
• Johnson Matthey (LON:JMAT)
• Equinor (OL:EQNR)
• Total SA (LON:TTE) (various listings)
• ENEL (BIT:ENEL)
• Repsol (BME:REP)

Victor will be appearing the Master Investor Show on the 15^th of April. Get your free tickets here.