By Martin Walker, Head of UK Equities, Invesco
Responsible oil and gas companies have a critical role to play in being part of the solution to environmental problems: in helping enable the global economy to successfully transition as rapidly as possible, and in a sustainable manner, towards targets for much reduced global emissions.
This can be achieved through actions taken by companies to successfully manage down a sustained decline in output of oil & gas, whilst at the same time maximising cash flows from operations for investment in new low carbon energy businesses.
Investing in oil companies that set out to achieve these objectives – and holding them accountable – is we believe entirely consistent with true responsible investing.
What role will oil companies have in the future?
“Big Oil” companies have long been vilified as exploitative businesses, driven to periods of excess, followed by near collapse, as a result of selfish actions that have literally fuelled global warming. A harsh view maybe – but one that has understandably had increasing resonance of late.
Whatever the moral burden that should fairly be borne by UK-listed companies, such as BP and Shell, for their historical actions what is important for investors to understand is how the Oil companies themselves now fit into the global industry. Investors want to know what the impact of Oil companies will be on that industry and on society, going forwards: what role they have to play in the future.
As much as the focus of some investors is on oil & gas producers, for the world to achieve net zero emissions in 2050 it ultimately requires reform of demand, and not just supply.
Supply in the industry (in the long run) very closely mirrors actual demand (the easiest place to store oil is still in the ground!). It is important here to also reflect that the global publicly quoted, US and European oil companies only account for around 12.3 mb/d out of total current production of approximately 100mb/d, with US privately owned production around a further 8mb/d.
Put another way, state owned oil production (including Saudi Aramco) accounts for almost 80% of global production.
The reality is that any cuts in production by any of the publicly quoted oil majors does not in itself affect global oil demand. Cuts to supply are supportive of short-term pricing, but demand is likely to simply be met elsewhere in the market – by “NOCs” – without any significant medium-term effect on global production.
BP turning the taps off tomorrow would have a negligible effect on global carbon emissions. The same emissions will still be made but fuelled by output from another supplier who is less accountable to investors.
Responsible oil companies do though have a very significant role to play in accelerating a sustainable transition to low carbon alternatives that can reduce demand for fossil fuels by providing a viable substitute product.
For example, BP and Royal Dutch Shell are both actively involved in promoting the transition through defined strategies that look to maximise cash flows from existing carbon resources, and then re-allocate cash flows to low carbon alternatives.
Because of the many and varied uses for oil as a fuel, as a key component in a wide range of everyday products, and the practical limitations associated with various alternatives currently available, the process of transition is likely to be gradual. It is clearly both necessary and highly likely that demand for oil will reduce over time, however we do not foresee at any time in the next ten years at least, a “Kodak moment” for oil.
Given the moral and business pressures on the oil industry not to invest and grow their hydrocarbon businesses, it is likely that normal market mechanisms will be disrupted and high prices will not be sufficient to stimulate supple, thereby adding to market tension, and extending an up-cycle (super-cycle?) in the oil price.
Strategic actions recently committed to by BP and Shell in respect of Carbon reduction are therefore being made into a stronger pricing environment than has been seen for almost two years. We see this as key to success – both from a pure financial perspective, but also from an environmental perspective as cash generated from hydrocarbons, as it winds down, will support the very substantial investment in transition.
BP expects to reduce its hydrocarbon production 40% by 2030 (source: Company Capital Markets Day, September 2020), at the same time it expects to continue to reduce its cost per barrel, enhancing the profitability and cash generation from this area. It is often over-looked that the company generates significant cashflow from downstream activities such as refining and convenience retail.
In addition to this, as we move into the next decade we are likely to see an upwards inflection in the cashflows from the company’s renewable investments where it plans to invest in 60GW of generating capacity, whilst also returning cash to shareholders through dividends and share buyback.
The role for responsible shareholders
An investor in BP or Shell who is willing to support, encourage and also hold the company to account during its transition period is, we believe, able to be well rewarded financially, through dividends and share buy backs, as well as by the prospect of owning a new “low carbon” and retail business whose growth has been fully funded from existing company resources.
Responsible oil & gas companies such as BP and Shell therefore have a critical role to play in being part of the solution: in helping enable the global economy to successfully transition as rapidly as possible, and in a sustainable manner.
This objective can be achieved through actions taken – with the support of shareholders – to successfully manage down a sustained decline in output, whilst at the same time maximising cash flows from operations for investment in new low carbon energy businesses. We believe, investing in oil companies that set out to achieve these objectives, and holding them accountable, is entirely consistent with our philosophy of responsible investing.