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Are Oil Stocks ‘Too Toxic To Trade’

Tsvetana Paraskova

Amid growing concerns about climate change, activists, shareholders, and many investors have started to see oil companies as the next ‘Big Tobacco’ set of toxic stocks because of Big Oil’s continued investment into fossil fuel-derived energy.

Despite climate activists’ demands that oil firms ‘leave it in the ground’, Big Oil are not getting out of their core oil and gas business, nor they are planning to do so, because the world will continue to need oil and gas in the foreseeable future, Shell’s chief executive Ben van Beurden says.

Yet, oil companies could take some steps to alleviate investor and shareholder pressure to start acknowledging climate change risks and set emission reduction targets, by learning from the experience of another demonized sector—Big Tobacco--according to RBC analyst Biraj Borkhataria.  

Although Big Oil and Big Tobacco are different enough, oil firms can take a leaf or two out of the tobacco industry’s playbook, Borkhataria said in a research note quoted by Avi Salzman of Barron’s.

These are: increasing capital expenditure in renewable energy and other alternatives to fossil fuels, and putting more cash into shareholder returns in the form of buybacks and dividends, instead of simply plowing more money into enormous projects with years-long time lag between investment and first oil production.

Among Big Tobacco, Philip Morris International said a few years ago that it is building the company’s “future on smoke-free products that are a much better choice than cigarette smoking.”

Since then, Philip Morris has had equally bleak earnings like those of its competitors Imperial Brands and British American Tobacco, but it has outperformed its rivals on the stock market as investors have appreciated the strategy shift to alternatives, Barron’s’ Salzman says.

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Now the next great ‘sin stock’ sector—Big Oil—faces challenges in convincing investors and society that it could still be part of the solution, not the problem, in a world which is increasingly sensitive to the impact of climate change on the planet and people.

At the same time, oil firms need to keep shareholder returns high in order to attract investors who are brave enough to continue to be or become shareholders in an industry which has been criticized and demonized as a major contributor to carbon emissions.

No major oil corporation is giving up their core business just yet. And according to RBC’s Borkhataria—they shouldn’t. What Big Oil needs is to invest more in shorter-cycle projects rather than in large deepwater projects where first oil is years away from first discovery and drilling, according to the analyst.

But Big Oil continues to prioritize deepwater development in their various core regions, because, as oil firms say, the world will continue to need energy from oil and gas in the foreseeable future. Conventional oil with good economics pumping oil for years and decades would meet more of the future demand than short-cycle shale, where well productivity declines dramatically in just a few years.

Big Oil will also continue to see oil and gas as their core business because returns on investment and profit margins in the alternative energies business are still being tested and currently, they are nowhere near the high margins in fossil fuels.

Some oil firms, like Shell for example, are taking steps to invest more in what it called ‘emerging power’ in its management day presentation in 2019. Shell looks to invest US$2-3 billion per year from 2021 to 2025 in the power business, which would be just 10 percent of its total annual capex in the coming years.

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“As we develop these lower-carbon products, we are seeing the pull from our customers, and, increasingly, a commitment from regulators. This is the perfect combination to develop a growing, profitable low-carbon business, and we are determined to be a leader in that process,” Maarten Wetselaar, Shell’s Integrated Gas & New Energies Director, said on management day.

Together with more potential for distributions to shareholders, Shell’s plan through 2025 includes “the ambition to stay on the right side of history,” CEO van Beurden said at the same event.

Shell is not worried that it will become irrelevant in the energy transition, not only because of its ambition to invest more in power and pledges to cut carbon emissions, but also because of the handsome returns to shareholders it can offer.

“If you are able to return $25bn to the owners of the company every year . . . you’re not going to disappear,” van Beurden told Financial Times’ Senior Energy Correspondent Anjli Raval in September 2019.

Now Shell and all of Big Oil have to convince investors that their core business will continue to be relevant a decade from now.  

By Tsvetana Paraskova for Oilprice.com

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