Fossil fuels companies were investors’ favorites in 2022. The major oil companies were able to consolidate profits of around $200 billion. Investors were remunerated generously in two ways: a) higher dividends, and b) share buybacks. A total of $ 110 billion were handed back to investors. In 2023 and 2024, the investor’s buyback are probable to be less frequent as Big Oil is going through some rough times. Recent earnings outlooks by some key players such as Royal Dutch (RDSa) and TotalEnergies SA (TTEF) evidenced much lower profit announcements.
While things are not different for US oil companies, the issues on hand are dealt with differently. Lacking future earnings expectations were overshadowed M&A activities. The recent purchases of Pioneer Natural Resources by Exxon and Hess by Chevron occurred most likely on the back of a lack of output capacities and new projects and management efforts to direct communication, at any price, into one direction. In fact, what happened to XOM and CVX is painstakingly difficult to admit: The industry is still recovering from the impact of the pandemic. Capital allocations are still too low to equalize the rate of reservoir depletion. On top of this, CVX and XOM have to deal with some unseen issues in the past: production is limited given the high level of wastewater pumped while the gas segment complains about the high level of carbon dioxide in natural gas production sites. It is unusual to hear such detailed field information from oil majors and we conclude that reservoir conditions must be terribly wicked.
That things can go right in the States is evidenced by Marathon Petroleum Corporation. MRO is one of the most sensible companies to volatile Brent prices benefited the most from the surge in oil prices and is also the fourth biggest gainer of the S&P 500 in the last three months.
Outlook for 2024: The global oil and gas industry is expected to spend about USD 545 billion, up by about 10%, which comes after a 33% increase for 2023. This additional top-up will allow the industry to maintain production levels to cover the expected bumper demand in 2024.
Longer-term outlook: In short it is about: Work harder to get less! The International Energy Agency (IEA) sees the fossil fuel demand to decline by about 25% by 2030. The agency also expects that another decline of 80 % will take place by 2050. The reduction will occur in two segments: a) in transportation and b) in heating. All other industry sectors will experience a higher level of demand given the constant increase of polymer products. In fact, the sector’s fall has long been in the making and its decline is rather constant. In 1980, the energy sector was about 30% of the S&P market cap, while today it is down to around 5%.
The Global Race Toward Net-Zero
The renewable energy sector faced recently some issues. There were multiple: a) inflationary pressures led to higher borrowing rates, b) a shift in capital allocation by investors which resulted in lower-than-expected investments, c) wind projects are much costlier than anticipated because of soaring costs and supply chain constraints, and e) technical and quality issues centered around infrastructure and equipment, i.e. rotor blades in more recent facilities. All these issues hampered profitability which in turn made the sector less attractive for new allocations. More importantly, the delays now experienced by the incidents at Siemens, Vestas, Equinor, Prysmian, Nexans, NKT, amongst others, put dozens of other projects at risk of not being delivered in time for countries to achieve the convergence towards net-zero targets. According to Bloomberg NEF data, global renewable energy investments were up 22% year-over-year in the first half of 2023 and reached $358 billion.
Given the geopolitical events in Europe, developed countries are transitioning toward renewable energy quicker than expected. In 2022, the US made some USD 140 billion worth of investments in the sector and renewable energy accounted for 43% of the country’s global energy mix. France has also recently announced the fast-tracking of its renewable energy capacity and plans to double it by 2035. Bloomberg Law reported that the country is targeting an additional 140 to 175 gigawatts of renewable capacity by that time.
Longer-term and according to a research report from IEA, renewable energy is forecasted to account for 90% of global electricity expansion over the next 5 years, and by 2025, it will surpass coal to become the largest source of electricity generation. Furthermore, IEA Executive Director, Fatih Birol, said that the number of renewables added to electricity systems in 2023 will break records.
What is our take on the story? Renewable energy is not as clean as one might expect as industrial recycling facilities for used batteries and photovoltaic panels are still lacking. Renewable energy is good in the fact that it redistributes the geopolitical powers. The Russian invasion of Ukraine occurred in anticipation that nothing will change on the downstream side for the country. In fact, the Russian government expected Europe to be tightly loyal to its purchases of cheap gas and oil from the Yamal and Novy Urengoy infrastructures it developed in collaboration with some European partners. Yet it was wrong.
Modern civilizations are, by definition, slow to react to dramatic change and more importantly to threats of individuals. After all, the system in place protects the individual person and not the State. For once, in response to the threat of being manipulated by one individual, policies and economic conditions were changed to secure future growth and well-being by means of solar and wind opportunities.
Investment conclusions:
While the shift from fossil to alternative energy offers undeniably investment opportunities, we believe that there are more valuable opportunities in the fossil energy sector and in the alternative energy sector. After all, the fossil energy sector relies on more than ten decades of ever-changing business conditions whereas the alternative energy sector is performing its first baby steps.
Obviously, one can perform multiple baby steps, fall, and restart to become an adult, or alternatively, you can track the experienced entrepreneur and benefit from a commodity that becomes scarce.