Not long ago, we argued that oil companies would not invest in alternative energy or electric power because those opportunities were not big enough and the potential return was not great enough compared to what the oil market offered. And they didn’t. But we were looking at the wrong measure for profitability. And so were they. What counts is how an investment builds value for the owners of the business, not what shows on the books. We’ll get to that next.
We also argued that over the past two decades, the oil and gas industry’s managers produced a mediocre return for their shareholders, who would have done better putting the money elsewhere, on a risk adjusted basis. One Wall Streeter shot back, “What are you talking about? They didn’t make mediocre investments. They destroyed shareholder value. That’s why all the activist investors have been up in arms.” In other words, oil industry senior managers made investments that reduced the value of their companies in the marketplace.
The last ten years demonstrate the investment prowess of the oil managers (or lack thereof). In the first years of this century, oil managers could at least claim that the climate and technology trends were unclear. After all, their experts told them climate science was still in dispute. So maybe it was better to just keep doing what they always did, rather than change course based on such uncertainty. But by ten years ago the industry’s senior managers had the information and could consciously act on it or, if they chose, to ignore it. Despite the onslaught of scientific evidence and new government climate policies they decided to invest in oil and gas, not in renewables or electricity or the other alternative, just give the money back to investors via dividends or stock buybacks. Related: Investors Boost Bullish Bets On European Natural Gas Prices
Table 1 shows the annual returns earned by investors in the 10 years ended Aug. 10, 2023, as measured by four S&P stock averages. Price return measures the annual increase or decrease in stock price. Total return measures the annual increase or decrease in stock price plus dividends collected. Investors in the oil majors ended up with annual returns ten percentage points per year below that of the overall equity market. That should make the case. Hard to do worse than that.
So, to start with our first point. If the oil majors had shifted some investment to renewables or electricity, maybe their shareholders might have been better off, no matter what the corporate books showed. They might have made some winning investments.
The next point is more important. The numbers show that the oil major’s shareholders made all their money from the stock dividend. Every use of funds beyond paying the dividend reduced the market value of the firms. Shareholders (the owners of the companies), would have been better off if the oil majors just gave all their earnings to shareholders and let them invest the money somewhere else on their own.
Why? Maybe investors discounted the investments from fear that they could not be recovered due to long term risks. Maybe investors felt the return earned was not commensurate with risk, so they discounted the investment. We aren’t planning to psychoanalyze investors, just to point out that they rendered this verdict over a period of a decade and the senior managers of the oil majors chose to ignore it.
To some extent, the situation mirrors the poor market performance of electric utilities over a period in the 1970s when electric utility managers doggedly pursued the construction of mismanaged, ill-conceived and uneconomical nuclear projects whose seemingly endless construction delays occurred during a period of runaway inflation in the US further exacerbating their troubles. These managements were determined to do what they always did, and resisted advice (and dogged opposition) from environmentalists and other assorted “anti-business” types. Culture prevailed over economics, at an enormous cost to shareholders and consumers. Eventually, utility managers stopped building and concentrated on running the existing nuclear plants far more efficiently and safely than before, to everyone’s benefit and relief.
Forget the ideological and cultural issues, though. This is a purely business matter. The managers of the oil majors made a decade of egregiously bad business decisions, as measured by broad market indices, which reduced the value of their companies, that is, they destroyed shareholder value. From what we can tell, these managements seem intent on making the same under performing capital allocation decisions in the future, with a few modifications to soften the edges (do some carbon capture with government subsidies, for instance). It seems they are still locked into the old paradigm.
Investors have three choices with respect to the long term strategy of the oil majors:
- Stay the course. The oil majors have the correct strategy. Don’t expect any change. Invest in oil and gas and forget the other stuff.
- Try to change the strategy of the oil majors (activist investing) because of the potential for market revaluation of the shares once a new strategy becomes apparent.
- Put money into growth opportunities that will come about through decarbonization and preparation for climate change, and don’t waste effort and money trying to rescue an old industry approaching its eventual decline.
Obviously, as brokers always say, past results are not guarantees of future trends or results, but at least they inform us. So, at least consider the past when choosing the course.
By Leonard Hyman and Bill Tilles for Oilprice.com
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