Big Oil’s Transition to Cleaner Energy Is Risky - Kanebridge News
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Big Oil’s Transition to Cleaner Energy Is Risky

How investors can prepare by building the oil company of the future.

By Leslie P. Norton
Fri, May 28, 2021 11:27amGrey Clock 10 min

Occidental Petroleum, one of America’s largest oil companies, plans to break ground next year on a new facility to pull carbon dioxide from the atmosphere and bury it—a novel solution to addressing global warming. Houston-based Oxy is already a leader in injecting CO2 extracted from gas and other natural sources into its oil reservoirs to improve pumping. It also plans to start piping in CO2 emitted by factories. But its new carbon-capture project in the Permian Basin is especially ambitious, aiming to pull one million tons of CO2 out of the air each year. Initially Oxy will use the gas in its own oil fields. Eventually, other companies will pay the oil producer to bury it in the ground to offset their own emissions.

“It’s going to be a huge industry,” says Vicki Hollub, Oxy’s CEO, who forecasts that carbon capture’s contribution to earnings and cash flow could approach that of the oil and gas business in 20 years. Four more Oxy carbon-capture plants will follow in the next few years. Occidental Petroleum (ticker: OXY) will receive tax credits for the carbon it extracts, and tax incentives will also encourage potential customers to use its carbon-capture service, much as they have encouraged customers to use solar power. “The incentives will spur investment in the space, and bridge the gap until the uneconomic asset becomes economic,” predicts Kyle Seipert, a consultant at Alvarez & Marsal who specializes in energy mergers and acquisitions.

One new investor in the project is United Airlines (UAL), and no wonder: Global aviation emits about a billion tons of CO2 annually. Eventually, Hollub sees Oxy morphing into “a carbon-management company, where we’re not only using the oil and gas business to generate value for shareholders, but also helping others achieve their goals.”

As Oxy’s example suggests, Big Oil is in transition. The world is moving to reduce its dependence on hydrocarbons amid growing anxiety about environmental damage. Yes, fossil fuels will remain a major driver of cash flows for the global energy industry for many years, even decades. But many companies will supplement their oil and gas businesses with substantial investments in renewable energy, carbon capture, and other technologies that help to speed the transition away from oil. The road ahead will be bumpy, with plenty of risks. Yet the transformation could also bring enormous opportunities for the companies involved, and their investors.

So far, the European and U.S. oil majors have followed different paths toward the future. BP (BP) and Royal Dutch Shell (RDS.A) have unveiled ambitious plans to reduce oil output and expand their renewable and low-carbon businesses, while curtailing emissions. Exxon Mobil (XOM) and Chevron (CVX), on the other hand, have announced plans to cut emissions but have been clear that they won’t get involved in large-scale solar or wind production, betting instead that the runway for oil remains long. The two U.S. giants reportedly discussed a megamerger last year to improve operating efficiencies during the industry’s pandemic-fueled downturn and to prepare for an uncertain future.

Says Daniel Yergin, the veteran oil analyst and vice chairman of IHS Markit: “You’re seeing the biggest difference in strategies among major oils that we’ve had in decades.”

Investors seem sceptical of the Europeans’ plans. The Stoxx Europe 600 Oil & Gas index is up more than 35% in the past 12 months and about 9% this year, trailing gains of 62% and 47%, respectively, in the S&P Oil & Gas Exploration & Production Select Industry index. The main thing that has mattered, it seems, is dividend preservation. While Exxon and Chevron maintained their payouts during the Covid pandemic, many other oil companies pruned theirs. BP halved its quarterly dividend to 5.25 cents a share last August, its first cut in 10 years, and Shell slashed its payout in April 2020 by 66%, its first reduction since World War II.

“They’ve lost their old audience and have yet to find a new one,” says Erik Mielke, global head of corporate research at Wood MacKenzie, a global energy consultancy.

Exxon sports a current yield of 5.9% and Chevron, 5.1%, while BP now yields 4.8% and Shell, 3.5%.

All four companies, and the rest of the oil patch, have been helped in the past year by a sharp rebound in crude. The price of oil sank last spring as the global economy retrenched, causing demand to crater; West Texas Intermediate, the U.S. benchmark crude, briefly turned negative as storage capacity dried up. Today, WTI fetches $62 a barrel, up about 30% on the year. The rally has restored energy companies to profitability after last year’s huge losses. Soon, demand could return to 2019 levels, and even higher prices could be in store.

Energy is the S&P 500’s best-performing sector this year, up 36%, well ahead of the No. 2-ranked financials’ 27% gain and the index’s rise around 10%. But focusing on near-term returns obscures the bigger picture: Energy stocks have been losing favor with investors for years. The SPDR S&P Oil & Gas Exploration & Production exchange-traded fund (XOP) is trading 65% below its level of 10 years ago, and energy stocks now represent just 2.7% of the S&P.

In comparison, shares of NextEra Energy (NEE), America’s largest generator of wind and solar power, are up sevenfold in the past decade, while electric-vehicle manufacturer Tesla (TSLA), the ultimate green play, has soared 17,000% since its 2010 IPO.

Mighty Exxon, meanwhile, was ejected last August from the Dow Jones Industrial Average after a tenure stretching back, via its predecessors, to 1928. The company will face a challenge at its annual meeting on May 26 from activist investment fund Engine No. 1 to refresh its board with directors more familiar with the carbon transition, such as the former CEO of Vestas Wind Systems (VWDRY), one of the world’s largest suppliers of wind turbines. Both Glass Lewis and ISS, prominent proxy advisors, have recommended voting for some of Engine No. 1’s nominees.

Investors’ concerns about Big Oil aren’t hard to understand. Governments, companies, and environmental activists around the world are pushing to slash greenhouse gas emissions, a byproduct of burning hydrocarbons. The Biden administration restored the U.S. to the Paris Agreement to limit global warming and has vowed to cut U.S. emissions to net zero by 2050. This month, the International Energy Agency said a halt to new oil and gas projects is necessary for the world to achieve the agreement’s goal of net-zero emissions by that year.

S&P Global put the debt of a swath of oil and gas producers on CreditWatch earlier in 2021, partly due to concerns about competition from renewable energy, reflecting its credit analysts’ view that hydrocarbon prices would be under pressure for many years.

Lenders are also moving to decarbonise their portfolios. J.P. Morgan, which has arranged more loans to, and bond sales for, Big Oil than any other U.S. bank, recently said it would align its lending with the Paris Agreement and push to decarbonize its lending portfolios by helping clients reduce emissions and pursue solutions such as business diversification. This coincides with actions from major investors such as Vanguard Group, State Street (STT), and BlackRock (BLK), all of which have pledged to support the goal of net-zero emissions by 2050 or sooner.

“Once banks understand that demand won’t grow to the sky, oil flips from an appreciating asset to a depreciating asset,” says Andrew Logan, senior director of oil and gas at Ceres, a shareholder advocacy organization.

 

So, what lies ahead for the industry, and investors? Dirty and unpopular though fossil fuels may be, they remain critical to the world’s energy transition, just as oil companies remain a part of many investment indexes. For those willing to bet on an energy transition, the European majors look particularly compelling, both because of their environmentally friendly initiatives and the sharp discounts their stocks fetch relative to their U.S. counterparts. The European majors trade for about 10 times next year’s expected earnings, versus 17.6 times for their American rivals. In the U.S., ConocoPhillips (COP) also looks like a winner, based on its focused spending and emphasis on returning capital to shareholders.

Among the European leaders, BP believes global oil demand could fall by 10% in the current decade. The company plans to cut its own oil and gas production by 40% by 2030, and to invest $5 billion in wind, solar, and biopower, using the cash flow from its legacy businesses to fuel its low-carbon endeavors. Royal Dutch Shell wants to bolster clean-energy trading, sell electricity to consumers, and build electric-vehicle charging stations as it aims to reach net-zero emissions by 2050. This month, Shell became the first oil major to put its climate strategy to an advisory vote. Nearly 89% of shareholders approved its plan.

J.P. Morgan analysts estimate that European oil companies will devote 15% of their capital spending to new energy over the current decade, up from around 5% two to three years ago. Yet investors have been wary, despite the recent shareholder vote. Since Shell announced its transition plan on Feb. 11, its shares have risen about 6%, while Chevron is up 15% in the same span. “Paradoxically, even though Shell and BP and Total [TOT] may be investing in renewables, which arguably have a less risky future, their ability to execute is more questionable,” says Allen Good, an analyst at Morningstar.

France’s Total maintained its dividend, at least, even as it committed to renewables. Total has been buying battery assets since 2016, and recently purchased solar-power and battery-storage assets in the U.S. It also launched a venture with European auto maker Groupe PSA to make automotive batteries. Its shares have risen 31% in the past year; they trade for 10.9 times 2022 estimated earnings and yield 6.34%. “[Total] has been very disciplined,” says Shawn Reynolds, manager of the Van Eck Global Resources fund.

J.P. Morgan analyst Christyan Malek thinks Total shares could rise to 51 euros ($62.15) from a recent €39.69 as the company uses its cash flow to produce lower-carbon gas and invest in renewable power. “Add a 7% yield, and you get a 37% return in 12 months,” says Malek.

While Total’s business is 55% petroleum and 45% natural gas today, it will look very different in 10 years. Total says its sales mix will be 30% petroleum, 15% electricity, primarily from green sources, 5% biofuels, and 50% natural gas. Total also is preparing to change its name to TotalEnergies. “We want to anchor the strategy,” CEO Patrick Pouyanné told Citigroup clients this past week. “Total has the financial capacity, technology capacity, and the will to become a strong player in the emerging transition.”

Legacy oil companies also have unique skills. One is running offshore drilling platforms, whose floating foundations can be used as sites for wind turbines. Norway’s Equinor (EQNR), formerly Statoil, is operating wind turbines offshore.

The company cut its dividend last year and now yields just 2.1%, but investors apparently forgave the move; the stock is up 41% over the past 12 months. “They’re doing the best job of balancing traditional fossil fuels and the decarbonized energy system,” says Van Eck’s Reynolds. “Over the next five years, there’s a pathway to a double” in the stock price.

Equinor invested in renewable energy earlier than its peers, and its investments are expected to yield profits sooner. Analysts see revenue rising 48%, to $67.8 billion, this year, while it is expected to earn $1.87 a share, versus a loss in 2020. Yet Equinor trades for just 11 times 2021 estimated earnings, compared with 18.9 times for Chevron. “When the returns begin from their energy-transition investments, they should easily justify Equinor’s trading in line with, if not at a premium to, peers,” Reynolds says.

As for the U.S. majors, Exxon and Chevron, too, have announced plans to cut emissions and unveiled additional steps to prepare for the industry’s transition. Exxon said last month that it would build a major project for carbon capture along the Houston Ship Channel that could be fully operational by 2040. Chevron is making venture investments in areas such as carbon capture, hydrogen, and nuclear fusion. Still, neither company plans to get involved in major solar- or wind-energy production, and neither has committed to a net-zero target.

Both posted steep losses in 2020: Exxon’s was $5.95 a share; Chevron’s, $2.96. Exxon also is heavily indebted, having borrowed as oil plunged last year. Long-term debt topped $47 billion at year end, up from $26.3 billion a year earlier. Exxon plans to cut capital spending by 11% to 25% this year amid an uncertain price environment. CEO Darren Woods said last year that oil and gas would still be 46% of the world’s energy mix in 2040, even under the Paris accord’s goal of limiting global warming to two degrees Celsius above pre-industrial levels. Wood reminded employees that it took roughly 100 years for oil to replace coal as the world’s dominant form of energy.

Chevron’s debt has also climbed—to $44.3 billion from $27 billion in 2019, after it borrowed to purchase Noble Energy last year. But neither the increase, nor the turmoil in the energy market, has threatened the dividend. Indeed, Chevron hiked its payout in the first quarter of 2021 by 4%, to an annualized $5.36 a share.

Given their continued reliance on oil, Exxon and Chevron both could face long-term pressure from Saudi and Russian suppliers, who can produce crude more cheaply. The companies could also find themselves under increasing duress from shareholders and activists demanding that they decarbonize.

After all, even the oil companies that have announced transition plans have been criticized for not doing enough. The Church of England Pension Board urged Shell this month to do more about emissions cuts, and warned that if Shell doesn’t meet its 2023 targets, the fund would divest its shares of the oil giant.

James West, an Evercore ISI analyst, sees wind and solar taking “considerable” share from coal, oil, and nuclear, with the solar market growing by 7.2% a year, and the wind market by 3.9% a year between now and 2050. He notes that renewable power, mostly wind and solar, is now the cheapest new power option for over 70% of global GDP.

Still, don’t count Exxon’s enormous resources out. Recently, the company brought activist Jeffrey Ubben, and the former CEO of Comcast, onto its board. A month later, Exxon unveiled a $100 billion plan to enter the carbon-capture business. Ubben, a proponent of ESG investing—or investing with an environmental, social, and corporate governance orientation—told CNBC: “I really believe that the return dynamics for Exxon from here are spectacular. They are part of the solution, not part of the problem.”

Says Renee Klimczak, a consultant with Alvarez & Marsal who focuses on improving energy-company operations: “Even if Exxon is late to the game, they have the resources [to transition] in a big way.”

But ConocoPhillips, which yields 3%, might be a better bet for now. It bought Concho Resources last year for $9.7 billion in stock. The company has a strong balance sheet and is committed to returning at least 30% of operating cash flow to shareholders. And it was the first big U.S. oil company to announce a net-zero plan. Safeguarding climate-conscious investors is director Jody Freeman, a nationally renowned scholar of environmental law and an expert on federal energy regulation and climate change in the Obama administration.

Occidental, for all its aspirations, remains distrusted by some investors after loading up on debt in 2019 to buy Anadarko Petroleum for $57 billion. CEO Hollub championed the deal over the objections of many shareholders. Oxy slashed its dividend by 86% last year and cut capital spending. Today, it yields a paltry 0.2%.

Oxy beat first-quarter earnings estimates, however, and has made progress on divestitures and debt repayment. It has reduced its cash-flow break-even to the mid-$30 level on oil prices from the high $30s, boosting its profit margins. The stock has zoomed higher, and John Freeman of Raymond James thinks it could be worth $40, versus a recent $26.

Big Oil’s transition to a low-carbon future won’t happen quickly, and the risks are daunting. “We look for management teams that understand the [carbon transition] issue and take it really seriously,” says Nick Stansbury, head of climate solutions at Legal & General Investment Management.

For investors attempting to navigate the changes ahead, that seems to be a good place to start.

 

Reprinted by permission of Barron’s. Copyright 2021 Dow Jones & Company. Inc. All Rights Reserved Worldwide. Original date of publication: 21, May 2021.



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These stocks are getting hit for a reason. Instead, focus on stocks that show ‘relative strength.’ Here’s how.

By KEN SHREVE
Wed, Jun 12, 2024 4 min

A lot of investors get stock-picking wrong before they even get started: Instead of targeting the top-performing stocks in the market, they focus on the laggards—widely known companies that look as if they are on sale after a period of stock-price weakness.

But these weak performers usually are going down for good reasons, such as for deteriorating sales and earnings, market-share losses or mutual-fund managers who are unwinding positions.

Decades of Investor’s Business Daily research shows these aren’t the stocks that tend to become stock-market leaders. The stocks that reward investors with handsome gains for months or years are more often  already  the strongest price performers, usually because of outstanding earnings and sales growth and increasing fund ownership.

Of course, many investors already chase performance and pour money into winning stocks. So how can a discerning investor find the winning stocks that have more room to run?

Enter “relative strength”—the notion that strength begets more strength. Relative strength measures stocks’ recent performance relative to the overall market. Investing in stocks with high relative strength means going with the winners, rather than picking stocks in hopes of a rebound. Why bet on a last-place team when you can wager on the leader?

One of the easiest ways to identify the strongest price performers is with IBD’s Relative Strength Rating. Ranked on a scale of 1-99, a stock with an RS rating of 99 has outperformed 99% of all stocks based on 12-month price performance.

How to use the metric

To capitalise on relative strength, an investor’s search should be focused on stocks with RS ratings of at least 80.

But beware: While the goal is to buy stocks that are performing better than the overall market, stocks with the highest RS ratings aren’t  always  the best to buy. No doubt, some stocks extend rallies for years. But others will be too far into their price run-up and ready to start a longer-term price decline.

Thus, there is a limit to chasing performance. To avoid this pitfall, investors should focus on stocks that have strong relative strength but have seen a moderate price decline and are just coming out of weeks or months of trading within a limited range. This range will vary by stock, but IBD research shows that most good trading patterns can show declines of up to one-third.

Here, a relative strength line on a chart may be helpful for confirming an RS rating’s buy signal. Offered on some stock-charting tools, including IBD’s, the line is a way to visualise relative strength by comparing a stock’s price performance relative to the movement of the S&P 500 or other benchmark.

When the line is sloping upward, it means the stock is outperforming the benchmark. When it is sloping downward, the stock is lagging behind the benchmark. One reason the RS line is helpful is that the line can rise even when a stock price is falling, meaning its value is falling at a slower pace than the benchmark.

A case study

The value of relative strength could be seen in Google parent Alphabet in January 2020, when its RS rating was 89 before it started a 10-month run when the stock rose 64%. Meta Platforms ’ RS rating was 96 before the Facebook parent hit new highs in March 2023 and ran up 65% in four months. Abercrombie & Fitch , one of 2023’s best-performing stocks, had a 94 rating before it soared 342% in nine months starting in June 2023.

Those stocks weren’t flukes. In a study of the biggest stock-market winners from the early 1950s through 2008, the average RS rating of the best performers before they began their major price runs was 87.

To see relative strength in action, consider Nvidia . The chip stock was an established leader, having shot up 365% from its October 2022 low to its high of $504.48 in late August 2023.

But then it spent the next four months rangebound—giving up some ground, then gaining some back. Through this period, shares held between $392.30 and the August peak, declining no more than 22% from top to bottom.

On Jan. 8, Nvidia broke out of its trading range to new highs. The previous session, Nvidia’s RS rating was 97. And that week, the stock’s relative strength line hit new highs. The catalyst: Investors cheered the company’s update on its latest advancements in artificial intelligence.

Nvidia then rose 16% on Feb. 22 after the company said earnings for the January-ended quarter soared 486% year over year to $5.16 a share. Revenue more than tripled to $22.1 billion. It also significantly raised its earnings and revenue guidance for the quarter that was to end in April. In all, Nvidia climbed 89% from Jan. 5 to its March 7 close.

And the stock has continued to run up, surging past $1,000 a share in late May after the company exceeded that guidance for the April-ended quarter and delivered record revenue of $26 billion and record net profit of $14.88 billion.

Ken Shreve  is a senior markets writer at Investor’s Business Daily. Follow him on X  @IBD_KShreve  for more stock-market analysis and insights, or contact him at  ken.shreve@investors.com .