ESG Investors Should Support Big Oil

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If you are an ESG investor, you should invest in major oil and gas. I know it sounds counterintuitive, but hear me out.

A decade ago oil and gas companies were generally terrible investments, regardless of your stance on the environment. Corporate governance was terrible, capital allocation was careless, and little time was being spent thinking about what happens after oil. The environment certainly wasn’t something companies were thinking about and sustainability was still technically difficult – we didn’t have renewable electricity or a cost-effective way to produce electric electric vehicles.

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People who invested in energy hoping for big returns as they entered the shale revolution took a wild rollercoaster ride and eventually didn’t make a lot of money. Aggressive exploration and production led to surplus and high-priced deals. Avoiding energy companies was the right call back then, whether you did it for environmental reasons or not.

Today’s energy companies are vastly different in terms of how they operate, and how they think about renewable energy.

Demand for fossil fuels:

Today’s energy companies operate with a more realistic set of expectations about the future. They, like the general public, understand that renewable energy is the future. Partly as a response to environmental campaigns in the past decade, they are ultimately conscious and supportive of regime change. Energy company operators everywhere are on board with that approach. You may hear different times and estimates for the transition to renewable energy, but at the end of the day most new power generation projects are renewable, regardless of whether you live in Texas, China or California.

However, as renewable energy becomes more viable, we also need to be realistic about how to frame the transitional period. We still need fossil fuels. Some environmentalists may not like it, but it’s true – today’s oil and gas prices are a testament to just how weak some of those supplies are. We need natural gas to heat homes, keep lights on and charge electric car batteries. Gasoline is still essential for most cars on the road, jet fuel is how our planes stay in the air, and plastic is still essential in the equipment we use every day. We don’t have viable options on a large scale.

Given the need is very real – who better to do drilling and extraction than today’s big energy companies? We must support them, invest in them and help them flourish. Think about it — we’re talking about essential goods with potentially high profit margins. At oil prices close to $100 a barrel, someone is going to go out into the world and pump some oil. No matter how strongly you feel about the environment – ​​the reality is that someone is going to get pumped at such prices.

If you are a conservationist the real discussion should be about who do you prefer to run the oil operations? An under-funded private operation with no government oversight or accountability, a conglomerate that is cutting corners to try to squeeze out every last profit? Or would you prefer Axon or Chevron?
do it?

Big Oil has decades of experience in complex operational excellence. They are heavily scrutinized by government regulatory agencies. They have large balance sheets to pay for rehabilitation or clean-up in the rare case that they have an on-site accident. They are large institutions that you can hold accountable and have faced criticism from the general public and capital markets for their environmental stance over the past decade.

In short, if you have to pump oil, they are the type of group you want to do.

In addition, look for positive externalities if large US energy companies are filling the supply gap for fossil fuels. They are based in the US so profits are taxed and distributed here. They create jobs here. And besides, ESG groups have put pressure on big energy over the past decades, so now a lot of profits have been reinvested in research and development of alternative energy supplies.

In particular we will be calling on energy companies as potential leaders in carbon sequestration efforts. Energy companies have operational expertise in drilling, injecting and monitoring various geological formations. They have significant human capital gains and large equipment reserves – these give companies a natural advantage over other entrants in the space.

Similarly, energy companies that currently focus on the transportation and storage of fossil fuels are naturally suited to future technologies such as hydrogen. It is difficult to specialize in the refining, compression and transportation of complex substances. Refining and middle market transportation firms are in the sweet spot to leverage expertise and existing infrastructure, which have been remodeled for the renewable age.

Energy Market Dynamics:

Energy companies are also looking attractive from a more structural standpoint. Oil production globally has struggled to meet demand as many different factors affect investment and production. The Russian invasion of Ukraine is the obvious disruption – Russia provided a significant portion of European natural gas and oil. But the Russian aggression isn’t the only issue – if the war ends tomorrow and sanctions are lifted, the world will probably still face tight energy markets.

There are three primary factors leading to this more structural issue.

First, Russia is not the only country whose supplies have been disrupted by violence or corruption. Several other important energy producers have also struggled politically over the years and have seen their output decline. Venezuela and Libya are two prime examples, and Nigeria is seeing a sharp decline in its energy output, even as it continues to increase imports of refined products. Individually a country struggling with production is not as impressive, but over the years we have seen geopolitical tensions or mismanagement drive millions of barrels of production out of the market.

Second, and perhaps most important, we have seen broad-based underinvestment in energy over the past several years. Part of this is political synergies toward renewable energy, part of it driven by more ESG sensitive public markets, and part a decades-long shift in how energy companies deploy capital. Although the cumulative effect is significant; We haven’t seen a new refinery built in the United States in a very long time. Pipelines to transport oil and gas have faced significant construction constraints, despite being significantly safer than truck or train transport. Exploration and reserve expansion have also declined.

Third, the technology used to extract the oil has changed. The shift from conventional drilling to shale has significantly shortened the investment cycle. The production of shale wells is very high in the first 12 to 24 months. To maintain the same oil production, you need to continually drill new wells and reinvest capital. While this is good for individual oil companies – they can each be more cautious in how they invest and react to the markets and the position of their capital – it also makes the overall market supply more volatile as the less stable or base Loaded barrels are being produced.

Caveats and Investments:

Combine all the above factors and it paints a very attractive picture for the energy sector as a whole. It is a strategically needed sector with attractive structural supply and demand dynamics.

However, it is worth noting that energy space is exceptionally unstable and space can change rapidly. If we’re not already in one, the world is approaching a recession, and geopolitics may be moving fast. Structural support for a location may not be sufficient to overcome the cyclicity of the field. This means that if you’re looking to invest in the space, you probably want to stick to the big companies — Chevron, Exxon, and other oil companies. They have the strongest balance sheets, can weather a recession, and again, while focused on the environment, they have strong corporate governance and in-depth research budgets.

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