Major investors like Warren Buffett and Goldman Sachs are increasing their positions in oil stocks. Buffett recently bought large positions in Chevron and Occidental Petroleum. For Goldman, Exxon is the favourite. The price of oil this year peaked at $123.70 a barrel on 8 March and has since fallen to around $100 a barrel. Historically, these are not low prices, but apparently there is more in the barrel.
The reason why the oil price has fallen since March of this year is mainly to do with the development on the demand side. For the time being, the supply of oil can hardly increase. The halving of the oil price after the invasion of Crimea has meant that there has not been enough investment in recent years, restricting supply.
Furthermore, do not underestimate the impact of central bankers’ classification of oil as a possible risky stranded asset. Commercial bankers no longer want to finance. Action groups picket headquarters and keep job applicants at bay. Investors dump the shares, putting the valuation under pressure. Even the help of the judiciary was called in to make sure that oil companies no longer invest in fossil fuels.
Lack of investment, for years
It resulted in a complete lack of investment for years. Even now investments lag behind. And then to think that investments only have an effect on supply many years later. Oil companies now choose the shareholders and the cash flow generated is used to buy back shares en masse.
Moreover, we are in danger of losing another part of the supply now that the West no longer is prepared to accept oil from Russia. This is not as simple as it seems, because many refineries in Europe run on Russian heavy oil. Switching to other types of oil is not easy.
Also, the chance of a deal with Iran seems to be getting smaller every day. That would easily cost a million barrels a day. Stocks are still being reduced. Drawing on strategic stocks is therefore only a drop in the ocean.
The fact that the oil price is not rising any further at a rapid pace is due to the drop in demand caused by the lockdowns in China. That is by definition a temporary effect. Once the Chinese economy opens up later this year, the oil price may recover quickly. Most forecasts are now between $130 and $150 a barrel by the end of this year, but a real oil shock would sooner involve a price of $200 a barrel. Moreover, natural gas in Europe has risen to the oil equivalent of $600 a barrel. In fact, compared to European gas, oil is dirt cheap.
Commodities versus equities
Two years ago was the time to invest in oil itself. For a while, the oil price was even negative, because the tanks in Cushing, Oklahoma were full and the incoming oil was nowhere to be found. The best remedy against a low oil price is a low oil price. Two years later we are at USD 100 per barrel.
In theory, the best remedy for a high oil price is also a high oil price, because then there will be more investment. Now that this is not the case, for various reasons. The question arises of whether it is better to invest in oil itself or in oil companies. The advantage of investing in oil companies rather than in oil itself is that at the current oil price, oil companies make superior returns. The oil price does not need to rise further for this to happen.
A direct investment in oil yields nothing, no dividend and no coupon. However, there is still backwardation in the oil market, which means there is a positive roll-return. At constant prices, an investor who buys oil at 12-month terms earns 15 per cent in a year. However, the market is not so stable and prices usually do not stay the same.
Two years ago was also the moment when many institutional investors threw in the towel on their investments in commodities, including oil. Today, investment in commodities is surprisingly topical as the ultimate inflation hedge. However, oil stocks are now preferred to direct investment in oil because, despite the recent price recovery, they are still undervalued. Moreover, this is where the key to the energy transition lies.
Sustainable impact
The energy transition is actually about the big oil companies. If we consider the entire carbon footprint - thus including scope 3 -, they are responsible for half of all carbon emissions. They have the cash flows, the engineers and the knowledge of large projects to have a major impact on that transition. By the way, we should not delude ourselves.
Today, only a few percent of total energy consumption worldwide is based on alternative energy. If we wanted to double that from roughly 2 percent to 4 percent, we would need just about all the relevant metals that are produced globally in a year. These metal prices are therefore rising sharply. The conclusion is quickly drawn that energy from wind turbines and solar parks alone will not suffice.
Nuclear power and nuclear fusion are required to give the energy transition at least a chance. Even then, three quarters of the world do not care about the energy transition. They see it as an expensive hobby of the rich West. Energy security has always been a priority for these countries. Energy security takes precedence over the energy transition, even for the EU’s climate chief Frans Timmermans.
Costly energy transition
Another point of attention for sustainable investors is the negative social impact of striving for such a fossil-free future. The energy transition will cost a lot of money and the burden will quickly fall on those least able to bear it. This will ensure that the support base for sustainability and the energy transition will rapidly diminish.
The only conceivable solution is for governments, citizens and the oil companies to work together towards a sustainable future. The attraction for investors is that there is a strong revaluation potential there. Oil companies are now seen as companies that will soon be phased out. As soon as the same transformed energy companies start to drive the energy transition, this type of company will attract a premium in terms of valuation. For the coming years, there will be a shortage of oil.
Han Dieperink is chief investment strategist at Auréus Asset Management. Earlier in his career, he was chief investment officer at Rabobank and Schretlen & Co. His contributions appear every Thursday on Investment Officer Luxembourg.
This article was first published on InvestmentOfficer.nl.
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