Over the years, the oil industry attracted investors with large and regular returns. Even when oil prices fell, Big Oil found ways to pay dividends, even if they had to cut them, which only happened in extreme cases. Now, it is becoming clear that dividends and profits are no longer the king. Today’s investors want other things from their oil investment.
Returns are not what they used to be
To be completely unbiased, returns are still important. They are not the only reason for an investor to buy or stay with the oil company. The stability of an oil company is attracting increasing attention, too. But more on that later. Even though returns are the one and only priority of investors today, they will be unhappy.
Back in 2006, the average return on capital employed in upstream activities among Big Oil majors was more than 27 percent, a recent study by Boston Capital Group showed. In 2019, this average did not exceed 3.5 percent. Before the pandemic forced the rise in oil prices and severe spending cuts. Oil industry returns, the study showed, had become much less flexible for price movements.
This difference closes largely to coincidence. In fact, the authors of the study noted that a notable change in the industry during the period 2006 and 2019 was a change in the upstream asset portfolio of companies.
Myths about Shale and Deep Water
As of 2006, BCG stated in its report, up to 80 percent of Big Oil’s portfolio was made up of traditional oil and gas assets. Since then, they have moved into things like deep water and shale. And while investors have been hearing for years how production costs are coming down in both deepwater and shale, this has not happened for all deepwater farms or all types of plays.
Traditional and deepwater exploration and production continues, overall, in shallow water and much more expensive than conventional oil wells. For deep water, this is purely due to physical challenges, such as the name suggests, depth. For Shell, this is due to the capital’s intensity of fracking.
There is a focus on the quick turnaround of tattered wells: they take far less than traditional wells to bring returns on planned investment. But unlike traditional wells, they have a very short life span. In short, unconventional and deep-water oil promises were well-promised, based on investment return rates.
Oil investors have been unhappy with Big Oil for a while, since the trend towards environmental, sustainable, and social governance has gained momentum. A growing number of people looking for a company now want to know that the business of this company is environmentally responsible. It is not just out of philanthropic purposes. Investors are being told that climate change is a potential threat to many companies, and the more environmentally responsible a company is, the greater its chances of survival.
Obviously, oil companies are in a fragile place, when it comes to environmental responsibility, to lighten it up. But this is not as delicate a situation as many might think. Global demand for energy is increasing, and it will continue to grow for the foreseeable future, despite the epidemic. And this means that the need for oil and gas will remain.
“On the one hand, the energy transition is real and has to be here,” said Carl Maguire, managing director of Carlyle Group. Cited By Argus Media. “On the other hand, there are 280mn cars on the road in the US today, 279mn of them running on oil, and the average age of a vehicle is 12 years.”
The need for oil and gas will remain, but they will need to be produced in a different way to satisfy investors’ changing sentiment towards the industry. According to a Boston Capital Group study, 65 percent of oil investors want companies to prioritize ESG factors over profits, even if it is said to be negative on profits.
Related: Why Natural Gas Is The Most Important Fuel Of The Next Decade
83 percent say that Big Oil should invest in low-carbon alternatives in its core business. More than 86 percent believe that investment in clean energy technology by oil companies will make them more attractive to investors. This should provide a much clearer picture of where Big Oil needs to go.
The road ahead is not green
Some would argue that Big Oil is already heading in that direction, with European supermergers adopting a path worth tens of billions with renewable energy investment commitments. Others will the counter They are still only making promises but do very little work on changing their business.
Indeed, whatever Big Oil’s green ambitions are, it will also have to stick to its core business of extracting fossil fuels. They need revenue from this core business to fulfill their renewable energy ambitions. But they could also do it differently. The BCG study suggests increasing its focus on low-cost production, taking steps to reduce capital intensity, and greater focus for risk reduction. Apart from the apparently inevitable diversification into alternative energy, which should make them more resilient to future oil price shocks.
By Irina Slavin for oilprice.com
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