Big Oil Running out of Gas

May 19, 2020

Bill McKibben in NY Review of Books:

“…we now know that Exxon had a full understanding of climate change in the 1980s, but that, instead of alerting the rest of us, it helped build the architecture of deceit and denial and disinformation that held off a real response to global warming for three decades.

During some of those years, Exxon profited handsomely, making huge sums of money. But producing a product that is destroying the planet courts the danger of regulatory pressure: you can use your political clout to hold regulators off for a while, but eventually they begin to catch up with you. That’s what happened at the Paris climate talks in 2015, as the notion finally began to break through that we had to wean ourselves from oil.

Meanwhile, the oil industry faced a second challenge: solar and wind engineers were relentlessly dropping the price of their technology, to the point where it was both cleaner and cheaper than digging stuff up and burning it—in Abu Dhabi last week, the low bid for what will be the world’s largest solar array promised power at little more than a penny per kilowatt hour (the average electricity price in the US is about 13 cents per kWh).

As a result of these twin pressures, the fossil-fuel industry has been the laggard in the last decade of economic expansion, underperforming every other sector of our economy. Exxon, in that span, went from being, in the words of a recent Bloomberg Businessweekreport, “once the undisputed king of Wall Street,” the most powerful corporation on the planet, to a “mediocre company,” worth less than Home Depot Inc.”

Front Page Live:

Royal Dutch Shell is the first oil major to get honest: Our business model is broken and we are a lousy investment. Slashing its dividend for the first time since World War II, Shell broke the spell on investors who had become so hooked on the promise of easy quarterly cash that they ignored the signposts of a sector entering its terminal phase. After the news, Warren Buffett validated voices that have been warning investors to pull out of fossil fuels for years: “Any shareholder in any oil-producing company, you join me in having made a mistake.”

Despite oil industry efforts to cast COVID-19 as a black swan that suddenly knocked them off course, investors were on notice that a crash was a long time coming. Divestment advocates have been warning about the financial risk, and moral cost, of holding onto fossil fuels for close to a decade. Research was clear that the dividend was a house of cards standing on a shaky pile of growing debt. Nevertheless, fiduciaries who should have known better — including prominent endowments like Harvard and climate-minded pension trustees in New York state and California — made an unspoken deal with the oil majors: Keep the oil dividend flowing and we won’t ask too many questions.

With oil majors historically offering dividend yields of 5 to 8 percent, institutional investors naturally came to rely on the steady flow of cash to grow and sustain their funds. For most of the past century, the oil dividend did what it was supposed to do: It rewarded shareholders for investing in a booming industry that brought billions of people from darkness into light. Yet oil’s heyday has long since passed as the world continues its rapid transition to electric vehicles and renewable energy. The industry has been under incredible strain and systemic decline for many years — the deep cracks in its business model now laid bare by the COVID-19 crisis.

A dividend as “the part of the profit of a company that is paid to shareholders.” To any layperson, the dividend is something extra – paid out when a business is thriving and there is an excess of profit to be returned to shareholders. Not so with the oil majors, who resorted to accounting tricks to keep the house of cards standing. As documented by the Institute for Energy Economics and Financial Analysis, ExxonMobil, BP, Chevron, Total, and Shell have been unable to sustain the dividend with free cash flow for a decade, borrowing money and selling assets at alarming rates in order to maintain the dividend and keep investors pacified.

Paying a dividend on credit should raise red flags with any prudent fiduciary. Yet investors enabled the practice. Even as debt ballooned on industry balance sheets, the message of shareholders remained the same: Sustain the dividend at all costs. “There is total inconsistency in what investors tell you except for one thing: Can you please sustain the dividend?” Shell CEO Ben van Beurden said in October 2019. “And that is fine. We have every intention to do so.”

Six months later, even Van Beurden’s best intentions were not enough. As COVID-19 decimated global oil demand, Shell slashed its quarterly payout from 47 cents to 16 cents — collapsing its dividend yield to around 2 percent. That’s a raw deal when the underlying stock is as weak and volatile: Oil stocks have badly underperformed the market for more than a decade costing investors billions in foreign gains.

The pandemic has squeezed the oil industry to such an extent that drastic cuts to the dividend, and to capital spending, are the only defensible options. Yet most investors breathed a sigh of relief when the other supermajors — BP, Chevron, Total and Exxon — pledged to preserve their dividend in the second quarter and keep the charade going a little while longer. This obsession with short-term gains, an irrational discounting of future pain and a dogged commitment to delaying the inevitable are the drivers of the climate crisis itself.

Mckibben again:

One group that took our advice was John Rockefeller’s heirs, who in 2014 divested their charitable foundation from fossil fuels—a front-page news story at the time, since the original oil fortune’s getting out of oil seemed to mark a turning-point of sorts. The Rockefeller heirs were indeed responding to worries about global warming—the announcement of their plans, at the Cathedral of St. John the Divine in New York City, included a remarkable video from Archbishop Desmond Tutu comparing fossil-fuel divestment to the campaign to which he’d contributed to end apartheid. But they also said they thought the economics of the move made sense.

It turns out they were right. Last week, the family reported on the results, offering a five-year snapshot of their returns through the end of 2019 (that is, before the coronavirus pandemic accelerated these trends). As The Washington Post put it, “defying predictions of money managers,” they made out just fine. Their portfolio gained 7.76 percent a year over the period, against a benchmark of 6.71 percent if they’d kept their old mix of investments.

One need not care enormously about the financial happiness of the One Percent to understand that this matters. It translates into a financial sector increasingly eager to turn its back on the fossil-fuel industry. In January, for instance, the asset manager BlackRock, which is the biggest box of money on Earth, said worries about climate change would require a “fundamental reshaping of finance.” More colloquially, America’s TV investment guru Jim Cramer told his CNBC audience this winter that “I’m done with fossil fuels” because “there’s no money to be made” as more and more funds divest their holdings. Big Oil, he said, “may just be on the wrong side of history.”

Do so-called “sustainable” investors earn more or less than conventional investors? The International Monetary Fund did a study last year that said, in effect, sustainable investors do as well as others. No big advantage or disadvantage. Other studies have found marginal differences in performance. So, it is hard to make the case that virtue, at least in terms of investment performance, has a steep cost.  

Five years ago, the Rockefeller Brothers Fund, whose origins are in the Standard Oil Trust, the monopoly of all monopolies, decided that investment in fossil fuels did not mesh with one of the foundation’s goals, to combat the impact of climate change. The foundation hired a new investment manager. They concluded much of the value of energy stocks is determined by an assessment of the value of their assets in the ground and that a significant portion of those assets would be “stranded”. (Any industry confronted with a new technology faces this risk).

The Rockefeller Fund divested its fossil fuel investments, starting with coal and oil sands. They also made “impact” investments in firms whose activities mitigate climate change. Five years later, Rockefeller Brothers Fund reported that it had performed better than the standard portfolio (by roughly one percentage point a year) and that a companion index of sustainable stocks did even better, probably enough to pay any extra management fees.

Bottom line? Investors have figured out that they can reduce or eliminate energy holdings and still produce respectable portfolio performance. And a 3% S&P index weighting makes the energy group even easier to ignore. This has negative implications for cost of capital and is a message not to be ignored.  

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