Having tracked the demise of the coal industry, I can see the signs here for the oil and gas industry. Exxon Mobil (NYSE:XOM) is the standout because CEO Darren Woods has decided that there is a big future for oil and gas while others panic. And so, just like management of Peabody Energy (NYSE:BTU), which closed at $6.92 today against a 52-week high $37.37) did in the past, XOM management is doubling down with massive new investment in exploration based on their view that the industry still has decades to run and they are the best at what they do. I’m writing this brief article because the predicted wave of “buy now” articles is starting to appear. I urge investors to consider the whole picture and to look before they leap.
The basis for buy now
It is all about the XOM price (cheap in the eyes of those urging “buy”) and an assumption that the price of oil is almost the only relevant determinant of future success of XOM.
How well does the XOM share price track the price of oil? Below I provide charts of XOM and Brent crude oil price over 5 years. I have trouble seeing a close correlation. Clearly, other factors are in play in determining the share price of XOM.
5-year share price for XOM. Source
5-year Brent crude price. Source Macrotrends
The price of oil may recover (or it may not) but decarbonization of energy and transport is happening and this means less oil and gas.
Pendragon is reassured by XOM providing reliable dividends, notwithstanding that when he last looked at the stock a year ago, the share price was ~$75 (today $64.11). Pendragon provides a lot of detail on what a fair price of XOM shares is based on dividends remaining strong. His conclusion is that XOM is a buy based on its dividend at any price above $75. I’ve indicated elsewhere that XOM’s dividend is not necessarily as safe as long-term investors realise. Maintaining the dividend by increasing debt and asset sales is not a long-term strategy, but between 2010 and Q3 2019, XOM has accumulated a $64.5 billion deficit between free cash flow and shareholder distributions.
Allstartrader starts with the assumption that XOM is a solid long-term hold (although he has other oil-related holdings in his core portfolio). His focus is on dividends and he points out that currently, the stock price of XOM, a King Dividend stock, has broken down. The assumption about the fall in stock price is that it is all about lower oil prices and that an attentive investor will make money from XOM as the share price rises in parallel with oil price rises.
As is often the case, the reasons given for the falling XOM share price invariably do not include serious consideration of two key factors.
The two reasons for caution
XOM is faced with not one, but two dramatic and game-changing events that are rapidly unfolding.
Oil and gas are becoming uncompetitive
Investors who don’t pay close attention to what is happening in the energy space can be forgiven for not being aware of massive changes happening under the radar. Major industry influence groups and the oil and gas majors themselves have essentially been in denial about massive changes in both capacity and cost of renewable energy in recent years. A case in point is the US Energy Information Administration (EIA) that has previously had an avowedly optimistic view about the future of the fossil fuel industry, especially gas. Indeed last year, the EIA predicted that natural gas would dominate US electricity in 2050. In its 2020 Annual Energy Outlook, the EIA projects renewables to become dominant rising from 19% today to 39% in 2050, while natural gas stays static at 36% (a slight decline in 2019 of 37%).
Coal is projected to decline from 24% in 2019 to 13% in 2050. This is a massive change compared with last year, but my take from looking at what is happening on the ground is that it is still a huge underestimate about what is happening with renewable energy. For example, EIA assumes that the cost decline for renewable energy starts to plateau long before I suspect it will. Coal is in free-fall and will be largely out of the system long before 2050, and renewables are outcompeting gas all over the country (and the world).
The electrification of transport is a similar story with the major information groups and oil and gas majors beginning to acknowledge that the shift is on and it is unstoppable. For example, between 2017 and 2019, BP’s Energy Outlook increased estimated penetration of electric cars from 4.5% to 12% by 2035. The UK Government is considering banning the sale of new ICE cars by 2040 (with calls to bring this forward to 2030). Fleet managers are considering more aggressive targets, such as National Grid considering 100% of its fleet being zero emissions by 2030. Similar things are happening all over the world.
This isn’t the place to provide a comprehensive coverage of what is happening with renewable energy. What can be said with some confidence is that renewable energy/zero emissions technologies are dramatically on the scene and that they are impacting today (not at some time in the future) how investor groups view investments in companies like XOM.
There is a climate emergency and need to decarbonize
I’ve covered the increased awareness of the climate emergency in a recent article. The science is clear that this is an emergency, the Australian fires have made people aware that there are consequences to not addressing climate change, and the world’s largest fund manager BlackRock has publicly positioned for exit from fossil fuels. Perhaps readers are not aware how seriously BlackRock views this issue and how dramatic the changes that they are implementing are. An article from IEEFA today covers these issues in a commentary of traditional investment views versus the new dialogue. They mention 6 points that sit underneath how BlackRock is acting going forward.
This is worthy of a whole article but a few highlights suffice :
1) The traditional view is that sustainable investment harms financial performance. BlackRock’s view is unambiguous “Our investment conviction is that sustainability-integrated portfolios can provide better risk-adjusted returns to investors.”
2) The traditional view is that quantitative analysis of past performance and extrapolation is a sufficient basis for investing. In times of dramatic change this isn’t adequate and qualitative analysis is needed in relation to the climate.
3) The traditional view is that environmental (climate) considerations are not financial. Today’s view is that environmental considerations drive liability directly and indirectly. In today’s world, it is credit positive to close a coal plant.
4) The traditional view is that markets price in risk. In today’s world it is understood that the market ignores some risks and misprices others. This has huge implications for the fossil fuel industry.
5) The traditional view is that what a company does is all that matters to shareholders. Investor returns are increasingly tied to the overall market and a narrow view of corporate responsibility is challenged.
6. The traditional view is that a company’s legal team’s role is to downplay and contest legal compliance. BlackRock’s view is that environmental risk and legal compliance are value opportunities. This is why it has joined Climate 100+.
This is chilling stuff for XOM management to consider today (not in the future), and this is just about how the world’s largest fund manager is thinking and acting.
Underpinning BlackRock’s (and others) changed position is a massive amount of science that can’t be ignored. The fact that President Trump’s efforts to expand fossil fuels, attack renewable energy and wind back environmental laws has not prevented progress in all of those areas, shows that the facts are winning. And the science is increasingly easy for even lay readers to understand, partly through their lived experience. (I know about this from personal experience of facing a 70 km-long fire front recently).
I don’t think that it is credible to ignore the above issues in addressing why the XOM share price is damaged. These factors are not going away and so the changes in investor views of XOM (leading to the falling share price) are not short term.
In the above discussion, I’ve introduced two kinds of issues. Firstly, I’ve considered what most analysis addresses, which is all about the oil price as this clearly has a major influence on XOM (although I have shown that the Brent crude price and price of XOM shares is poorly correlated). Secondly, I’ve addressed challenges to XOM’s business as a result of massive disruption caused by technology innovation as energy and transport get decarbonized due to the rise of renewable energy, energy storage and flexible demand management. Related to this change is the need to decarbonize due to the climate emergency.
Most analysts acknowledge that trying to predict the oil and gas price is fraught with challenges due to politics (especially of the Middle East, but also Russia and less politically stable areas such as Africa, South America). However, the basis for optimism about XOM is that oil prices are cyclical and that they will go up at some time. Hence, the buy recommendations.
The second group of issues (renewable energy and climate) are dismissed as either unable to reach scale sufficiently to challenge fossil fuels, unable to be price competitive, and in the case of climate off in the never-never. And so they don’t even get discussed.
My reading suggests that complacency about the rise of renewable energy is misplaced and one just needs to read the daily news to see coal, oil and gas threatened in competitive bids for energy supply and in the emergence of electric vehicles. This is a near-term problem for XOM investors and I argue that is why the share price is falling consistently now (not some time in the future).
The climate emergency has come into new focus with the catastrophic Australian bushfires that have been predicted by the climate scientists. This is today’s problem and it is why groups like BlackRock have dramatically changed their position. It is important to mention that climate change isn’t just about the Australian fires. Any one of a huge number of similar climate disasters could have been sufficient to highlight the issue (e.g. Californian fires, floods in central US last year, floods in Europe, extreme weather everywhere).
And it is important to note that scientists are increasingly strident about the immediate danger, saying that this decade will decide whether humanity copes with limiting the extent of the catastrophe or whether it gets completely out of control. These are strong issues and they require immediate action.
I am wrong about my thesis that the rise of renewable energy and climate change are massive problems for XOM now, if suddenly the switch to renewable energy and electrification of transport slows and humanity continues to ignore the climate issues. There is a risk that this might happen (especially on the climate front since the oil and gas majors led by XOM are resolute that they plan to expand their oil and gas production). My view is that we have reached a point where the seriousness of the situation is acknowledged, meaning that this is an urgent problem for now, not some time in the future.
To buy or not to buy?
You need to decide how enticing the dividend from XOM is, but I suggest that you remember that XOM is paying for the dividends out of hoped-for future earnings and these future good times are quite some way off. To be able to enjoy the good times XOM needs the climate emergency not to bite, gas to stay competitive and electrification of transport to falter. From where I sit, the risks are high that all of these things will not be XOM’s friends.
I am not a financial advisor but I do follow the oil and gas industry closely, in particular stocks that are threatened because management thinks that the oil and gas industry will not be threatened for decades. If my commentary helps you understand some basic facts that are a major threat to your fossil fuel investments and your decision about investing (especially concerning XOM), please consider following me.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.