Transition Plans Not Obvious in Oil Shares

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Big Oil is starting to respond more seriously to energy transition pressures, but top oil companies aren't seeing their efforts rewarded with higher share values. While the correlation between addressing environmental, social and governance (ESG) issues and share performance may be absent, firms ignore these pressures at their own peril. Exxon Mobil, which recently saw three of its directors replaced after a shareholder revolt, has discovered this the hard way. Exxon shares are down 30% since the start of 2018, roughly when ESG investor pressure on oil companies gained serious momentum. Exxon’s “business as usual” approach, including an aggressive, pre-pandemic investment plan to significantly grow upstream production, invited scrutiny. Its board defeat last month by small activist hedge fund Engine No.1 means Exxon now must balance any growth ambitions with the transition bent of its three new directors (PIW May28'21). Bold net-zero targets and designs to back off the traditional oil and gas business have not translated into superior share performance. BP’s plan to achieve net-zero emissions by 2050, which includes a 40% reduction in upstream oil and gas production volumes by 2030, has not yet delivered for shareholders (PIW Feb.14'20). BP’s US-traded shares are down about 40% since 2018, making it the worst performer among top five Western majors along with Royal Dutch Shell, another aggressive ESG mover whose shares are also down about 40%. BP and Shell both score well in Energy Intelligence’s Energy Transition Vulnerability Index, ranking as the seventh and third least vulnerable, respectively, of the 26 leading oil and gas companies assessed. The pandemic slammed oil shares across the board last year, but the sector has rebounded with strong profits this year, regaining some investor interest (PIW May7'21). Of the five top Western majors, Chevron and TotalEnergies have fared best in the stock market since 2018, limiting share declines to around 20%. The two companies have very different transition strategies. Chevron has not set a net-zero target and follows the traditional Big Oil model, focusing mostly on the resilience of its oil and gas operations to low prices (PIW Oct.16'20). Total is also fixated on portfolio resilience but is investing in renewable power generation too, having committed to net zero by 2050. Total ranks as the least vulnerable company and Chevron the 11th in the Vulnerability index. Share prices still respond to changes in near-term earnings outlooks, so financial performance and movements in commodity prices will continue to drive oil and gas stocks until business models are transformed. But investors show no signs of backing off ESG demands. Pressure will mount on all oil companies to set net-zero targets -- including Scope 3 emissions from the end use of their products -- and present a coherent plan for achieving it. Overall, the trust of shareholders is essential for the industry to remain an attractive and reliable long-term investment. Preparing for the transition is less about capturing upside in share prices and more about protecting future downside risk. Climate risk exposure will increasingly be priced into shares, and investors will not cut any slack to companies that ignore these risks -- particularly from a sector with a recent history of equity market underperformance like oil and gas (PIW Apr.23'21). Already, S&P Global Ratings has found a gap emerging between the borrowing costs of higher- and lower-carbon intensity oil and gas producers in North America. Maintaining a low cost of capital is critical to the sector's long-term viability, and oil company strategies will come under greater scrutiny and pressure as more generalist investors latch onto ESG in the coming years. There is no single right way to reach net zero, and companies have a number of ways to get there, including moves into electrification and renewables, hydrogen, biofuels, and carbon capture. Nor does it preclude continued growth in upstream production this decade so long as volumes are low in cost and carbon intensity -- as Total’s strategy shows (PIW Jun.12'20). But portfolio resilience -- making operations as competitive as possible on both a financial and carbon-intensity basis -- is imperative to demonstrate now.

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