Investors would be forgiven for believing there is no future in the oil and gas sector when listening to global politicians talk about 2030 targets of renewable energy production and emission reduction. Clearly a world that is powered by green renewables is a desired outcome, but calling the death of oil and gas would seem premature.
Josh Snyder, Global Investment Strategist at GQG Partners, says the belief that everyone can drive electric vehicles (EV’s), and the air quality suddenly improves is simply not true. Synder is very much for renewable energy, but he is of the view that the global discussion around energy transition is currently unrealistic and he thinks the role of oil and gas in the energy transition is likely to be measured in decades not years.
He cites Norway, where 80% of new car sales are EV’s, and more than a fifth of the country’s fleet is now battery powered and yet total oil consumption has only fallen around 10% over the past decade. While automotive gasoline useage has dropped by 37% in Norway in the last 10 years, demand for Diesel (to power heavy transport) and Jet Fuel has continued to grow.
The International Energy Agency forecasts oil demand continues to rise at least until 2028, at which point demand is forecast to be 5 million barrels per day higher than at 2019. Snyder says that it may be an uncomfortable truth, but oil is central to everyday life in a way that will be difficult and expensive to change without impacting current living standards. Consider these everyday items that use petroleum products in their manufacture – solar panels, plastic packaging for medical, computer components, electrical goods, cosmetics, furnishings, clothing in the form of polyester and aspirin.
Hugh Dive, the Chief Investment Officer from Atlas Funds Management says that China signed a 27 year LNG purchase agreement starting in 2027 with Qatar for 4 million tonnes annually and an equity stake in the expansion of Qatar’s North Field LNG project. The Chinese Government (2nd largest economy) clearly believes gas won’t be a useless molecule from 2030 onwards.
Put simply, the demand for oil remains elevated while supply is constrained due to a general underinvestment in exploration since 2014, and in particular during COVID when oil prices fell which resulted in oil companies conserving cash.
To some, Hydrogen is a threat to the oil and gas sector, but Dive says it is also an opportunity as hydrogen is difficult to transport as it is flammable and also corrosive to steel. Oil and gas companies have experience in handling hydrogen as it is used to scrub sulphur and crack heavy oils into lighter blends. Oil companies would be the natural companies with the experience and assets, such as pipelines, storage and tankers to transport green hydrogen globally.
Environmental/Social/Governance (ESG) focus has been both positive and negative for the oil and gas sector. Snyder highlights that large banks have shrunk their lending exposures to the sector which has led to management teams having to be more disciplined in how they allocate capital. This results in them becoming more share holder friendly where companies are keen to return money to share holders in the form of dividends.
Dive sees the US shale oil producers as an indicator of the marginal cost of oil, with their cost of production around US $60 per barrel. This is an important likely floor for the oil price. Currently the oil price is around US $70 per barrel.
Dive’s top pick in the energy sector is Woodside Energy because they have the lowest production cost ($US 8.50 per barrel) and the lowest gearing (7%). He prefers Woodside to Santos as Woodside has minimal exposure to the East Coast Australian gas market which is subject to great political uncertainty and he is also attracted to Woodside’s 7% fully franked dividend.
Snyder’s top pick is Brazilian-operator, Petrobras. It has some of the lowest oil breakeven costs globally and richest reserves outside of Middle East and Russia, providing resilience through commodity cycles. Petrobras generates tremendous free cash flow (more than Chevron despite being one third of Chevron’s size) and an aggressive capital return policy. Currently trades at 4x 12-month forward PE and expected to pay ~20% dividend yield this year.
Oil and gas will be around for some time to come and investors could be missing handsome dividends by ignoring this sector.
Mark Draper writes monthly for the Australian Financial Review and this article featured in the 26th July 2023 edition