Why it’s still worth investing in oil and gas
The demand for oil remains elevated while supply is constrained due to a general underinvestment in exploration since 2014.
Investors could be forgiven for believing there was no future in the oil and gas sector when listening to global politicians talk about 2030 targets of renewable energy production and emissions 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 there is no truth in the belief that if everyone drove electric vehicles (EVs), the air quality will suddenly improve. Snyder is very much for renewable energy, but believes the global discussion around the energy transition is unrealistic; he thinks the role of oil and gas in the energy transition is likely to be measured in decades, not years.
Norway has the highest percentage of electric cars per head in the world.
He cites Norway, where 80 per cent of new car sales are EV and more than a fifth of the country’s fleet is battery-powered, and yet total oil consumption has only fallen about 10 per cent over the past decade. While automotive petrol usage has dropped by 37 per cent in Norway in the past 10 years, demand for diesel (to power heavy transport) and jet fuel has grown.
The International Energy Agency forecasts that oil demand will continue to rise at least until 2028, at which point demand is forecast to be 5 million barrels a day higher than in 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 affecting living standards.
Consider these everyday items that use petroleum products in their manufacture: solar panels; plastic packaging for medical, computer components, electrical goods, cosmetics and furnishings; clothing in the form of polyester; and aspirin.
Hugh Dive, chief investment officer at Atlas Funds Management, cites China’s signing of a 27-year LNG purchase agreement with Qatar starting in 2027 for 4 million tonnes a year, and an equity stake in the expansion of Qatar’s North Field LNG project. The Chinese government (the world’s second-largest economy) clearly believes gas won’t be a useless molecule from 2030.
Put simply, the demand for oil remains elevated while supply is constrained due to a general underinvestment in exploration since 2014 – in particular during COVID-19 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 since it is flammable and 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 have the experience and assets – such as pipelines, storage and tankers – to transport green hydrogen globally.
The environmental, social and governance focus has been 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 being more disciplined in allocating capital. The savings from this are going to shareholders in the form of higher dividends.
Dive sees the US shale oil producers as an indicator of the marginal cost of oil, with their cost of production about $US60 a barrel. This is an important likely floor for the oil price. The oil price is about $US70 a barrel.
Dive’s top pick in the energy sector is Woodside Energy because it has the lowest production cost ($US8.50 a barrel) and the lowest gearing (7 per cent). He prefers Woodside to Santos as it has minimal exposure to Australia’s east coast market, which is subject to great political uncertainty, and he is attracted to Woodside’s 7 per cent fully franked dividend.
Snyder’s top pick is Brazilian operator Petrobras. It has some of the lowest oil breakeven costs globally and the richest reserves outside the Middle East and Russia, providing resilience through commodity cycles. Petrobras generates tremendous free cash flow (more than Chevron despite being a third of Chevron’s size) and an aggressive capital return policy. It trades at a 12-month forward price-to-earnings ratio of four and is expected to pay a dividend yield of about 20 per cent this year.
Oil and gas will be around for some time, and investors could miss handsome dividends by ignoring this sector.
AFR
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