Oil (and Climate Change) – Is it still a good investment?

Note: This article is a premium article that first appeared on Patron. 

I received a bunch of great questions from my Patron members recently! This post will spotlight some Oil / ESG issues.

Oil / ESG

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Hi FH. Recently the some of the oil majors are being told to increase their green portfolio and reduce their capex on fossil fuels as a result (activists on Exxon, court rule on shell etc.).

I view this as a very bullish for oil price as supply will be squeezed further and demand in the near term is going to shoot up when Covid mandates start lifting.

What are your views on investing in oil majors? On one hand, higher oil prices will benefit the oil majors for sure but on the other hand, they will have to spend more money on less profitable ESG ventures and less on profitable oil businesses.

Does it still make sense to even hold or buy the oil majors stocks? Tks

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Recap of ExxonMobil’s Proxy Battle

For those that haven’t been following, here’s a summary of the proxy battle:

· Engine No 1, an activist Hedge Fund, bought a small position in Exxon last year (0.02% of Exxon) and started to jostle for change

· The changes they wanted are basically climate change / ESG – Forcing Exxon to put climate change at the heart of its business, focus more on ESG, and accelerate change away from oil

· They created a proxy fight, and nominated 4 of their directors (all very reputed in the industry) onto Exxon’s board

· Along the way, they managed to get support from some big names, including Pension Funds like Calstrs, Calpers and New York State Common Retirement Fund

· Last week was the AGM, and Engine No 1 won 2 seats on Exxon’s board in a stunning victory

· As it turns out, some of the big names like BlackRock and Vanguard decided to back Engine No. 1 at the last minute

More details here if you’re keen.

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Implications of this for the oil industry

So why is this such a big move for oil?

Some context is required.

Now, Exxon is the 800 pound gorilla for Oil & Gas.

Part of the original Standard Oil, Exxon was the biggest oil company following the breakup of Standard Oil due to antitrust regulations.

Today it has a staggering $250 billion market cap (this was a lot more impressive in the 2000s before the FAANG).

For decades, Exxon was literally the biggest boy around. Exxon management and board did whatever they thought was best for the company, shareholders be damned.

Investing with Exxon was a privilege.

Fast forward to 2021, and the entire climate has changed.

And the fact that it was Exxon who suffered such a massive defeat to ESG activists, will no doubt strike a blow through the heart of the oil industry.

If it can happen to Exxon, you bet it can happen to the smaller players like Chevron or Shell.

So the implications of this should not be understated, and right now every single oil & gas player out there is going to start taking ESG or Climate Change more seriously.

Couple that with some recent decisions like Shell being orderedby Dutch courts to cut emissions, and the winds of change are clear – whether they like it or not, the oil & gas industry will have to start going green.

Implications for Investors?

Ask yourself this – why do the big boys like BlackRock and Vanguard want to back ESG and climate change?

Is it because they are worried about climate change, and want to build a better world?

Or is it because they think that Exxon going green and focussing on ESG will be good for the stock price?

Call me a cynical horse, but my money’s on the latter.

BlackRock and Vanguard back the move, because they think it will be good for business (and the stock price) in the short to medium term.

And I’m with BlackRock on this one.

I think in today’s world, not attempting to go green, and ignoring climate change, is simply bad for business.

It’s going to attract a lot of attention from regulators (who want to regulate your emissions), and a lot of attention from shareholders (who will create proxy battles like this, or funds that cannot invest in non-ESG companies etc).

It’s better for business to just talk about going green now, and avoid all that unwanted attention.

So going green, is just good for business both in the short and medium term. It’s a no-brainer.

What about underinvestment

The problem though – is that if everyone decides to go green, and cuts investment in oil, what’s going to happen in 2 – 3 years when COVID is over, and everybody goes out again?

Who is going to be pumping the oil that we need in the medium term?

Sure, 5 – 10 years time, most of the cars may be electric.

But in 2022 – 2025, most of the planes and cars and ships are still going to be running on dirty fossil fuels.

Throw in all that inflationary pressures from money printing, unlimited QE, and low interest rates, and I can see why people are talking about a commodity supercycle.

How to play oil?

The way I see it, there are 2 ways to play oil: short term, and mid term.

The long term is out because the world is moving away from oil, and with a longer term timeframe (10 years or so), I think we will achieve it.

So I definitely don’t want to be holding onto oil for such a long timeframe.

Short Term (6 – 12 months)

This is a short term play on the COVID reopening.

This was the trade I’ve been talking about since middle of 2020, and Exxon is up almost 80% for me now.

You buy oil, watch oil prices spike as the world starts to reopen, and sell it.

The million dollar question is when to sell.

Stocks are forward looking about 6 months, so in the world of stocks, we’re already in end 2021 now.

And heading into 2022, the world starts to look a lot more uncertain. As the reopening starts to gather steam, the stimulus may slow, Feds may start to taper, Saudi’s may start to pump more oil.

It’s a buy the rumour sell the news kind of thinking – and I think we may be fast approaching peak oil, at least in the short term.

Short term wise, I’m not sure how much upside there is in oil from here. 10 – 20% maybe, but another 50% from here, less likely.

Mid Term (3 – 5 years)

The mid term play is a bit more complex.

This is to use oil as an inflation hedge.

There are 2 structural factors that drive oil’s price in the medium term:

1. Reduction in supply – As discussed above, lots of players have cut investment into oil because of (1) COVID and (2) ESG / Climate Change. This could set us up for massive undersupply a few years out.

2. Money Printing – With all that money printing and stimulus and low interest rates, it’s possible that this creates a far more inflationary world. And in an inflationary world, commodities (and oil) are a fantastic hedge.

What will I do?

I’m still a bit undecided on the midterm play for oil.

I think that eventually, all that money printing is going to show up in inflation.

I think the difference this time around (vs 2008) is that the stimulus is not just monetary, it’s fiscal. In 2008 it was QE to buy Treasuries, inflating asset prices globally. This time around, it’s governments giving money directly to people to spend, all while the Feds supress interest rates and do QE.

I think this time really is different.

But I’m not sure if inflation is a 2021 concern.

I still think it’s more of a 2022 and beyond story, which makes it slightly early to start buying inflation hedges.

I definitely could be wrong on this – But I would suspect that the economy will weaken in the short term first as interest rates go up, and the whole reopening trade starts to fizzle out. And at some point the Feds are forced to commit to even more stimulus, finally putting us on a path to inflation.

But like I said this is a tough call, and it’s possible we skip straight to inflation.

Whatever the case – As a short term play, I’m already sitting on pretty big gains on my Exxon position (~80%), so I may sell half of it in the next couple of months just to lock in some profits.

If oil dips in second half of 2021, I may buy it back. If it doesn’t dip, I’ll rotate into the secular long term plays like Tech or REITs.

And keep the rest of my oil as a medium-term inflation hedge.

But that’s just me though.

Would love to hear what you think! Is there anything I’m missing?

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