Aug. 25, 2021
Big Oil is coming off yet another blockbuster season, posting the second consecutive quarter of stellar top-and-bottom line growth. According to the latest FactSet data, the energy sector's Q2 2021 revenue growth rate of 24.9% came in way higher than Wall Street's estimate of 19.4% while the sector reported earnings of $15.9 billion compared to a loss of -$10.6 billion in Q2 2020 marked the biggest Y/Y improvement of any of the S&P 500's 11 market sectors.
Interestingly, the Big Oil duo of ExxonMobil (NYSE:XOM) and Chevron Corp. (NYSE:CVX) were largely to thank for the outstanding performance, with the two combining for $13.9 billion of the $26.8 billion year-over-year increase in earnings for the sector.
Not surprisingly, the majority of the oil and gas majors have been using their cash bonanza to reward shareholders with higher dividends and buybacks.
Chevron, Marathon Oil (NYSE:MRO), Equinor ASA (NYSE:EQNR), and Royal Dutch Shell (NYSE:RDS.A) have announced dividend hikes during their latest earnings call while ConocoPhillips (NYSE:COP) and BP Plc (NYSE:BP) have reinstated share buybacks after bumper earnings.
But contrary to Wall Street's expectations, Big Oil's cash bounty, including fat dividends, has mostly failed to impress investors, a rather surprising development in a market starved of yields.
There's a method to the madness, though.
Kathy Hipple, finance professor at Bard College in New York, has told CNBC that Big Oil's bid to lure back investors with cash rewards is unlikely to work on long-term investors.
Dividend traps
Companies in all sectors normally use dividends and share buybacks to make their shares more attractive to investors.
For most companies, dividend payments act as a token reward to shareholders for their investment. However, oil companies are particularly adept at dishing out these token rewards, and Big Oil sports some of the most impressive yields in the business.
ExxonMobil currently sports a 6.60% dividend yield (Fwd); Chevron yields 5.68%, BP 5.56%, Shell 5.01%, while MPLX LP (NYSE:MPLX) checks in with 10.01% fwd yield.
Meanwhile, share buybacks are designed to boost a company's earnings, which eventually reflects in its share price.
However, Hipple says that whereas a 10% yield can act as a powerful magnet for the average income investor, savvy, long-term investors are not falling for it because they view oil and gas companies as dividend traps with a sell-by date that is moving closer by the day.
"Once institutional investors determine that demand has peaked--which likely has already happened--they will abandon the sector permanently. Many already have, based on the stock performance of the sector over the past several years."
Stranded assets
Hipple said that savvy long-term investors will continue to shy away from oil and gas majors "unless and until" they fully acknowledge the climate crisis due to the very real risk of stranded assets.
"These investors understand that the oil majors are still investing tens of billions in unnecessary oil and gas infrastructure, ignoring the IEA findings that no additional infrastructure is possible to meet a 1.5 [degrees Celsius] scenario. These investments are likely to become stranded assets, and investors don't want to be left holding the bag."
She certainly has a valid point here.
Last week, the Intergovernmental Panel on Climate Change delivered its starkest warning yet about the deepening climate emergency, saying a key temperature limit of 1.5 degrees Celsius could be broken in just over a decade in the absence of immediate, rapid, and large-scale reductions in greenhouse gas emissions.
U.N. Secretary-General, António Guterres, has described the report's findings as a "code red for humanity," saying they "must sound a death knell" for fossil fuels.
True, U.S. Shale companies are exercising a lot more capital discipline than they have in the past. Shale drillers have a history of matching their capital spending to the strength of oil and gas prices; However, Big Oil is ditching the old playbook this time around. Rystad Energy says that whereas hydrocarbon sales, cash from operations and EBITDA for tight oil producers are all likely to test new record highs if WTI averages at least $60 per barrel this year, capital expenditure will only see muted growth as many producers remain committed to maintaining operational discipline.
However, the lion's share of these investments is still flowing towards developing new oil and gas assets, with a minuscule fraction going towards sustainable energy.
Hipple is hardly alone in her dim view of legacy oil and gas companies.
"We frankly just don't think these are very good businesses. With the oil companies, we still just don't think they represent good long-term businesses. They don't generate consistent returns on capital or cash flow, albeit at the moment they look to be in a pretty good place," David Moss, head of European equities at BMO Global Asset Management, has told CNBC.
Moss, in particular, faults European energy majors which are currently generating "very strong" cash flows amid a sustained rebound in oil prices but many are choosing to keep a tight lid on spending rather than invest in sustainable energy.
It appears that Wall Street is now doing a 180 and increasingly turning bearish on oil and gas.
In a recent report, Standard Chartered says Wall Street is plain wrong in its expectations of high oil prices because "...a significant amount of money has already entered the market in the Wall Street-generated belief (mistaken according to our analysis) that the balances are much tighter and justify USD 80-100/bbl."
By Alex Kimani for Oilprice.com
