Last night and this morning, the national media were dominated by the news from the Intergovernmental Panel on Climate Change that we are all going to fry in a rapidly rising world temperature unless we change our ways. CO2 emissions continue to rise and even to limit temperature rises to 1.5 degrees Celsius requires unprecedented changes to many aspects of our lives.
The suggested solutions are changes to transport to cut emissions, e.g. electric cars, eating less meat, growing more trees, ceasing the use of gas for heating and other major revolutions in the way we live.
So one question for investors is should we divest ourselves of holdings in fossil fuel companies? Not many UK investors hold shares in coal mines – the best time to invest in coal was in the 18th and 19th century. That industry is undoubtedly in decline in many countries although some like China have seen increased coal production where it is still financially competitive. See https://ourworldindata.org/fossil-fuels for some data on trends.
But I thought I would take a look at a couple of the world’s largest oil companies – BP and Shell. How have they been doing of late? Looking at the last 5 years financial figures and taking an average of the Return on Assets reported by Stockopedia for the period 2013-17, the figures are 2.86% per annum for Shell and 0.06% per annum for BP – the latter being hit by the Gulf oil spill disaster of course. They bounce up and down over the years based on the price of oil, but are these figures ones that would encourage you to purchase shares in these businesses? The answer is surely no.
The figures are the result of oil exploration and production becoming more difficult, and in the case of BP, having to take more risks to exploit difficult to access reserves. It does not seem to me that those trends are likely to change.
Even if politicians ignore the call to cut CO2 emissions, which I suspect they will ultimately not do, for investors there are surely better propositions to look at. Even electric cars look more attractive as investments although buying shares in Tesla might be a tricky one, even if buying their cars might be justified. Personally, I prefer to invest in companies that generate a return on capital of more than 15% per annum, so I won’t be investing in oil companies anytime soon.
But one aspect that totally baffles me about the global warming scare is why the scientists and politicians ignore the underlying issue. Namely that there are too many people emitting too much air pollution. The level of CO2 and other atmospheric emissions are directly related to the number of people in this world. More people generate more demand for travel, consume more food, require more heating and lighting and require more infrastructure to house them (construction generates a lot of emissions alone). But there are no calls to cut population or even reduce its growth. Why does everyone shy away from this simple solution to the problem?
Roger Lawson (Twitter: https://twitter.com/RogerWLawson )
A few points on this post. Firstly whilst I agree with the average ROA calculation for Shell, I get an average for 1.6% for BP, rather than 0.06%.
More significantly, the low ROA is not simply due to the cost of discovering reserves, but also to the cyclical period those numbers cover. The oil price crashed in 2014 and is only now recovering. I’d expect much stronger profits and ROA to be reported this year and next year, as the oil price recovers. Natural resource companies in general have been under pressure from shareholders not to invest in projects that do not produce decent returns (at lower commodity prices). Hence companies have been making generous capital returns to shareholders instead of investing in new capital projects. This comes after a period of profligacy by those companies during the boom years. Current frugality, in turn, sows the seeds for higher commodity prices and higher profits, as supply is likely to lag rising demand, until the cycle turns again!
It is notable that both BP and Shell are classified as “superstocks” with high StockRanks by Stockopedia – I think that is because the market is taking Roger’s view and not adequately considering the stage in the cycle we’re at, hence making these “cash cows” available at very reasonable prices.
For those reasons – and current and future income generation – my largest current investment is in the BlackRock Commodities Income Trust (BRCI), which invests across the full spectrum of natural resource companies. It’s largest current investments are: BHP, Shell and First Quantum (of Canada). Of course, Roger’s opening remarks do raise questions about the future sustainability of the oil majors – but I think those risks are beyond my forecasting horizon. Another risk, which the market seems roiled by at present, is the risk to demand growth that the “trade wars” pose. A global economic slowdown would pose a risk to demand and prices.
The target to reduce CO2 emissions worldwide to zero, or something close to it, is about 30-40 years, and population changes are not possible (at least as a result of policy) on anything like that timescale. More to the point it may well not be possible at all – at the moment it could probably still be done with a concerted effort from a large number of countries, but that doesn’t look likely. As far as oil companies go we might be looking at a profile which ramped down their production over something like 30 years, but exploration and development costs would also fall.