What is the Future of Investing in Fossil Fuels?

By Kirsteen Mackay

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With oil prices rising in time with socially responsible investing narratives investors are conflicted in how to invest. Will oil stocks bring wealth?

The rising price of natural gas and oil, along with a sharp increase in coal consumption is giving pause for thought in the climate change debate. While the world is alarmingly aware of the damage climate change is capable of, the road to reducing carbon emissions is far from clear.

The price rises are a stark reminder of how demand for fossil fuels is not set to disappear.

With COP26 getting underway, this subject is under the global microscope and world leaders are converging to make some significant decisions. Many low-carbon solutions are being presented and a multitude of renewable technologies are making the transition a viable possibility.

The trouble is we are not close to giving up fossil fuels for good. But without investment in this sector, drilling will stop, supplies will dry up and the prices will continue to soar.

Should you invest in oil, gas, and coal stocks?

In recent years big institutions have diverted their funds from oil and gas investments to renewables. This has left the gate open for hedge funds to invest. And in recent months they’ve been reaping the rewards.

Does that make investing in fossil fuels a wise choice for the retail investor?

This is not a black-and-white situation. Morally, many retail investors want to steer clear of fossil fuel stocks in the same way they steer clear of gambling, weapons, alcohol and tobacco stocks.

But not everyone agrees with taking the moral high ground. Josh Young, CIO of Bison Interests recently told CNBC:

“I don’t think it’s a moral thing, because what we’re doing is helping keep poor people fed, and warm in the winter and cold in the summer. It’s more a question of what you’re trying to accomplish, so we’re in business to make money.”

From a purely financial viewpoint, many energy companies are making their investors decent returns.

Let’s take a look at how the oil majors share prices have fared year-to-date:

  • Royal Dutch Shell (RDS.A) year-to-date the RDS.A share price is up 38%.

  • BP (NYSE: BP) - the BP share price is up 40%.

  • Exxon Mobil Corp (NYSE: XOM) - the XOM share price is up 54%.

  • TotalEnergies SE (NYSE: TTE) - the TTE share price is up 19%.

  • Saudi Aramco (TADAWUL: 2222) - the Saudi Aramco share price is up 8%.

  • Chevron Corp (NYSE: CVX) - the CVX share price is up 32%.

  • Marathon Oil Corp(NYSE: MRO) - the MRO share price is up 137%.

  • The PJSC Lukoil Oil Company (OTCMKTS: LUKOY) - the LUKOY share price is up 47%.

In comparison how have renewable stocks fared year-to-date?

  • Brookfield Renewable Partners (TSE: BEP.UN) – Brookfield stock is down 15%.

  • NextEra Energy (NYSE: NEE) – NEE stock is up 14%.

  • Enphase Energy (NASDAQ: ENPH) – the ENPH share price is up 25%.

  • Tesla (NASDAQ: TSLA) – the TSLA share price is up 42%.

  • First Solar (NASDAQ: FSLR) – the FSLR share price is up 8%.

  • Vestas Wind Systems (CPH: VWS) – the VWS share price is down 5%.

  • Canadian Solar (NASDAQ: CSIQ) – the CSIQ share price is down 26%.

  • Orsted (OTCMKTS: DNNGY) – Orsted stock is down 34%.

  • Iberdrola (BME: IBE) – IBE stock is down 13%.

Will the oil price keep rising?

While some traders foresee the oil price surpassing $100 a barrel by the end of the year, many believe it will fall. There are signs Asia is reluctant to buy Western oil at high prices and indications of a slowdown are beginning to appear.

Fossil fuel stocks are a risky investment because of the volatility they display. Small-cap oil stocks have large spreads meaning the risk-reward is high. But liquidity is low, so trying to get out of a trade quickly is not always easy.

Big oil stocks on the other hand are usually highly liquid. Another reason oil majors appeal to long-term investors is that they pay such generous dividends. The regular dividend payments help mitigate against share price volatility. Some also engage in share buyback programs which reduces the number of shares in circulation and increases the value of shares held.

However, many of these oil majors are under extreme pressure to transition to a greener business. They’ve been divesting assets to reduce their emissions and invest in renewable alternatives.

These companies have the expertise, talent and resources to forge ahead in building a renewable future. But it comes at a cost, and they are feeling the pinch in missing out on the soaring profits a high oil price can bring.

Oil majors moving into renewables:

  • BP (NYSE: BP)

  • Royal Dutch Shell (NYSE: RDA.A)

  • TotalEnergies (NYSE: TTE)

  • Eni (NYSE: E)

  • Equinor (NYSE: EQNR)

Are oil supplies drying up?

The rising prices come from soaring demand, OPEC+ limiting output, a lack of domestic natural gas and stockpiles dwindling.

Cushing, in Oklahoma, is one of the world’s largest crude oil storage hubs. Here oil traders are worrying that its supplies are diminishing to record lows. This has helped drive prices higher as traders panic buy future contracts with the concern domestic supplies will diminish.

While theoretically, OPEC+ should be able to open the taps at a moment’s notice and bring the price of oil down as it responds to demand, there are whispers this is not entirely true. No one knows exactly how much spare production capacity OPEC+ really has. If it’s less than reported, its reluctance to flood the market anytime soon makes sense.

Why is coal consumption rising?

The US Energy Information Administration (EIA) expects demand for coal from the electric power sector to outpace production this year, but for production to rise in 2022.

The pandemic has led coal mines to operate at reduced capacity and limited transportation. But these constraints should lift in the coming months.

However, the situation in China and across Asia is more alarming. A worsening power crisis in the region is driving increased coal consumption.

But a shortage of coal supplies has led the government to force power cuts of varying duration throughout at least 20 Chinese provinces. This has a knock-on effect on global supply chains because factories have to shut down, meaning goods are not produced or are produced at higher prices.

Coal consumption is rising because increasing demand in Asia is offsetting declines elsewhere. According to the International Energy Agency (IEA) this is not slowing down soon.

Chinese President Xi Jinping has committed to reducing China's carbon emissions but this is going to be very difficult and detrimental to its economic growth. It’s likely to accelerate its already substantial investments in renewable energy to combat this. Indeed nuclear is one area in which it has a head start.

Socially responsible investing is growing and fossil fuel stocks do not fit the narrative. Whether individual investors opt to invest in hydrocarbons or renewables remains a personal choice.

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In this article:

Topics:
Oil, Gas and Consumable Fuels
Industries:
Energy

Author: Kirsteen Mackay

This article does not provide any financial advice and is not a recommendation to deal in any securities or product. Investments may fall in value and an investor may lose some or all of their investment. Past performance is not an indicator of future performance.

Kirsteen Mackay currently holds a position or positions in the stock(s) and/or financial instrument(s) mentioned in the above article.

Kirsteen Mackay has not been paid to produce this piece by the company or companies mentioned above.

Digitonic Ltd, the owner of ValueTheMarkets.com, does not hold a position or positions in the stock(s) and/or financial instrument(s) mentioned in the above article.

Digitonic Ltd, the owner of ValueTheMarkets.com, has not been paid for the production of this piece by the company or companies mentioned above.