Asset AllocationNovember 7, 2023

Why Oil Stocks, Slipping Now, Have a Bright Future

The industry will be needed to bridge the long transition to net-zero from now to 2050, JPM says.

Reported by Larry Light

Things don’t look so wonderful in the oil patch, as crude prices dipped to $81 per barrel, as of Monday’s market close, down from the 2023 high of $94 in September.

Despite that high, oil company earnings per share slumped by more than one-third in the September-ending quarter, per FactSet. At the largest U.S. oil company, ExxonMobil Corp., EPS fell 27% this year. Exxon stock is 12% off its yearly high and flat for 2023.

But a consensus is growing that oil companies, despite current bumps, have a good long-term future. The thesis is that, even if renewable energy is the overwhelming power source by mid-century, the transition from fossil fuels will be slow—and hence profitable for producers.

“Rising energy demand places greater pressure on traditional fuels to fill the gap,” a report by J.P. Morgan researchers concluded. “This is because the clean energy system is not yet mature enough to capture and distribute the significant increase in the generation of clean joules [a standard energy unit] due to supply chain, infrastructure and key materials bottlenecks.”

Many nations and companies have pledged to get to net-zero of greenhouse gas emissions by 2050, but that is more than a quarter-century away. Some investors have a sense of urgency. Among many public pension plans and college endowments, unloading oil stocks is a cause célèbre. In April 2021, Yale University set investment principles which sought to restrict its investment in fossil fuels.

Of course, a number of allocators disagree. The University of Texas and Texas A&M University systems benefit from lush oil and gas revenues courtesy of the 2.1 million acres of land they jointly own in the West Texas Permian Basin.

By their nature, oil prices are very volatile, so long-term forecasts may turn out to be off-base. After years of stagnation between $50 and $60, they shot up in early 2022, after Russia’s invasion of Ukraine, and have since backed off amid escalating interest rates, China’s tepid post-pandemic-lockdown recovery and ongoing jitters over a possible recession.

At the moment, demand for oil has held up, and the oil-producing countries in OPEC Plus have cut back on pumping. “While there are downside risks linked to a global recession and disappointing economic performance from China, energy stocks should outperform the broader equities market as supply-demand fundamentals remain tight,” JPM strategists wrote.

As a result, two large industry mergers have bolstered the case that many years of oil usage lie ahead: Exxon’s $59.5 billion planned acquisition of Pioneer Natural Resources Co. and Chevron Corp.’s $53 billion purchase of Hess Corp., a big integrated oil outfit.

Interestingly, this has not aroused a great deal of green-minded opposition. Consider the reaction of the three people that environment-oriented hedge fund Engine 1 successfully pushed through to become Exxon board members: They supported the Pioneer deal. Engine 1’s leader, Charles Penner, was quoted in the Wall Street Journal as saying that the acquisition was OK because it would do nothing to defer net-zero goals.

This acceptance of oil companies playing a big role well into the future sounds like a recipe for their stocks to rise. In JPM’s view, “even as equity valuations face risks from higher-for-longer interest rates, energy stocks tend to be well-positioned.”