My hypothesis is that US majors underinvest both in renewables and in oil and gas needed to get us through the energy transition. Perhaps, the right question, addressed to both the anti and pro ESG wings, should be: how to get more investment in both oil and gas (if needed) and in renewables, which is clearly needed?
Now that the House of Representatives had turned over to the Republicans, the rhetoric around claims of “woke” capitalism have grown louder. One of the major beefs of the anti-ESG wing of the Republican party is that ESG is responsible for the cut in US investment in oil and gas production. At the same time, the International Energy Agency (IEA), by no means a liberal mouthpiece, calculated that “in 2020, clean energy investments by the oil and gas industry accounted for only around 1% of total capital expenditure.” That proportion was expected to go up to around 4% in 2021.
These claims, when juxtaposed, lead me to a hypothesis that has not garnered much attention thus far: US majors potentially underinvest both in oil and gas production and on renewables.
I believe that the anti-ESG wing is partially correct in that US majors do appear to under-invest in oil and gas production. However, I am not sure the underlying cause is ESG. The pro-ESG wing is also right to argue that US oil majors under-invest in renewables. But should they even invest in renewables? Do they have any kind of comparative advantage in renewables relative to startups and other ventures?
How long will the energy transition take?
Let us start with a little bit of a background related to how long the energy transition will realistically take. I am not sure anyone really knows what the demand for oil and gas will look like in the next 20-30 years given so many contradictory signals: the Ukraine war, the government and venture capital going into renewables, the push for electric vehicles, the difficulty in sourcing lithium for electric vehicles, the large upfront capital investment needed for wind and solar, the elusive promise of hydrogen and so on. The International Energy Agency (IEA) expects oil demand to rise at 0.8% per year to 2030, but to peak soon after at around 103 million barrels per day or roughly 38 billion barrels a year. Of course, the IEA has several demand forecasts under different demand scenarios. Companies cherry pick the one that suits their purpose. Hence, I am not even sure whether or not more investment in oil and gas production is needed but my gut tells me the answer is yes.
Hence, if you are an emissions optimist, you might argue that the relatively quick decline in the oil and gas inventories of ExxonMobil and Chevron, shown below, is justified as the world moves away from fossil fuels. If you are not so optimistic about renewables quickly coming on board to replace fossil fuels, you might worry that the US oil majors are effectively ceding market share to Saudi Arabia’s Aramco, which has reserves to sustain its current production levels for more than 50 years.
What are the US majors actually doing?
I present two data points to arrive at my inference. Compare the closing inventory of oil and gas reserves left in the ground to the quantity of oil and gas produced that year. I present data for five three-year intervals for Exxon Mobil ended December 31, 2021 to parsimoniously present information on how these companies have evolved over the last decade or so.
All data are drawn from S&P CAP IQ, which, in turn, gets it from Exxon’s 10-K. As shown in the table below, as of 12/31/2009, Exxon had 13.3 years of oil and 18.4 years of gas left. Those numbers for oil peaked in 2018 below at 18.9 years but fell to 14.8 years in 2021. The fall is even steeper for gas. As of 12/31/21, only 11.3 years of gas is left untapped. Hence, Exxon is apparently not investing in adequately replenishing its oil and gas reserves.
Chevron is a smaller company, as can be seen from the size of its reserves, which are virtually half of Exxon Mobil’s for oil and a third of Exxon Mobil’s in terms of gas at the beginning of the analysis in 2009. By 12/31/21, Chevron’s gas reserves are just slightly smaller than that of Exxon Mobil. Regardless, at the beginning of the sample period, Chevron had 10.3 years of oil and 14.3 years of gas left. At the end of the sample period, as of 12/31/21, the company only had 8.99 years of oil and 10.0 years of gas left.
How do these numbers compare with those for BP and Shell, the European giants, and Aramco?
BP’s oil inventory has certainly fallen from around 11.4 years of production left in 2009 relative to 8.0 years left as of 12/31/21. But their gas inventory is almost constant at around 13-14 years for 2009 relative to 2021. BP does seem to have cut its oil reserves and production in 2015 in the table but that cut is more likely on account of lower oil prices as opposed to ESG which started taking off as a mainstream investment idea much later.
Shell’s oil inventory has fallen from 9.2 years in 2009 to around 7.2 years in 2021. More worrisome, look at the gas inventory that has fallen from 14.7 years in 2009 to only 8.0 years in 2021.
What about Aramco?
Aramco has been public only for a brief while now and I could not find data on reserves and production before 2017. Hence, I present data continuously from 2017 till 2021 below for Aramco. As one can see from the data, Aramco is in a league of its own. It has more oil and gas reserves than all the four Western majors combined. Aramco’s inventory has actually increased. In 2017, Aramco had oil inventory equivalent to 48.8 years and that has increased to 57.4 years partly on account of lower production in 2021. Its gas inventory stood at 51.2 years in 2017 relative to 57.9 years in 2021.
Does the US even have a low investment problem?
Of course, all measurement is complicated. Estimates of reserves are a function of the prevailing oil and gas price and technology used to discover fossil fuel deposits. The technology keeps getting better but oil and gas prices fluctuate a lot. Some skeptics argue that US majors do not have an under-investment problem. They look at the following two data points:
· The lower reserve to production ratios for US majors may reflect their shift to shorter cycle production, such as in US tight oil and shale gas. Short-cycle production has higher rates of return because these companies earn revenues fairly quickly. In contrast, Shell and BP have most likely sold out of their US short-cycle shale positions and have more long-lived deep-water fields in their portfolios. It may take seven years or longer to get production and revenues going for those reserves. Moreover, I am told that reserve to production ratios can stay the same for many years despite the intervening years of production and hence may not solely represent under-investment. I am not as sure about this statement.
· The overall domestic situation is arguably much better as per the U.S. Energy Information Administration (EIA), which reports that US proven domestic reserves of oil and gas stood at 41 billion barrels and 625 trillion cubic feet as of December 31, 2021. Domestic production for the year 2021 was 3.8 million barrels and 38.1 trillion cubic feet respectively. This leads to a reserve to production ratio of 10.7 years for domestic oil and 16.4 years for domestic gas. Of course, looking at domestic reserves alone is not totally appropriate as US majors have both domestic and international fields.
While I hear these arguments, I don’t fully buy the claim that reserve to production ratios do not indicate under-investment. Remember that I am comparing reserve to production ratios for US majors across the last 15 years or so. For the experts’ counter arguments to fully work, US majors must have radically changed their focus from long cycle production in the 2010s to short cycle production now. Even if that is fully true, don’t short cycle production ratios, by definition, suggest the need to keep investing in future reserves continually?
How much do US majors invest in renewables?
Climate change activists argue that oil companies should be investing less in oil and gas and more in renewables. In November 2021, Exxon announced investments of $15 billion on carbon capture, biofuel and hydrogen. I do not know for sure over what period, and how much is devoted to biofuels and hydrogen, which can produce energy, as opposed to money spent on carbon capture. Exxon’s exploration and development spending for 2021 alone was $20.5 billion, in contrast.
Chevron has announced that they will spend $10 billion on “a lower carbon future” by 2028, an average of $2 billion per year. It was not obvious how much of this will be devoted to renewables, as opposed to carbon capture. Chevron’s exploration and development spending for one year (2021) was $9.8 billion, or five times as much.
Bloomberg reports that “currently, about 90 cents goes to low-carbon energy sources for every $1 put toward fossil fuels. That ratio needs to change dramatically by 2030, with an average $4 invested in renewables for every $1 allocated to high-polluting energy supplies, analysts at BNEF said. For context, that ratio has never before crossed the 1:1 mark.”
For Exxon and Chevron, the ratio is nowhere close to 1:1, as can be seen from the data I just presented.
So, what do the US majors do with their excess cash flow?
Exxon appears to have funded some capex, repaid debt and paid out dividends from its operating cash flows over the last five years ended 2021. In 2022, they have bought back stock. Chevron has done something similar.
Is this the right strategy?
One could argue that a wind-down strategy is perhaps the right answer for US majors. If they keep inventories in the 8-10 year range and pay out dividends, investors can use the money to bet on pure play renewable companies that are better positioned than Exxon Mobil or Chevron to invest in these emerging risky ventures. As I have said before, companies are rarely good at investing in the next big thing that likely cannibalizes their traditional product. One view is that oil majors should just deal with carbon: produce it and capture it back.
Why are both sides right for the wrong reasons?
I am skeptical of the anti-ESG wing’s argument that lower investment from oil and gas companies in the US has been due to ESG. I suspect investor demands unrelated to ESG are responsible. Returns on capital were miserable for oil and gas companies for the last decade, a point made forcefully by Engine no.1 in its presentation against Exxon.
Experts tell me that the US oil and gas industry was re-investing at a ratio of 130% of operating cash flow after the shale revolution and taking on debt to do so. Going forward, investors wanted to see lower debt, higher share buybacks and dividends. I am told that any company that announces an expansion in capital spending experienced an immediate 10% drop in their share price. For instance, Continental Resources reportedly got tired of it and their biggest shareholder (Harold Hamm) took the company private.
Hence, ESG is unlikely to be the primary driver of lower investment. However, you could argue that we now have a smaller pool of investors willing to invest in oil and gas and thus companies bend over backwards to satisfy the ones they can attract. In joint work with Robert Eccles and Jing Xie, we did find a higher cost of debt (not for equity though) for oil and gas companies even after accounting for all fundamental attributes of the company that we could think of. Clearly the number of debt financiers is smaller than the number of equity investors.
The question going forward is whether this changes with higher oil prices. Given enough years of good returns, will investors come back? Vivek Ramaswamy’s pitch for DRLL seems to think yes. Or do increasing concerns about ESG shrink the pool of investors such that they must retain capital discipline?
On the other side, I am not sure that the pro-ESG wing has made a strong case for why oil majors should invest in renewable power. It is not obvious that there is a shortage of venture and government capital in the world devoted to renewables. If so, why should the oil and gas industry invest in renewables? As mentioned earlier, do oil and gas firms have the appropriate skills needed to succeed in the renewables business? Except for land ownership and offshore skills that suggest wind could be a relevant business, experts do not see a fit for oil and gas renewables.
In sum, capital discipline imposed by investors will probably result in the US majors ceding production to state owned enterprises such as Aramco. Aramco does not have the same investor pressure related to capital discipline. They also most likely will not have the same degree of ESG pressure as US majors. Of course, I continue to be unsure of the extent to which US majors’ production is actually hurt by ESG concerns.
Perhaps, the right question, addressed to both the anti and pro ESG wings is how to get more investment in both oil and gas (if needed) and in renewables, which is clearly needed?