Trying to get a fix on whether Americans will be able to buy cheap gas in ten or 20 years time isn’t easy. In fact, it’s hopeless. What we do know is that interest in energy is growing at a furious pace, and the reason is worryingly simple: the earth’s oil supply is running out. And while our planet might not run dry of it entirely, sucking the carboniferous stuff out of the ground is increasingly costly, especially if oil companies have to travel to high-risk areas of the world to bring it home.
But as perilous and resource-intensive as this industry is, many energy companies are seemingly on a roll. Shell, lately associated with dual board problems and its reserves debacle, stunned investors recently when it reported a £9 bn ($17.2 bn) profit haul. BP followed days later with an £8.7 bn return.
Robert Barrington, director of governance and socially responsible investment (SRI) at F&C Asset Management in London, says although the recent bumper oil company profit gush is impressive, the short-term profiteering must be set against long-term reserve concerns.
‘Today’s profits are partially a function of high oil prices,’ he points out. ‘But investors have to look to the long term. One area of increasing interest to us is whether poor management of social and environmental issues will block off access to reserves. In Nigeria, for instance, if the population riots, companies cannot pump oil. So although the oil is there, it may happen that companies are denied access to it due to social and political risks. The same applies to ecologically sensitive areas. If companies cannot operate there, it does not matter how much oil is in the ground. On the other hand, a good track record in environmental management means companies are more likely to be given the keys.’
Risky business
Of course, the further an energy company has to travel to find oil, the more risks it exposes itself to, particularly on social, environmental and ethical (SEE) issues, and these are an IR matter. Analysts and managers are increasingly knowledgeable about how oil company reserves get linked to human rights or access to environmentally sensitive areas, explains Robin Batchelor, co-manager of the Merrill Lynch World Energy Fund and Merrill Lynch New Energy Technology Trust. He thinks companies with poor SEE track records are increasingly seen as liability-ridden.
‘The market is slowly moving its emphasis from penalizing ‘bad’ companies to being neutral on good companies,’ he says. ‘The next stage will be to reward good companies, but that’s difficult to do when so many of the moving parts are difficult to value. Nevertheless, as SEE rules, costs and penalties become more established with this progression, strong SEE companies will be rewarded.’
Although Batchelor says there’s little chance of oil companies of any size escaping scrutiny, some firms are less accepting of climate change issues. ‘ExxonMobil has been very public in saying the need for climate change is not as proven as others believe,’ he notes. ‘But now the Kyoto Agreement on climate change has [come into effect], fund managers are going to talk more and more about the environment. It simply isn’t good enough to say, Who cares about this? We’re about making profit and people need our oil.’
New ideas
If the world is to be weaned off its thirst for oil, however, new commercially viable energy ideas are needed. And Charles Thomas, fund manager of Jupiter’s £135 mn Ecology Fund, has plenty, though he’s careful to align his picks with long-term energy trends. ‘It’s the kind of technology that won’t make money today but the right alliances with manufacturers are being made – call it the conceptual stock,’ he says.
A step back, Thomas believes, are renewable technologies like wind, solar and wave power that are backed up by enabler stocks: companies that don’t provide renewable energy per se, but help make it possible. ‘I have a thematic approach, much of it down to clean energy – all renewable – but also to water companies, public transport and organic food,’ he says. ‘It’s a broad remit so I can go into defensive sectors, too.’
It’s also a fund that refuses to be easily labeled, being green, global and growth-based simultaneously. ‘My approach over the long term is to invest in good companies that deliver performance while meeting the demands of environmental and social issues,’ Thomas explains.
Certainly pockets of Europe appear to be working hard with eco-friendly technologies such as wind and wave energy, though laying hands on the cash to back the more pioneering projects, at least compared with a more entrepreneurial US, remains an issue. Energy funds in the UK, for example, still have a tendency to focus on management buyouts or already profitable companies, points out Batchelor, whose own New Energy Technology Trust has a 70 percent US bias.
As for IR quality, Batchelor says it can be jaw-droppingly awful, particularly lower down the range. ‘Sometimes it’s almost embarrassing,’ he notes. ‘The IR people have some script that’s been prepared, but they’re trying to reply to our questions via that script. That makes IR look as if it doesn’t know what it’s talking about, or it’s not allowed to talk. So why then are we having the meeting? Sometimes IR people don’t know how our job works. We need to hear from a financial and operational perspective and expect those people to engage with us, and know about their own company and how the stock market works. If not, we’re wasting time and we’re better off going to management.’ Batchelor also believes competent IR is so important – as illustrated by companies such as BP and Exxon – that it should be a management role.
Still, long-term vision in the energy industry appears a mixed bag. Last year Goldman Sachs produced its global Energy Environmental and Social Index, which rates all international oil companies on issues such as climate change, human rights, safety and transparency. BP took top honors, scoring high on climate change and human rights. Shell and Statoil came close behind while Yukos and Cepsa turned in particularly dismal ratings on safety and pollution. But the Goldman findings also reported that up to 14 percent of European pension fund holdings are now run on a core SRI basis, or are influenced by SRI-based sector exclusions. And, according to a Thomson Extel Survey, 45 percent of UK fund managers say more than 10 percent of their total assets are managed on SRI factors.
Reserving judgment
This is all good news for SRI/SEE investment. But it’s not clear-cut. In 1995 Greenpeace and the oil industry clashed over Shell’s intention to sink its massive Brent Spar oil platform into the Atlantic (it was eventually chopped up for scrap and recycled into the foundations of a new Norwegian ferry terminal). While Shell probably suffered damage to its reputation from the outcry, Goldman report author Anthony Ling points out that Shell’s ‘share price outperformed the sector by 2 percent over the course of the affair.’
Some investors could have been sufficiently dismayed by Shell’s apparent lack of respect for the environment to sell their holdings but, even if they did, says Mark Campanale, head of SRI development at Henderson Global Investors, it would have had little impact. ‘If Shell had taken this rig offshore, the total costs would have been negligible compared with the overall profitability of the business,’ he explains.
At least in the short term, that is – which brings us back to the short-term versus long-term supply issue. Short term, we know there’s a problem with supply and price certainty. Long term, thirst for oil from countries like China and India is set to soar; both are huge importers. Things, it appears, can only get worse. But will they? And can the oil industry be trusted in the meantime to supply the full story, whether on reserves or other market fundamentals?
One London oil analyst says if we are to understand the oil industry, we need to get less worked up about the reserves issue. ‘It really has led a lot of people in the wrong direction,’ he observes. ‘I would say almost all oil companies are now bending over backwards not to get reserves wrong. But the reserves issue is like trying to audit your current account while debts and credits are constantly being made. In the case of Shell, yes it is replacing less than 100 percent of its reserves annually. Shell’s booked reserves currently are between 12 bn and 13 bn barrels, but there’s also stuff in the long-term account, which Shell doesn’t yet have a plan or market for. You have to look at the broad sweep of the hydrocarbon resource base. There are lots of projects going on, whether off the west coast of Africa or in the Caspian Sea, and though the frequency of new discoveries is not as high as in the past, it’s a far more sophisticated situation than the bare numbers tell.’
