Is oil a good investment?

Ordinary people have just learnt a completely new term, ‘polar vortex’, which appears to be responsible for the extreme, freezing temperatures recorded in Chicago, one of the world’s major cities. Meanwhile, constant wildfires are ravaging California due to persistently high temperatures and a lack of rain, whilst in Australia they are triggering sweltering summers.

It is undeniable that the Earth is undergoing radical climate change, caused primarily by the continuous emission into the atmosphere of gases from fossil fuels, mainly petroleum derivatives.

Meanwhile, the US has already announced its withdrawal from the Paris Agreement, which aims to limit emissions of the gases that cause the so-called greenhouse effect.

And this is where we need to decide whether or not it is worthwhile investing in companies that specialise in these energy sources.

According to data provided by the International Energy Agency, over the next 20 years, the world will undergo a level of electrification never seen before. And this electrification will not be driven primarily by the replacement of the vehicle fleet, as everyone seems to think, but by the improvement in living conditions for many poor people across Asia and Africa. And not major improvements, but simply having access to mains electricity in their homes, enabling them to own a fridge or an air-conditioner.A striking statistic is that, in emerging economies alone during this period, 2,500 million air-conditioning units are forecast to be sold, compared with the current figure of 600 million.

This massive electrification requires a source of energy and, interestingly, it will not be so-called clean or renewable energy, but rather existing sources, with nuclear energy being the only one to see a substantial increase.

Whilst China has 60 nuclear power stations under construction – which will double its current nuclear energy production and mean that the country’s electricity supply will be based primarily on this form of energy – the Western world, namely Europe and the US, is drastically reducing the number of such stations. This policy of phasing out nuclear power will make Europe the only major economic power that is 100 per cent dependent on other energy sources. A complete aberration.

Against this backdrop, the International Energy Agency does not believe that demand for oil will fall over the next 20 years; indeed, it estimates that demand for oil will grow by 12 per cent above current levels during that period, despite the expected improvements in fuel efficiency.

China will become the world’s largest consumer of oil in 2039 and its largest net importer in 2040, importing 13 million barrels a day, whilst the real new player in this market will be the US, which will account for three-quarters of the increase in oil production set to occur in the market. The US will increase its production at a rate of 5 million barrels per day, with peaks of up to 18.5 million. And all this is due to a new source of oil: shale oil, or as we call it in Spain, fracking.

This new source of oil has enabled the US to become an energy-independent power, with all the strategic implications that this entails for what remains the world’s largest economy.

Saudi Arabia, having seriously misjudged this new source of oil, triggered a drastic fall in the price per barrel in 2015, with the aim of driving these new companies into bankruptcy, as their upstream break-even point was around $60 per barrel. Not only did it fail to achieve this, but it also inflicted such a budget deficit upon itself that, for the first time in history, the Saudi state had to issue public debt and consider a move – albeit a partial one – to list its state-owned oil company on the capital markets. Over time, thanks to R&D, these companies have reduced their average break-even point to below $40 per barrel, which clearly makes them stronger.

Furthermore, the World Bank’s most optimistic forecasts estimate that by 2030 the proportion of electric cars on the road worldwide will not exceed 17 per cent. And all this without forgetting that, whilst the hydrogen fuel cell is becoming standardised as the main source of power for cars, a significant proportion of the electricity consumed by these supposedly ‘clean’ cars comes from thermal power stations whose primary energy source is fossil fuels and which are, therefore, polluting.

If we add to all of the above the fact that driving the current oil companies into bankruptcy would be like shooting oneself in the foot, as they constitute a systemically important sector at a global level, whose collapse—triggered by a drastic reduction in their revenues—would leave the world without one of its main sources of energy, we believe that oil and gas companies will continue to be a sound investment, even in the long term.

Previously, an extraction company was not the same as a refinery, nor was an aggregator the same as an engineering firm. But now size comes into play – and how. Research into alternative forms of energy and future leadership capacity, together with size – due to the systemic nature it provides – will determine a company’s ability to create value.

It is here that we believe the greatest potential for value growth lies in the world’s five major oil companies: Total, Royal Dutch, BP and, above all, the two largest, Exxon and Chevron. Engineering firms such as Schlumberger also offer such potential.

The number of wells currently in operation or for which they hold rights, together with their distribution network, will provide them with sufficient funds to undertake the necessary investments and remain market leaders, whilst also enabling them to spearhead the electrification of the automotive sector through hydrogen fuel cells.

One example of leadership is Exxon, which is, unfortunately, notorious for the environmental disaster caused by the oil tanker Exxon Valdez in the late 1980s off the coast of Alaska. Whilst the other four major oil companies have forecast modest growth over the next five years, Exxon forecasts growth of 25 per cent in oil and gas production by 2025, driven by the wells it can drill profitably when the market price of a barrel of West Texas crude is above $50.

Of the ‘Big Five’, Exxon is the company with the highest return on capital employed, which, according to the announcement made by its new chairman during the latest results presentation, will see it invest the staggering sum of 200,000 million USD by 2025 with the aim of tripling the profits reported this year by that date.

We therefore regard the oil and gas sector as an excellent sector in which to hold long positions, primarily in large companies with highly diversified R&D activities.