There’s plenty of life in oil stocks yet

BP logo © Simon Dawson/Bloomberg via Getty Images

At a recent event hosted by the Financial Times, Rhian-Mari Thomas, chief executive of the new (and exciting) Green Finance Institute, pointed out to the audience that, over the past decade, green has firmly trumped black.

If you had invested in the FTSE All-World index excluding fossil fuels, she said, you would have outperformed the index by 5.5 percentage points in the five years to March 2018. If you had invested in the FTSE Environmental Opportunities All-Share index you would have outperformed the FTSE Global All Cap index by 14.5 percentage points.

For her, that was proof that you can invest for good without losing out financially – and that you should continue to do so. For less “woke” listeners it meant something else. I’m afraid my low-grade mind instantly assumed we should buy energy stocks as fast as possible – or indeed anything else in the filthy carbon-releasing part of the indices that Thomas disapproves of.

Where else can you get a yield of 6% plus in a world of negative real interest rates? I mentioned this; Thomas knocked me back. To save the planet, she said, we must stop removing carbon from the ground – and that means these companies can’t last much longer in their current form. She argued that you might buy BP today on a yield of 6.4%, but there is no way your dividend payout will be sustained for very long.

OK, I said. But maybe ten to 15 years still works. Let’s say I buy an oil mega cap – or a miner, perhaps – on a yield of 5%-7% (for the avoidance of doubt, I already own Shell and BP). I’ll get my money back in nominal terms in ten to 12 years and in real terms in not much more than that – and that’s assuming the dividend never rises. My capital will effectively have been fully transformed into an income.

Oil stocks: better than an anuity?

Compare that with, say, investing in the government bond market. If I buy a ten-year gilt now and hold it to redemption I can be pretty sure that I will never get my money back in real terms.

Then compare it with buying an annuity today. Annuity rates have just hit a 25-year low (records only began in 1994 or I’d be saying a record low). According to Hargreaves Lansdown, if you take £10,000 to an annuity provider today and agree it need not be linked to inflation, they’ll swap it for you for £410 a year.

You might say that you’d take a guaranteed 4.1% a year for life over a not guaranteed 6% that might last long. That may be the right call, but it is worth at least discussing the optionality that comes with the latter. Your capital remains yours and might even rise in value itself. The dividend on a dirty equity might also rise with inflation. Finally, your dirty equities might not be quite as grubby as you think – or indeed as likely to expire gently as some might predict.

Think about electric vehicles. The most important part is the battery – which is jammed with lithium, cobalt, nickel, magnesium, copper and aluminium. Mine those, and you are a natural beneficiary of the shift to a low-carbon economy. Resource companies, say the analysts at BlackRock, are “hooked into a number of long-term structural trends.” You can only say the same for oil in a negative kind of way.

Most people take a pretty dim view of the long-term prospects of the industry (including me – I’ve written about it before). The energy market is in a stage of hugely disruptive transition during which long-term structural demand for oil is surely going to get lower, while the technology to find it and get it out of the ground is getting better.

A lot of it, then, is likely to stay in the ground. But that doesn’t mean it will stop being valuable overnight given that, however you cut it, oil and gas are going to be part of our energy mix for at least as far as anyone can forecast. For example, BP sees a major role for hydrocarbons until 2040.

There’s also the chance that some of these big companies will be encouraged to spend more time at the forefront of the new energy transformation than at the tail-end of the last one. Thomas says hundreds of billions of pounds will need to be spent to meet climate goals. That is “too large for the public purse”. The market can’t be alienated; instead it must be encouraged to help – to “green” its model.

The lack of demand for oil and resources company products over the long term could potentially mean more cash for investors in the short term. Capital expenditure in the mining sector has more than halved since its peak in 2013, say analysts at BlackRock. The result to their portfolio was 38% more dividend income in 2018 than in 2016.

Resource stocks will be around for a while yet

The real point is that the future of resource sector stocks, whatever you may think of them, is hardly set in stone. You could buy the shares, take your yield and see what happens. There is the risk that dividends disappear and you suffer capital losses; it may be that all you get is your money back over 12 years and no more. But there are an awful lot of factors in the mix that suggest the outcome could be rather better.

Many retirees have a “decumulation” problem – they want to see their capital gradually turned into income, yet don’t want to give up control of their capital by buying an annuity. The industry has not come up with any brilliant solutions.

Yet here we have a group of people and a group of stocks with something in common – a very strong chance of not existing in anything like their current form in 25 years.

For more adventurous older investors, a time-limited investment trust that only holds high-yielding shares of the kind Thomas wouldn’t touch could appeal.

Less brave but still risk-aware retirees can, of course, just stick with the FTSE 100 as a whole – by uncanny coincidence, it is currently yielding 4.1% – exactly the same as the annuity rate mentioned above.

Holding equities comes with massive risk, of course. Buying an annuity comes with no risk to your capital (for the simple reason that once you’ve bought one you won’t have any left) and no risk to your income either. That’s a compelling proposition. But if the numbers are still the same when I retire as they are today, I know which one I’ll take.

• This article was first published in the Financial Times