Oil had a terrible 2020. This year will be better

2020 was a bad year for Big Oil. Oil prices went negative in April as global demand collapsed and big state producers embarked on an intriguingly-timed price war, so you’d expect oil companies to have struggled last year.

But a longer-term pressure has been building for some time. That’s the growing enthusiasm for ESG – environmental, social and governance-focused – investing. And ironically, it could contribute to oil having at least one last big hurrah.

2020 was a terrible year for oil

ExxonMobil just reported its first annual loss ever – and it was a big ’un, more than $20bn. As the FT points out, last year also saw ExxonMobil kicked out of the Dow Jones Industrial Average as its market value collapsed.

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Then we have our own BP Group. It recorded its first annual loss since the Deepwater Horizon disaster in the Gulf of Mexico, back in 2010. It swung from a $10bn profit in 2019 to a loss of $5.7bn. Most of this is down to the shutting of the global economy in 2020. But there’s longer-term pressure building on the oil industry too.

Big investors were already talking about “divestment” and “stranded assets” well before Covid-19 became an issue. This is the idea that investors should sell out of oil companies (and other fossil fuel producers). The overarching argument is that it’s unethical to hold these companies because they contribute to climate change.

That can sound preachy, particularly when it comes from big institutions who are good at talking the talk on ethics, but pretty bad at walking the walk. However, the underlying logic is simple and rooted in practicality, to an extent. If governments continue to impose increasingly strict rules on carbon dioxide emissions, then eventually it will become uneconomic to pull existing resources out of the ground. Hence the term “stranded assets”.

The latest big news story on this front is that Aviva, one of the UK’s biggest asset managers, has warned that it will ditch its holdings in 30 oil, gas and mining companies if it doesn’t see more evidence of an effort to clean up their acts.

Aviva manages more than £350bn. As Attracta Mooney reports in the FT, this threat “marks a departure from the current blueprint of most asset managers, which is to stay invested in the oil and gas industry while urging companies to do more on global warming”.

It hasn’t named specific companies, but the group has written to companies “calling on them to set net zero emission goals and integrate climate risks into their strategy, including their plans for capital expenditure”. If they don’t meet expectations in the next one to three years, Aviva will sell both shares and bonds linked to these companies.

So far, this sort of move has only been applied to coal companies at an asset management industry-wide level. A cynic would point out that this is because coal companies have been terrible investments anyway.

The goals of such divestment are slightly nebulous. There’s the practical argument: “these are bad investments because these companies are going to go out of business”. There was an argument about starving companies of capital, but that one seems to have fallen by the wayside after none other than Bill Gates pointed out that it was nonsense.

And then there’s the argument that such public pressure strips companies of their “social licence to operate”. This might actually hold a bit more water in that CEOs certainly seem to be swayed by social agitation to a surprising degree (look at the number of times in recent memory that a stray communication on social media has led a company straight into foot-shooting mode).

Certainly, Exxon is a notable holdout on the “energy transition” front. Both Shell and BP are making very public attempts to shift their focus towards greener investments, such as electric car charging points.

Like it or not, we still need oil

The big problem here is simple: we use oil for a reason. We have this inane habit of splitting things into “goodies” and “baddies”. But the pollution from fossil fuels is a side-effect. It’s not the goal. We put up with the bad bit (pollution) because we enjoy the gains created by the good bit (lots of cheap energy). Beyond a few fringe extremists, we don’t want to stop using energy, or regress to the stone age. So what are our realistic options?

We can replace oil, and we are making some progress on this front. Electrification of cars will be a big step – as long as we don’t generate the electricity to fuel them from coal, then that should improve things. But it’s going to take a while. And you’ll still need oil for a lot of other stuff.

The other option is to make the oil extraction process cleaner using technology. That will drive up the cost of oil, however. And will it ever satisfy increasingly hardline ESG requirements? Depends on which way the wind is blowing.

In short, this is yet another pressure on an industry that we still need. Meanwhile, the collapse in oil prices last year has led to companies and producers across the globe reining in production.

If you want to know why the oil price is suddenly rising quite sharply, that’s basically what it boils down to. Supply is being slashed. And on the demand front, we might be a while away from “normal” but if we can just get these vaccines rolled out fast enough, the pressure to re-open will build. And I suspect the tone will flip – from one of “we’d better not leave the house” to “get me out of here!” much more quickly than most of us can imagine right now.

So don’t be surprised to see oil prices spike just as companies are tying themselves in knots about strategy. Which is also why I think it’s worth you hanging onto your oil investments just now, even if others are keen to sell them off.

We’ll have more on this topic in MoneyWeek over the coming months. If you’re not already a subscriber, get your first six issues free here.