Green Around the Gills

Big Oil Can't Avoid a Cleaner Future

Industry should go easy on the capex. It can't avoid a carbon-unfriendly future.
At Closing, June 20th
564.40 GBp
At Closing, June 20th
2538.50 GBp

With crude prices near an 18-month high and Donald Trump about to enter the White House (joined by Exxon Mobil Corp.'s Rex Tillerson as Secretary of State), big oil's enjoying a moment in the sun.

Having slashed spending during the downturn, companies are itching to grow again: Statoil ASA is increasing exploration for the first time since 2013 and BP Plc has green lit a $9 billion expansion of its Mad Dog deepwater project in the Gulf of Mexico.

But while some immediate optimism is understandable, there are sound financial and climate-related reasons why frugality make sense longer term.

In 2017, the top 15 oil and gas companies by market capitalization are expected to invest almost half as much as in 2013, according to Bloomberg data. Not all of that drop relates to upstream development, yet there's little doubt the industry has prioritized easier to get at reserves over expensive swashbuckling projects.

Don't Drill Baby

The top 15 oil and gas producers by market value have slashed their capex

Source: Bloomberg

If you worry -- understandably -- about fossil fuels cooking the planet, this is welcome. True, cheap oil encouraged Americans to fall back in love with gas-guzzling trucks. But $30 oil also meant high-cost projects in the Canadian oil sands and the Arctic were delayed or scrapped. Once an oil producer spends billions on a development project, it's obliged to milk it for years, locking in more dirty emissions.

Instead, the majors have been moving further into natural gas. This helps explain Royal Dutch Shell Plc’s $52 billion takeover of BG Group. And gas is much less carbon-intensive than coal.

Big oil's restraint is good for investors too, not just tree-huggers. Crude's collapse called time on the unhappy habit of committing enormous capital to projects with diminishing returns. Although falling prices made this worse, returns on capital were sinking even when oil was worth more than $100 a barrel. A big reason was the cost of tapping deepwater and unconventional resources. 

Returns to Nowhere

Oil and gas companies used to make huge returns on capital but life has gotten much more difficult

Source: Bloomberg

So what happens now? Oil and gas stocks rebounded in 2016, which makes sense. Rising crude prices, combined with lower operating costs, bode well for profit, while American shale producers will happily embrace any Trump cut in regulations or taxes. The capex slump, if sustained, might lead to less supply and higher prices -- for a while at least.

As such, there's a risk of companies pursuing more ambitious projects again, pushing up their costs.

Yet executives shouldn't misread equity markets. Shell and BP's dividends both yield more than 6 percent, suggesting investors still think they could be cut. Meanwhile, price-to-book ratios don't exactly indicate confidence: 

Lost Potential

Oil and gas stocks look cheap but that's probably because investors don't expect much value creation

Source: Bloomberg

If they can't find capital-light projects, the majors could do worse than return money to shareholders or pay down debt. It could then be reinvested in businesses with better capital returns and a lower carbon footprint.

Otherwise, there's a risk that new high-cost resources become stranded when -- as seems inevitable -- governments are forced to impose stricter regulations to stop the planet getting hotter.

Fossil fuel companies tend to dismiss the idea that their assets might become unburnable to prevent temperatures rising more than two degrees. Yet energy markets are evolving rapidly. In just the last 12 months, German utilities separated their legacy fossil power assets to favor renewable activities, carmakers finally got serious about electric cars and solar power became cheaper than coal in many countries.

Oil isn't about to become surplus to requirements, but that doesn't preclude preparing for a world that consumes less of it. Shell thinks peak demand may happen within five years 1 . Even Saudi Arabia wants to hedge by selling 5 percent of Saudi Aramco.

That smacks of trying to cash in while the going's still reasonably good, bringing to mind Blackstone Group's IPO in 2007 or Glencore Plc’s 2011 listing. Both marked high points for their industries.

Though things look better for big oil than 12 months ago, executives should keep the champagne on ice. Unless it melts.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
  1. Others see oil demand increasing for much longer, however.

To contact the author of this story:
Chris Bryant in Frankfurt at

To contact the editor responsible for this story:
James Boxell at

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