They’re cheap, pay big dividends and have benefited from a recovery in oil prices. That’s an attractive combination for investors who are nervous that the broader market is overvalued after the relentless rally from the pandemic bottom last year. As an added kicker, many crude producers are plowing cash into renewable energy, helping to blunt criticisms that they’re contributing to climate change.
“It just strikes us that looking right now in the market at what is very cheap, generating lots of cash, but also having very strong earnings momentum, the energy stocks really stick out as being very attractive,” Niall Gallagher, investment director of European equities at GAM Investments, said in a telephone interview.
Gallagher owns Equinor ASA, BP Plc and Royal Dutch Shell Plc, and is overweight the energy sector in his GAM Star European Equity and GAM Star Continental European Equity funds.
For now, even with their big investments into renewable energy, battery storage, electric-vehicle charging points, carbon-capture technology and other decarbonization efforts, these companies still devote a big chunk of their capital expenditures to fossil fuels, which weighs on their environmental, social and governance scores.
“I think oil and gas is quite a difficult one to spin them as positive ESG plays at this stage because their proportion of non-fossil fuel revenues is still very small as a percentage of their overall revenues,” said Alan Custis, head of U.K. equities at Lazard Asset Management LLC.
And for investors in oil and gas stocks, it hasn’t been easy: The pandemic prompted oil majors to slash dividends in an effort to cut costs and preserve capital, and the sector lost a quarter of its value in 2020, the biggest drop in the Stoxx Europe 600 Index.
But now that economies have reopened and oil prices have recovered from their 2020 plunge, they’re turning the taps back on with pledges to increase cash payouts and buy back shares. Still, the sector is again the worst performer in the broad market.
For this, investors blame economic concerns but also worries over Big Oil’s role in contributing to climate change. European crude producers are fighting back by increasing investments in the transition to cleaner energy, but that causes its own problem: The spending threatens to deprive the companies of cash needed for dividend payments.
Investors have wondered how much cash oil and gas firms would divert to renewables, when it’s yet to be proven that they can earn a return long term on that investment, Custis said. These worries are abating as companies have given more details of their plans.
“It does feel that the market’s become incrementally more comfortable with how these companies are going to ultimately pivot their business away from fossil-fuel production,” Custis said by phone.
Meanwhile, oil producers will continue to profit from drilling for crude. Fossil fuels are here to stay for at least 30 or 40 years, and there’s still demand from the chemicals industry for making plastics, said Alasdair McKinnon, lead manager of the Scottish Investment Trust. He counts Exxon Mobil Corp., BP, Shell and TotalEnergies SE among his holdings, with oil and gas companies making up 15% of his portfolio, almost quadruple their weight in the European stock market.
“People tend to pick on Big Oil and say, ‘You guys are evil, these companies shouldn’t exist,’” McKinnon said by phone. “What we do is say, actually, it’s really complex.”
Plenty could still go wrong for investors betting on energy.
The delta variant of the coronavirus is threatening to damp growth more than investors had expected, and at the same time the Federal Reserve is lining up to begin a pullback on economic stimulus this year. Both elements are already weighing on oil prices. Oil bulls aren’t deterred.
“The companies themselves are transitioning into being integrated energy companies from integrated oil companies, so they are becoming greener in what they are doing, but they are also generating a lot of cash,” GAM’s Gallagher added. “At the current share prices, these are very, very cheap investments.”