As the well-worn investment advice goes: only when no-one else wants it, is it the right time to buy. And if you are looking for investments that have lost their popular appeal, look no further than integrated oil companies, which participate in every aspect of the sector.
Or at least, that is according to Ashley Lynn, head of fixed income at Orbis, an asset management firm which prides itself on generating returns for its clients by investing in undervalued companies.
Lynn’s take on fossil fuels flies in the face of mainstream investment trends.
In June, Norway took the lead in fossil fuel divestment when it determined its trillion-dollar sovereign wealth fund, known as the oil fund, would divest billions from 150 upstream oil and gas companies and channel up to $20bn in renewables.
But for Lynn, who spoke at the Allan Gray investment summit last week, the large integrated oil companies, especially the European ones, present an exceptional investment opportunity. Integrated oil companies are involved in the discovery, extraction, refining and distribution of oil and gas.
When oil peaked at $110 a barrel in mid-2014, these companies — Shell, BP and Tota — were fat and happy. But when prices plummeted to unsustainable lows of below $40 a barrel in early 2016, they had to become lean and mean to survive. Their share prices have since bounced back, but not nearly enough to reflect the underlying improvement in the oil price and the companies themselves, Lynn says.
In terms of free cash flow, these companies did better in 2018 with an average oil price of $72 a barrel compared with 2014 when the average price was $99 a barrel.
“They’re just better companies, but they are still being treated like terrible companies in terms of their price. At the moment, integrated oil companies are at their cheapest levels in history if you look at them relative to world markets,” she says. “They are at a 60% discount relative to world markets on a price to book basis. On price to cash-flow they are 50% cheaper than the rest of the market and are giving about 2.3 times the dividend yield.”
Offshore drillers offer even more bang for your buck, says Lynn.
Growing concerns over climate change are stoking negative sentiment toward major producers and consumers of fossil fuels, as well as the institutions that fund it, but from a practical stand point, Lynn does not see that fossil fuels, especially gas, are going away anytime soon.
As much as wind and solar are increasingly becoming part of the mix in national power resources, they remain intermittent and so unable to provide baseload. For that to happen requires large scale and economic ways of storing renewable power for use when needed. Lynn thinks the advent of this is a long way away.
But natural gas, as produced by oil and gas major companies, may provide the answer. In fact efforts to reduce emissions when burning fossil fuels, has been more effective in this aim than any green tech or power generation has, Lynn says. “Of course, very often, the most practical things are not the most popular — and oil and gas are definitely not popular — which is another way of saying they’re cheap.”
Tom Sanzillo, director of finance for the Institute for Energy Economics and Financial Analysis, a global energy finance think-tank, agrees fossil fuel companies are not going anywhere, “but I mean that in a financial sense”.
Sanzillo says that while technical advancements have seen oil and gas companies increase global production dramatically, they are not doing so profitably.
“You have an increase in oil and gas production in the world at the same time the industry is slipping,” says Sanzillo. “These companies don’t have a business model that can capture the value and so they are in financial decline.”
Once the fossil fuels industry led the world economy, but now it is a laggard, Sanzillo says.
Their ability to come back, would have to mean a profound change in the markets in the world, “and according to one of the biggest owners of oil and gas in the world in the world, Norway, that’s not going to happen”.
He says Norway’s move away from oil and gas is simply because it can see it will not get sufficient revenues from these going forward. “Norway is a big investor in oil and gas but has an economy based on it, but it can no longer be so exposed to something with lower profits and even higher risk.”
Sanzillo agrees natural gas will play a role, but probably not continually. “The market incentives are not there. Just like we see renewables cutting into natural gas’s market share in the US, that’s going to happen all over the world.”
For the integrated oil companies, the recapturing of former glory days just is not going to happen, he says. “This is not a speculative one day thing. This is a profound 39-year trend.”
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