Oil is unlikely to be a good investment » Yale Climate Connection

When we think about solving the problem of climate change, oil's dominance of our economy sometimes seems unbearable.

But what if the production of oil and methane gas (commonly known as natural gas) is no longer as dominant as it once was?

Despite recent record profits, the industry is forecasting weak underlying growth, which has broad implications for investors, not just those of us who care about addressing climate change.

Fossil fuel energy performance review

The chart above shows the 10-year returns for the energy industry (which consists primarily of oil and methane gas) through October 31, 2024.

For all the debate over whether we should divest from fossil fuels moral From perspective, it is important to see if this is a good investment financial position.

How are energy investments performing?

Consider the financial performance of energy investments over several time scales.

Over the past 10 years, energy investments have returned just 0.61% annually to investors, compared with the S&P 500's 10.95% return.

The main reason for lower returns is the decline in crude oil prices in the 2010s, which was triggered by a variety of factors such as cheap US fracked oil, OPEC lowering prices to destroy fracked oil, slowing demand from China, and of course from competition from other countries.

Non-profit RMI and energy expert Nat Bullard said wind, solar and batteries are growing exponentially and cannibalizing oil's market share.

If you look at three-year price performance, energy has produced better financial returns than stocks and bonds overall, with an annual return of 16.02% as of November 1, 2024. Performance is not a guarantee Therefore, it is important to investigate whether the one-year spike in oil prices in 2022 is actually an emerging trend, or if it is just a cyclical shock from Russia's invasion of Ukraine and the resulting reduction in oil supplies.

Energy investment has fallen sharply over the past year, with the SP500 index having a one-year return of 36.04% and a return of only 4.48% as of November 1, 2024.

signs of weakness

A more forward-looking indicator is the 2017 peak sales of internal combustion engine vehicles, one of oil's largest markets. While cars will be on the road for many years, the oil industry would ideally like to see growing demand now in anticipation of growing demand later.

This is not the case.

Estimates of future oil demand vary widely.

A good source for forecasts is Resources for the Future, a US-based non-profit organization that conducts independent research on environmental, energy and natural resource issues. The organization's Global Energy Outlook 2024 reviews some of these predictions. It’s worth noting that no one expects oil to grow exponentially—not even the most optimistic prospects from ExxonMobil and Shell.

Possibility of future growth

The oil and methane gas business could conceivably grow as demand for power generation increases from artificial intelligence data centers, cryptocurrency mining and electric vehicles. But currently, only 6% of oil is used to generate electricity. 85% of new power generation in 2023 will be renewable energy.

In addition to increasing demand for power generation, what other avenues must the oil and methane gas business take to achieve exponential scale?

Oil and gas needs to innovate as expected demand from its main business is expected to stabilize.

One place they could do that is with carbon capture and storage – removing carbon dioxide from the air and storing it underground. It's an expensive business, but new tax credits under the Inflation Reduction Act may help.

But fundamentally, the conundrum facing the industry is that its leaders want to use carbon capture and storage to improve oil recovery, which involves injecting carbon dioxide under depleted oil or gas reservoirs to squeeze out more production .

This isn't really a new line of business, it's just creating a more sustainable version of an existing business. And this is unlikely to grow exponentially.

It’s difficult to determine what long-term effects competition from renewable energy will have. The oil and gas industry may remain stable or decline significantly.

But no one thinks it's going to grow exponentially from now on, which is what you want to find in return on investment.

We have a precedent for investment changes when major energy sources stagnate: the example of coal. View investment performance from 2010 to 2021.

That’s a steep drop!

My point is that oil will not degrade as significantly as coal because oil is used in many more uses than coal, such as heavy transportation (trucks, aviation, shipping, etc.), light transportation (automotive), industrial processes (cement, steel , papermaking) and chemical manufacturing. But when investors don't see exponential growth, they may flee.

On the other hand, if you're looking for an exponentially scalable business, consider low-carbon energy.

Take a look at how quickly solar and wind energy are expanding in the visual above, taken from Our World in Data.

Renewable energy has high construction costs but low maintenance costs, or technically speaking, this is what is known as a high capex to low opex business. Construction requires an upfront loan, and the higher the interest rate, the higher the payment. So it's worth noting that this growth occurred even in the face of rising interest rates.

focus

Knowing all this, you can develop an investment strategy that consists of three parts.

Conclusion One: Even under the most optimistic scenario, oil demand is unlikely to grow much. So maybe don't invest there?

Conclusion Two: Renewable energy and climate solutions are expanding exponentially. So maybe invest a little more there.

Third: Some business models can exist through this energy transition. Think of companies like Costco, Apple, Meta, and Microsoft. So there's value in retaining these assets for diversification, and they're likely to last.

In other words, you can build a portfolio by remembering this simple rhyme: divest, reinvest, hold the rest.

Breene Murphy is president of Carbon Collective Investing, a climate investment advisory firm for employer 401(k)/403(b)s, individual and institutional investors. Murphy is a Grist 2024 Top 50 Climate Leader, Carbon Collective Investing is an implementation partner of Project Drawdown and CEO of Rewiring America's electrification division.

expose

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