As geopolitical tensions increase and the first Russian troops enter Ukraine, oil has surged to over $100 a barrel, reaching its highest level in over seven years. But what does the sky-rocketing oil price mean for the fortunes of the share price of BP (LSE:BP) and Shell (LSE:SHELL)?
The unintended consequences of ESG
The world today faces a climate emergency. The need to accelerate toward a low-carbon economy has never been more pressing. In the rush to meet the goal of decarbonising our energy mix, however, we have forgotten about how we are going to meet the basic needs of society in the near-to-mid-term. As huge amounts of capital (both human and financial) have flowed into technology over the past 10 years, the natural resources sector has been left behind. But if the world is to meet its ambitious climate change targets, then this imbalance must be addressed, and soon.
Activist investors, changing public sentiment and increased regulatory pressures from governments have all contributed toward negative sentiment toward big oil. Although the industry as a whole continues to clean up its operations and improve its public image, for me only a concerted effort across many stakeholders (including governments and society) will help us navigate toward a greener economy. Without it, my fear is that the chronic dearth of talent enrolling in earth sciences and related university degrees will continue to remain low. In this scenario, meeting the public’s desire to meet net zero emissions by 2050 or before is unlikely to be achieved.
Given the macro economic forces I have outlined above, I still believe the prospects for BP and Shell throughout this decade remain strong. We’re already seeing large institutional investors rotating out of overvalued US equities and into tangible assets. Software might be eating the world, as Marc Andreessen once famously said; however, you can’t live on it! And as inflation really begins to take off, investor sentiment and with it, capital could begin to flow back into oil stocks, boosting their share prices.
How high can oil go?
Both BP and Shell recorded a huge surge in free cash flow in their annual results a few weeks ago. Although sentiment in the industry has improved in recent months, many investors remain wary about the prospects for the oil and gas industry long term. However, I have been adding to my positions in both companies recently. This is why.
The last time we saw oil at over $100 a barrel was in 2014. A similar situation occurred leading up to the global financial crash in 2008. Back then, oil reached $150 a barrel. Subsequently, when the housing bubble burst, the oil price collapsed too. Many analysts believe that we’re in a similar set-up today and that oil prices will fall from here. I am not sure, though:
- Headline CPI today is double what it was back in 2008
- In 2008, inflation was being caused mostly by energy and housing. Today, a much broader set of factors are in play as I outlined in a recent article
- In 2008, every oil major was pumping money into exploring for new fields. Today, we’re at record low levels of investment relative to the oil price
These macro factors, together with continuing recovery from Covid, will keep oil prices high for some time.