As oil prices collapsed from the four year, $100/barrel plateau it was on, I started looking at investing in the industry, in order to take advantage of an assumed revival of prices. Given the financial strain I knew that a potentially long period of low oil prices will place on producers, I wanted to invest in the less exciting oil majors, which I can feel comfortable with holding for a longer period, allowing for my assumptions in regards to the future of oil prices to play out. I bought Chevron (NYSE:CVX), Suncor (NYSE:SU) and Shell (NYSE:RDS.A), starting in the fall of 2015 and occasionally added to these positions as oil prices continued to decline, culminating with the bottom reached in February, 2016. To date, Shell is the only stock where I am still down. It is not by much, and certainly when including the dividend payments, I am actually up on the trade, but Shell does remain a laggard nevertheless.
I do believe that things will improve going forward. I bought each stock for a reason and I do believe that the reasons why I bought Shell remain valid. The BG Group merger will pay off in the longer term, even if it may have created some shorter-term difficulties. The latest quarterly report suggests that things are headed in the right direction, with earnings of $1.4 billion, versus a last year quarterly loss of $6.1 billion.
Total oil & gas production compared with the same quarter from last year was 25% higher. LNG liquefaction increased by 45%. Most of this increase is due to the addition of BG. The addition of BG's assets will go a long way in allowing Shell to increase production, as well as LNG liquefaction for many years to come. LNG in particular is what got me interested in Shell as a way to strategically play the longer-term developments in global energy, as I see it unfolding. It is this bigger picture that I find to be more important even than looking at the latest quarterly results, which are indeed important, because it gives us an insight in regards to important aspects such as profitability of operations. I see LNG as the most important sector providing Shell with growth in revenue and profits going forward.
The emergence of the global gas economy.
Last year, as the the Paris climate agreement was being put together, something rather interesting happened. A global consensus on the need to cut greenhouse gas emissions emerged. The most intriguing part was the fact that unlike other attempts made to reach this consensus, a pledge was made by developing nations to make significant efforts to cut their use of fossil fuels. The previous major global agreement, known as Kyoto was so flawed that it never had a chance of actually making an impact. It was in the end only implemented by the Europeans and it had the net effect of cutting growth in emissions from about 52% over 1990 levels, to just 50-51%. Not exactly the impact that was envisioned. It was also arguably not worth the unilateral economic self-sacrifice that Europe subjected itself to.
The story about reducing emissions usually ends up conjuring up images of wind turbines and solar panels from our imagination, because those are the kinds of solutions that are always talked about when discussing cutting emissions. When we look at the way that Europe managed to keep its emissions bellow 1990 levels, we see that aside from the more or less stagnated economy, the replacement of coal with natural gas was the main factor which helped them do it.
Data source: EIA.
Just so we are clear, I do not believe that the pledges made in Paris will be met by most actors who signed on. I do believe however that an effort will be made to show that individually stated goals by most signatories to the deal were attempted to be achieved. The pledges are not ruled by an enforcing mechanism, so they are just that, pledges. It does nevertheless mean that most countries will try to limit their coal use, which is by far the most pollutant fossil fuel.
The simple fact that we are likely looking at global coal demand being capped at current levels means that global natural gas demand is likely to skyrocket. The EIA projects demand to increase by about 70% in the 2012-2040 period.
I personally think that this forecast is slightly conservative, because even though I believe that global economic growth will be much slower than currently envisioned by the mainstream, I also believe that other factors, such as an over-estimation of the contribution of renewable to the future global energy mix. Wind and solar are greatly handicapped from playing a major part in the global energy mix by the fact that they need back-up capacity or storage for when the wind does not blow and the sun does not shine.
Just to give an indication of how much potential backup capacity or storage would be needed, the case of Germany is an ideal example. It set a renewable energy one day record of 78% in 2015. But in reality Germany only produces about 15% of its total electricity from wind and solar on average. Looking at this, it is reasonable to assume that any attempts to secure more than 25% of electricity from these sources is not viable. It is perhaps because of this fact that Germany intends to cap its wind power maximum capacity installation, to 40-45% of its current electricity demand.
Electricity demand on the other hand may be greatly under-estimated by the fact that there is a growing fleet of electrical cars, with global EV sales growing exponentially.
The rate of growth in sales seems to have slown this year, but based on most likely outcome of the last three months of 2016, we might still be looking at 20% growth in sales y-o-y. We should think of each EV added to the global car fleet as more or less an addition of a new household to the electrical grid. An EV being driven a typical distance each day uses about as much electricity as a typical household does. The US currently adds about a million households each year, so in effect we are getting close in terms of EV sales to adding the equivalent of about a million households to the global grid every year. We will most likely reach that level before 2020.
Regardless of whether the EIA estimate for natural gas demand growth will end up being somewhat too optimistic or too conservative, bottom line is that there will be a significant increase in global natural gas demand moving forward. A large part of this growth in demand will not be satisfied by pipelines, therefore LNG demand should soar as well. When it comes to global LNG, Shell is currently the undisputed leader among publicly traded companies. Based on the Q3 report, it liquefied 7.7 million tones of LNG, which means that it has the annual capacity to liquefy about 31 million tons, which means that Shell currently holds about 12% of the current global LNG market. With global natural gas demand growing at a robust pace, and with global LNG increasing its share of global natural gas supply, I think Shell is perfectly positioned to be perhaps the most successful oil major going forward. For this reason, I will continue to hold this stock, and continue enjoying those dividends while I wait for this story to play out.
Disclosure: I am/we are long RDS.A, CVX, SU.