In a recent article Nicholas Ward asked for views about including Exxon Mobil (NYSE:XOM) in his portfolio, and expressed concerns about XOM's fundamental valuation and its ability to continue to pay its 3.7% dividend yield.
His concern came from being underweight in the energy/materials space and he thought that, with the election of Donald Trump, perhaps things may change for the fossil fuel industry.
I suggest that a significant part of XOM's current risks relate to structural changes that are happening in the global economy and that XOM isn't immune to these issues impacting its business, nor is President Trump likely to have a significant impact on these major global changes. Everyone gets stranded when the tide goes out.
Here I address some significant structural issues, which are worth throwing into the mix when considering investment in XOM.
Most countries in the world have committed to exit fossil fuels
One hundred and thirty three countries have now ratified the Paris Agreement, which aims to reduce global temperature rise to less than 2C, with a goal of 1.5C. To achieve even the "less than 2C" goal, the world needs to decarbonize by mid-century. This means almost immediate exit from new coal projects and likewise a dramatic reduction for new oil and gas developments. By my calculations, based on countries that have ratified the Paris agreement individually and also those who have committed via the EU ratification, and also the 48 countries in the Climate Vulnerable Forum that have committed to more aggressive action than the Paris agreement, now countries with 86% of global greenhouse gas emissions have committed to the Paris agreement. 29 countries have ratified the Paris Agreement since the US election. No country has pulled out of the Paris Agreement since President Trump won the US election. This indicates that the world is continuing to proceed with implementing the Paris Agreement, notwithstanding negative comments by President Trump.
Note that a core feature of the Paris Agreement is increasing commitments by participating countries to progressively decarbonize their economies. China, India and Europe are leading this process, while the US has been a key supporter. What will happen to the US commitment is unclear with the election of President Trump. While he has said he plans to exit the agreement, it isn't clear that he has thought this through. The US is responsible for 17.89% of emissions and this isn't enough to kill the deal if the US exits. If the US does exit (and it will require 4 years to disengage) it would be surprising if other countries were passive about rogue action. The Russian Federation (7.53%) and Turkey (1.24%) are the only significant greenhouse gas emitters that are yet to ratify the Paris Agreement.
XOM supports the Paris Agreement, although it isn't clear to me that this is more than a position that they know they have to take. Examination of their business planning, apart from support for a carbon price which is more about dismantling the coal industry, there is no real hint that XOM thinks that the world will decarbonize.
The electric car is gaining momentum
The current penetration of BEVs (Battery Electric Vehicles) is small (less than 2% in most countries) but rising rapidly.
A bet against the electric car is a bet against Tesla (NASDAQ:TSLA), BYD (OTCPK:BYDDF), BAIC Motor Corp (OTC:BCCMY), Volkswagen (OTCPK:VLKPY), Volvo (OTCPK:VOLAF), GM (NYSE:GM), Ford (NYSE:F), Nissan (OTCPK:NSANY) and most other internal combustion vehicle manufacturers, all of whom have major BEV programs underway.
It is also a bet against a number of countries who plan to ban sale of new internal combustion vehicles in the next 10-15 years. Germany, which is surely the home of the internal combustion engine (ICE) car, has plans to cease ICE sales by 2030. A number of other countries including Netherlands, India, Norway have similar plans around 2025.
Personal internal combustion engine vehicles make up a crucial element of oil sales. While the oil majors are now beginning to factor in substantial electrification of transport, it is clear that they don't believe that the BEV is going to be a significant threat for a very long time.
Oil price stability is fragile
There is a lot of discussion about the factors keeping the oil price in the mid-$50s. It isn't just about the recently struck OPEC agreement holding, but also about the US oil producers who are hoping to get back into the game if the oil price rises.
Has President Trump changed his vision?
If today's speech by President Trump is to be taken seriously, he wishes to open the floodgates of innovation. This wasn't a vision of return to the glorious past, but a forward looking speech, which should send shivers down the spine of the fossil fuel industry. I doubt that he actually meant what he said, but we shall see more soon. He certainly made a big point about clean air and clean water, which doesn't fit with moves to destroy the EPA and cancel the Stream Protection Rule.
Regardless of where President Trump ends up on the innovation spectrum, his ability to hinder climate change action and the switch to renewable energy is constrained because much of the heavy lifting happens at state level. To give one indication of state actions, North Carolina has just dropped opposition to the Clean Power Plan, indicating that clean power jobs, enhancing the state's energy independence and taking action on climate change are the focus rather than spending scarce resources on legal fights.
Other oil and gas majors are acting
DONG Energy (OTCPK:DNNGY) and Statoil (NYSE:STO) have major investment in wind, while Engie (OTCPK:ENGIY) and Total (NYSE:TOT) have major business intentions and positions in emerging solar PV, so XOM's competitors are taking action to secure their future.
I don't see evidence of serious planning to exit fossil fuels in companies like XOM and BP (NYSE:BP), where there is talk, but the underlying assumption is that fossil fuels will continue to dominate. For example BP's Deputy CEO Lamar McKay is concrete about gas and oil upstream and downstream, while in relation to low carbon investments he says the following:
We're going to do more venturing, more experimentation and more partnerships. In other words - not very high capital acquisitions, but working at the grass roots with new technologies; understanding which ones may work and make great investments for the future.
I read this as a wait and see approach. XOM's future vision is all about gas.
Capacity of management
Darren Woods, the new CEO of XOM is steeped in the XOM tradition. Woods has commented "I feel like I spent 25 years preparing for this job." This means that XOM has the best leadership for business as usual. Costs will be cut, investment decisions in new oil and gas will be handled expertly. And it is all about fossil fuels.
My concern is whether such leadership is suited to think about where XOM's future lies. Contrast XOM management with Engie, where new CEO Isabelle Kocher laid out a three-year plan to transform the company from one focusing on fossil fuels and nuclear power to low carbon (solar and wind) energy:
We are engaged in a process of extremely profound transformational change, because we see a future in which the world of energy will be very different. We want to focus our investments solely on generating low carbon energy and innovative integrative solutions for our customers.
My view is that until management takes on the need for change and actually begins the process, you still have a management team with the philosophy that "there will always be a fossil fuel industry and we are the best." This is what got Peabody Energy (BTUUQ) into trouble and it will continue to trouble Peabody Energy as it emerges from bankruptcy. Could XOM's current malaise be the start of a similar process?
In the above discussion I've summarized several issues that are not often considered by investors considering an investment in the oil and gas industry in general or specifically XOM. I suggest that plans to decarbonize the world economy, the rise of BEVs and consideration of the likely price stability of oil are all worthy of being part of an investment decision concerning XOM, to go alongside company specific issues (such as debt and likelihood of being able to sustain the dividend). I also think that it is important to scrutinize the preparedness of senior management to cope with the major energy transitions that are already happening. I suggest that it is worth thinking about what actions by President Trump might be able to reverse the trend away from fossil fuels and whether he might actually end up engaging in the new horizons that are out there. These are important considerations in making a decision to invest in XOM, or indeed whether to keep it in your superannuation portfolio.
I am not a financial analyst, but I am interested in major qualitative changes that are happening in the energy space as the world begins the transition from fossil fuels to a low carbon economy. My view is that these big picture issues are worthy of being part of your investment decision making. If my comments help sharpen your thoughts, please consider following me.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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