The fall of big oil … the short- and long-term headwinds … what could be its replacement in your portfolio
Oil investors are hurting.
Let’s look at XOP, which is the SPDR Oil and Gas Exploration ETF. It holds many oil majors including Exxon, Chevron, Marathon, and Occidental.
Over the last decade, an investment in XOP has destroyed 74% of investor capital over a period in which the S&P 500 has climbed nearly 180%.
Let’s zoom in on Exxon.
For decades, the oil giant was the crown jewel of countless “mom ‘n pop” portfolios.
From 1990 through 2010, Exxon returned 635% for its investors. Over that same period, the S&P returned just 255%.
In 2011, Exxon was the world’s biggest company, being valued at just over $400 billion (before being upended by Apple).
But over the last decade, the combination of poor management decisions, declining oil prices, and the growth of renewable energy has dealt successive blows to the company … and its shareholders.
Today, Exxon’s market value has eroded from that $400-billion mark to $137 billion.
And this year alone, it has destroyed 50% of investor capital, as you can see below.
Adding insult to injury, in August, it was booted out of the Dow Jones Industrial Average and replaced with a software company.
The latest hit came this past Friday, when Exxon reported its third straight quarter of losses, with revenue down nearly 30%.
***Coronavirus lockdowns have dragged oil prices to lows not seen since March
Though Exxon made several strategic errors over the years, its recent hit to earnings have come from declining oil prices.
Last week, oil fell to a four-month low as lockdown restrictions grow in Europe. This caps off the worst month for oil prices since March.
The slide is continuing as I write Monday morning. And with global lockdowns intensifying, a near-term, sustained rebound appears to be wishful thinking.
If we review the year-to-date pricing in oil, we’ll see the U.S. benchmark, West Texas Intermediate crude (WTI), trading around $62.70 a barrel in early January.
In April, it made history when the May contract for WTI collapsed into negative territory — the reason being coronavirus-related lockdowns and a lack of storage as oil inventory rapidly built up.
Since then, prices rebounded into the low $40s. But as I write, they’ve slipped back into the mid-$30s.
Source: The Wall Street Journal
Looking at the world today, with coronavirus cases surging and global economies shutting down again, a repeat of this negative-pricing isn’t out of the question if there’s another mass investor-panic.
But even without that, the heavy downward pressure on prices creates existential pressure on many companies in the sector.
From The Wall Street Journal last week:
A new drop in oil prices would mark the latest blow to the global energy industry and would threaten projections for a 2021 rebound.
For much of the year, prices have been too low for many producers to cover their costs.
Layoffs, bankruptcies and a wave of mergers and acquisitions have all swept through the oil patch in recent months.
From the start of the year through September, 40 North American energy producers filed for bankruptcy protection, according to law firm Haynes and Boone LLP.
At current prices, we should expect that bankruptcy number to continue climbing.
***Beyond the coronavirus-lockdowns, there are the environmental/political headwinds
Coronavirus lockdowns are the immediate threat — but even if we look beyond this challenge, we find an equally-if-not-greater issue …
Policy change.
Take Joe Biden.
As the presidential debates made clear, if elected, Biden would seek to transition away from fossil fuel energy sources, toward renewable energy.
This summer, he announced a plan to spend $2 trillion over the next four years toward accelerating the adoption of clean energy in the transportation, electricity, and building sectors.
It’s part of Biden’s sweeping proposals designed to spur economic activity and strengthen infrastructure, while, perhaps most importantly to him, tackling climate change.
But it’s not just government policy. We’re seeing a similar policy change sweeping through corporate America.
For example, Amazon will have 10,000 electric-delivery vehicles on the roads by 2022. And as early as 2024, 80% of Amazon will be operating on renewable energy.
Or look at Google …
Roughly a year ago, it announced it was investing $2 billion into new renewable energy projects. That’s a record corporate purchase.
Even Duke Energy, the nation’s largest utility, is getting in on the renewables/conservation game. It announced it will reach an interim target of 50% carbon emission reductions by 2030.
Put all of this together, and the writing is on the wall.
***So, what should investors do now?
Well, first, big oil is not going out of business tomorrow.
It’s a massive part of the U.S. GDP, so even our greenest politicians recognize the danger in a sudden, guillotine chop.
Two, there’s still a substantial global appetite for oil in emerging market countries. So, demand is not about to dry up completely.
But the issue boils down to a question …
Do you want to invest with tailwinds or against them?
As we stand today, oil is not a growing sector. Yes, if we get a vaccine and the global economy re-opens, it will take pressure off prices.
Yes, OPEC could engage in tactical moves to help prop up the sector.
And yes, technological advancements could help the U.S. energy complex produce oil profitably at lower costs.
Despite all of that, long-term demand is on the decline.
California is an instructive example.
Last month, Governor Gavin Newsom signed an order that will phase out the sale of all gasoline-powered vehicles by 2035. It’s a bid to reduce greenhouse gas emissions by encouraging drivers to switch to electric cars.
If California were a sovereign country, it would boast the fifth largest economy in the world. And that economy is going to be done with gasoline-powered cars in 15 years.
That’s a massive headwind.
So, back to the question — what’s an investor to do about this?
Well, why not look at what’s intended to replace gasoline?
***The rise of solar and renewables
For any newer Digest readers, Matt McCall is our expert thematic investor.
In his newsletter, Investment Opportunities, he finds the massive trends that are reshaping our world, and by extension, our investment markets. He then identifies the specific stocks best positioned to ride those trends higher.
It just so happens that one of the biggest trends of the next decade will be renewable energy. Specifically, Matt is looking at solar energy.
From Matt:
… in just the past decade, a solar revolution has begun … one that will lead to the biggest change to the energy market in a century …
Last year, only about 2% of electricity in the U.S. came from solar power. Right away, you can see the huge growth potential.
At the same time, solar accounted for 18% of all new energy capacity last year. That’s nine times the amount of the current power.
You can see where this is going.
There are several major catalysts that will continue the momentum that clean energy — especially in solar power — has today.
In Matt’s October issue of Investment Opportunities, he pointed toward a slew of tailwinds driving solar higher. Among them are …
The increasing cost effectiveness of solar … the pro-renewable policy changes being implemented by governments around the glove … and the rise of ESG or “Environmental, Social, and Corporate Governance” investing.
On that last point, Matt notes that solar power is a major trend within ESG investing, and it’s been suggested that big institutions could mandate that 50% of investments fall into this category in coming years.
Matt writes that this would lead to hundreds of billions of dollars, if not more, flowing into ESG-related stocks.
***How to play a rising solar sector
If you’re considering solar and are looking for one of the simplest ways to play it, consider the Invesco Solar ETF, TAN. It holds many of the solar sector’s top names.
Below, you can see TAN destroying the S&P here in 2020.
While the S&P is up 3% on the year, TAN is up 131% … which is actually down from its recent peak that put it up more than 150% on the year.
However, if you’re looking for an even more dynamic way to play solar than an ETF that includes dozens of companies (some that don’t perform as well as others), Matt recently added four new stocks to his Investment Opportunities portfolio. You can click here to learn more as a subscriber to Investment Opportunities.
As we wrap up, the long-term writing is on the wall for oil investors.
However, there are massive tailwinds coming together behind renewable energy — solar in particular.
If your portfolio doesn’t have exposure, give it a look. If not, you risk missing out on what could be one of the most explosive sectors of the decade.
Have a good evening,
Jeff Remsburg
