Is This The Beginning Of The End For Oil Super Majors?

Energy-oriented investors could not fail to have taken note of the decision that came down in the Dutch court against Shell, (NYSE:RDS.A), (NYSE:RDS.B), last week. This decision was the first time an energy giant had been held liable for emissions not directly tied to its internal activities. Basically it requires Shell to accelerate its planned carbon intensity reductions by 45% to include "Scope-3 emissions" by 2030. Some twenty years sooner than the time frame to which it has already committed publicly. 

For those who are unaware, Scope-3 emissions include those from consumer impacts derived from using products supplied by companies. Buying gasoline or diesel has a climate impact according to this decision, and the intent of the court-although it is not specifically stated, is clear. Produce less oil and make less refined petroleum products.

The decision refers to several well-known accords and scholarly position findings from European sourced universities and quasi-governmental working groups. Among them:

Shell, of course, will appeal this decision as stated in a press release from its corporate site.

Two other giant integrated energy companies were also dealt perceived setbacks in their annual meetings where activist groups scored some unanticipated victories.Engine#1 , a tiny activist fund with support from some major investor funds, like Blackrock, managed to get their slate of directors approved in ExxonMobil's, (NYSE:XOM) annual meeting of shareholders. Across town in the Chevron, NYSE:CVX annual meeting, an activist proposal to accelerate its decarbonization plans found 61% approval among shareholders, and will force some of the same "morning after-gazing in the mirror," type soul searching that Shell must be, (or should be) doing.

It has been rightly pointed out as noted in the below linked WSJ article that this case, if upheld on the years-worth of appeals that will follow, will likely be used as a precedent in future climate-oriented legal wrangling.

“This case does open the door for challenges to other energy-intensive sectors,” said Liz Hypes, an analyst at risk consultancy Verisk Maplecroft. Other industries that could face lawsuits include agriculture, transport, and mining, all of which are already being targeted by regulators and civil society over their emissions, Ms. Hypes added.”

So it's a fairly safe bet that other oil companies will come under attack as the environmental lobby(s) around the world take note. I think the legacy "old" oil companies are under the greatest threat from the length of time they have been selling oil and gas products. For what it's worth probably few of them have done as much to shoot themselves in the foot as Shell. 

Shell’s own internal assessments of climate impacts from producing oil and gas, and their failure to notify governments of their research are part of the "cigarette settlement-like" foundation of this suit. In the 1990s the major cigarette manufacturers were found, through leaked documents to have known the risks of smoking and mislead the public on this fact. Here's some verbiage from the internal Shell 80's report on climate effects that was inadvertently “leaked.”

“Shell’s analysts also warned of the “disappearance of specific ecosystems or habitat destruction,” predicted an increase in “runoff, destructive floods, and inundation of low-lying farmland,” and said that “new sources of freshwater would be required” to compensate for changes in precipitation. Global changes in air temperature would also “drastically change the way people live and work.” All told, Shell concluded, “the changes may be the greatest in recorded history.”

In legal parlance internal reports like these are often referred to as "smoking guns." In the case of the cigarette companies, it was certainly the case, leading to hundreds of billions of dollars in restitution payments over the last few decades. In this article, we will point out some likely consequences of these adverse outcomes for these large, integrated oil companies.

One oil company's trash, another's treasure?

It is impossible to chart the actual course events may take with any clarity. Still, trends are observable and may replicate or expand as oil companies react to these events.

I think one reaction you are going to see from the Super Major oil companies will be a further paring of their upstream asset portfolios. It almost has to follow along those lines as they try and insulate themselves from this type of litigation. There are those who argue that this could break the Super Major upstream/downstream model of vertical integration in petroleum and derivatives.

This has already been occurring downstream as oil companies stepped back from the lucrative refined products businesses. As many as one in five U.S. refineries face closure or repurposing to biodiesel in the next few years. Shell has been shedding refining capacity at a ferocious rate this year, with two sales in the past few weeks. The one in Alabama seems particularly cheap-$75 mm for a 90K bbl/day refinery?? Another of which is its massive Deer Park refinery, going to Pemex. Mexico is gaining control of the biggest refinery in the U.S.A. at 340K bbl/day.

As these companies reevaluate their business models in the coming months and years, I think it will be more difficult for new projects to gain sanction. Many new discoveries, like Shell and Chevron's GoM, Leoparddiscovery just announced will see an extra layer of review. With its giant Perdido hub in the GoM, Leopard would seem to a slam dunk for sanction as it is "advantaged" oil, and it may still be. But does this judgment perhaps make Shell reevaluate its position in U.S. deepwater? 

I am not necessarily forecasting a self-destructive move like this on the part of Shell, but at this point, it's got to be considered. Remember, they are under court order in their home country to reduce emissions drastically in the next 8.5-years. Bringing on new discoveries, like Leopard may get in the way of that paramount goal, and cause it to fail to meet sanctioning parameters.

One possible outcome of the above speculation is that I think this will create opportunities for new companies to step in. I think both U.S. domestic companies, foreign NOC's without offshore exposure will take notice of this portfolio high-grading-for want of a better term (climate oriented portfolio cleansing?), and step into the gap.

Could Occidental, (NYSE:OXY) make a move if assets are sold cheaply? I think they might. Obviously, OXY is in no position to take on debt, but with the cash, they are generating if Shell decided to sell the Perdido fold assets, that wouldn't be an issue. OXY already is one of the biggest GoM operators thanks to the Anadarko purchase. Size matters in this business.

Perhaps minority partners in the many U.S. offshore, GoM fields, like Total, (NYSE:TOT) or CNOOC, (NYSE:CEO)-doubtful this would meet U.S. Homeland security review, or perhaps a smaller player like Talos, (NYSE:TALO), or Kosmos Exploration, (NYSE:KOS). Or maybe HESS, (NYSE:H) would assume operatorship of an asset like this, and expand their GoM footprint? Perhaps a cash-generating Canadian Major like Canadian Natural Resources, (NYSE: CNQ) might see a chance to gain a foothold below the 49th parallel? They're selling a lot of their oil down here already, why not refine it?

Many of these companies have significant operator and non-operator interests in the GoM and might be glad of the chance to pick over Shell's carcass.

U.S. oil assets will become more valuable

I have been pounding the table on this subject for a couple of years now. U.S.-based oil and gas assets are undervalued, and by extension, the companies that own them. Particularly as regards pipelines, as I noted in a prior OilPrice article last year. This notion also holds true for upstream assets. There are several reasons I believe this to be the case.

U.S. courts have shown much more restraint about taking on sweeping climate change litigation, and big oil's track record in this country is much better than in Europe. Many cases have been dismissed with the courts choosing to punt the issue to Congress. An article carried in Gizmodo laid out the environmentalist frustration at this judicial reluctance.

New York’s case against energy corporations for knowingly contributing to the climate crisis was thrown out in 2018 after defendants like Exxon and Chevron frustratingly stated that “global warming is an important international issue that concerns every nation on Earth.” How, they asked, could specific corporations accept responsibility for a global problem? Never mind the fact that just 100 companies are responsible for over 70 percent of global greenhouse gas emissions or that oil companies funded a decades-long campaign of denial and delay that continues to this day. Despite that, the court agreed and threw out the suit while arguing it was “not for the judiciary to ameliorate” the climate crisis.

Who's to say if this reluctance will continue, but the judicial modesty exhibited thus far sets a precedent that other jurists are likely to follow.

The oil and gas infrastructure in the U.S. is just so massive that as prices rise, and they will as I will detail in the next section, the profits are going to be enormous. Consider this point. U.S. oil and gas operators retooled to be profitable on $30 oil. At $65 or $70, they are going to rain cash.

The dichotomy here is that as assets come on the block from companies wishing to distance themselves from petroleum, other companies will find them irresistible and accretive to their bottom lines almost immediately.

Oil is going to be more expensive and the era of the Super Major Oil Company may be at an end

The era of cheap energy, which has lasted for the past seven or so years, is coming to an end. To summarize, I think U.S. companies and particularly the $2-$30 bn independents that comprise much of the landscape in the frac patch, are going to rake in huge profits as the realization dawns on America and then, the world, that there is no substitute for petroleum. 

All of the forms of alternative energy have problems that are only just beginning to crop up. Wind and solar power require metal mining on a vast scale that may be unsustainable. Solar farms take up thousands of hectares of space in often fragile environments. Hydrogen requires essentially free electricity to split the H molecule from water or natural gas streams and is very corrosive. Biofuels, like ethanol, produce a lower density form of energy than petroleum products, requiring more of it to accomplish the same amount of work. There is no free lunch in the energy business, and the current shift to renewables will ensure that petroleum becomes scarcer and more expensive.

From years of under-investment spawned by multiple price crashes in the past decade, supplies are going to be tight. There isn't much lagniappe (extra) as shown in the EIA chart below.

I don't see OPEC+ upsetting this applecart by boosting production significantly. They've been praying for $70 Brent, which we have just surpassed. With the wisdom of the past seven years behind them, why would they tamper with the success they helped to orchestrate when it finally arrives? In my view, they won’t.

Nor are the U.S. shale drillers going to ramp production up in a meaningful way. The era of drill and grow at any cost, has passed and companies are much more focused on cleaning up their balance sheets, and rewarding long-suffering shareholders, than expansion. Company after company has developed a plan for “sustaining capital expenditure” to hold production at current levels or increase it very modestly.

There is also the undeniable politics in place. The U.S. government is going to throw roadblocks at the oil industry for as long as it can make political capital doing so. I should also point out this mentality could change abruptly. Most U.S. drivers have never sat in a gas line. If that comes to pass, the mentality will change quickly. Actually coming up with more oil will take time though, as the energy infrastructure and manning has collapsed to levels that can only sustain current production rates. 

All of this will work to tighten supplies and drive costs up for energy consumers for the foreseeable future. The world will likely be shocked to find how quickly we move from the era of energy abundance we have just come through, to the one where energy supplies are held very dear.

Finally, as noted previously the Super Major model of vertical oil integration may pass into the history books as these giants, legacy oil producers try and limit their exposure to climate litigation.