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Daily Intelligence Briefing

Thursday, December 14, 2023

Identifying Change-Driven Investment Themes

The Daily Intelligence Briefing is published by McAlinden Research Partners. The report is provided to Hedge Connection blog readers once per week for free. Below is just one of the five sections that delivers Change-Driven Investment Themes everyday.

I. Today’s Thematic Investment Idea

A deep dive into a market driver with alpha generating potential.

Ongoing Oil & Gas Consolidation is the Latest Factor to Complicate Green Investment Goals Set out by COP28

Summary: COP28 concluded with big promises this week, but the level of investment needed on behalf of the global energy industry to meet the summit’s ambitious climate mitigation goals remains a far stretch from what is being invested today. Energy sector M&A is on track for a record quarter, driven by megadeals that will consolidate big oil’s hold on some of the most valuable fossil fuel resources in the world. Financing for new energy projects at the world’s largest banks actually shifted toward a greater emphasis on oil and gas development. Elevated energy prices and heightened profitability among oil majors has managed to keep capital flowing toward fossil fuels, depriving renewables of the many billions of Dollars needed to cut global emissions to net zero by 2050.


Related ETFs: Invesco DB Oil Fund (DBO), Energy Select Sector SPDR Fund (XLE), SPDR S&P Oil & Gas Exploration & Production ETF (XOP), iShares Global Clean Energy ETF (ICLN)

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At the 28th Conference of the Parties – known more commonly as COP28 – new progress was made toward the allocation of hundreds of billions of Dollars in commitments meant to finance climate mitigation measures. These investments, along with even more set to be announced at next year’s conference, are meant to limit global warming to 1.5°C above preindustrial levels and push global emissions toward an explicit net zero target by 2050. Though the summit was held in the oil and gas stronghold of the UAE, conference attendees, which included governmental representatives from the US, UK, France, India, Brazil, the EU, and more, struck a deal that makes an unprecedented call for “transitioning away from fossil fuels.”


However, as the world’s largest climate conference transpired, the oil and gas industry was continuing a massive consolidation drive in the background. Bloomberg data indicates that the fourth quarter of 2023 has been the most lucrative ever for energy sector M&A, with a total of 227 deals valued at $163.1 billion being announced. This sum has been largely driven by blockbuster purchases of US-based shale resources. Exxon Mobil disclosed a $59.5 billion deal to acquire Pioneer Natural Resources in October, just days before Chevron would announce a $53.0 billion acquisition of Hess Corp. This past Monday, Occidental Petroleum Corp. picked up oil driller CrownRock for $12.0 billion.


Per Wood Mackenzie, the total value of deals focused on the US Permian shale basin alone have surpassed $100 billion so far this year. Exxon’s Pioneer purchase will more than double its Permian footprint while Occidental’s CrownRock deal will add around 170,000 barrels of oil equivalent per day of unconventional production to its Permian portfolio in 2024, as well as approximately 1,700 undeveloped locations. Beyond the US, Australia’s Woodside Energy is now in negotiations to acquire Santos Ltd for $52.0 billion. Such a deal would combine two of the country’s largest energy sector firms and result in the creation of the single largest liquefied natural gas (LNG) producer in Australia – the world’s second-largest exporting nation of the fuel.


Though MRP has previously highlighted significant green energy investments made by big oil in recent years, these expenditures do not come close to what is being spent on expanding their fossil fuel businesses. Between 2018 – 2022, the industry generated around $17 trillion in revenue – half of went to governments in the form of tax or other costs. Other half was almost wholly spent developing and operating oil and gas assets and distributing dividends to investors. Just a fraction of revenues were invested in clean energy, according to an International Energy Agency (IEA) report. Last year, the oil and gas industry invested just $20 billion in clean energy projects last year — only around 2.5% of its total capital spending.


Though some significant green energy milestones have been reached with current levels of investment, including the expected generation of more US electricity from renewables than coal in 2024, the 1.5°C scenario targeted by COP28 suggests that a reasonable ambition is for 50.0% of capital expenditures to go towards clean energy projects by 2030. Bloomberg New Energy Finance (BNEF) data on financing for the energy sector suggests that there is little sign of change in the pipeline. At the end of last year, the ratio of spending on low-carbon infrastructure relative to fossil fuels was 0.73 to 1. This so-called energy-supply banking ratio (ESBR), which includes debt and equity underwriting, actually worsened from 2021 (posting a ratio of 0.75 that year) and remains significantly below the 4 to 1 ratio needed to broadly remain in line with climate mitigation goals by 2030. BNEF calculated that Barclays had the highest ESBR among top 20 banks by financing volume, but only clocked in at 1.55.


Though the climate goals laid out by renewable energy proponents are lofty and well-supported among governments, years of elevated prices and strong profits in fossil fuel markets have captured capital flows within the oil and gas space. Consolidation of the world’s output capacity, particularly that of the US’s shale resources, around among a smaller number of large firms could end up keeping prices elevated for a longer period of time. As MRP has previously noted, the goals of large fossil fuel producers appear to have shifted significantly over the past couple of years. According to reporting from Barron’s, compensation packages at energy majors have cut incentives for energy executives to prioritize production and boosted their pay for pumping cash instead. In 2019, production goals made up about 15% of executive compensation incentives, according to Morgan Stanley analyst Devin McDermott. By 2022, production made up just 6% of the packages. Meanwhile, the percentage for hitting free cash flow goals rose to 18% in 2022 from about 7% in 2019. That inversion is a break from historical trends and coincides with heavily criticized spending on buybacks, dividends, and other shareholder payouts over the last year.


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