This post was written exclusively for U.K. Investing.com
If you invest in the U.K. stock market then it is very difficult to avoid large cap oil and gas stocks, which currently constitute just over 15 percent of the FTSE 100 and a little over 12 percent of the FTSE All-Share index. This counts double if you have a corporate pension fund - BP (LON:BP) and Royal Dutch Shell (LON:RDSa) are stalwarts of such investment products due to their business longevity and sustained dividend payments over time.
However old certainties are crumbling. A recent OPEC report noted that the 2020-2025 period will see the first ever fall in oil demand from the 36 developed market countries that make up the OECD.
Overall global oil demand will still grow, driven by various global emerging markets, but this is being viewed as the start of a regime shift, as the use and scope of renewable energy sources builds.
Analysis of the word count in the annual OPEC World Oil Outlook publication shows in recent years more mention of ‘electric vehicles’ than ‘tight oil’ and - in the last year - a sharp increase in the use of the word ‘climate’. The times they are a-changin’. Maybe this is why the oil price has been a bit suppressed over recent years.
Change is also apparent at the UK stock market’s two big oil companies. BP has just announced that the promotion of Bernard Looney - previously head of its oil and gas exploration division - to take over from company legend Bob Dudley as Chief Executive. Traditionally being head of exploration would have been a very uncontroversial route to becoming BP CEO, given it’s a rather important position at a company such as BP.
Given Mr Looney’s comments a few months ago that 'comparing gas to coal isn’t good enough on its own...we need to compare gas to zero carbon...shouting louder about the good that we do is not a winning strategy...we need to demonstrate that we are part of the solution' suggests an acknowledgement of the need for a wider agenda.
If the incoming CEO is truly serious about regime change, then BP is going to be either much smaller and/or highly dependent on pulling off some major deal coups over the next few years.
Just take a look at the company's recent quarterly results. Profits are wholly generated in the core oil and gas or closely affiliated activities. Meanwhile if you look at the capital expenditure line, spend is on about a 7:1 ratio in favour of carbon related activities rather than any renewables or low carbon dioxide initiatives. Even with a sharp pull on the oil supertanker wheel, BP is in reality not going to be living up to its 'Beyond Petroleum' strapline for a while.
And then, of course, there is the dividend payment and other shareholder remuneration forms such as share buybacks. One of the big rationales for large cap oil stocks being so widely held is the 6.5 percent dividend yields currently on offer at BP and Royal Dutch Shell. Any talk about fading oil demand and the challenges (and costs) of evolving a business model more towards renewables, immediately raises questions about medium-term dividend and share buyback sustainability.
One noteworthy comment in Royal Dutch Shell’s third quarter update a few weeks ago was the comment that 'the prevailing weak macroeconomic conditions and challenging outlook inevitably creates uncertainty about the completion of the share buyback programme by the end of 2020'.
This was a striking comment given they also announced results which showed a profit decline and a rise in the company’s debt level, influenced by lower profits and cash flow due to lower oil, gas and LNG prices.
Meanwhile back at BP the company felt obliged to make a public statement concerning the timing of board level discussions about the company’s future dividends. That sounds like a corporation that is feeling some heat to me.
So be it at the macroeconomic, thematic or individual stock levels, the two largest UK-listed oil companies (which constitute a huge proportion of the country’s leading indices, plus corporate and private pension holdings) are struggling. Both shares are strongly above their 2016 lows but have made little share price progress over the last 2 years.
This dullness could very well be a period of calm before a storm. Big decisions await the executives of all the major oil companies. Equally U.K. investors have to ask themselves whether it is time to step away from such bedrock holdings - and maybe even the passive index tracker funds that are naturally also chockablock full of such names. That is a big decision...but ultimately irrespective of whether you are managing a huge corporate pension fund or your own investments, this is what the financial markets are all about.