What are we looking for?
Oil and gas companies that have had a banner year but whose products will be less in demand in the future.
Today’s energy investors are caught between two narratives:
- Oil and gas majors have enjoyed windfall profits since the energy squeeze, induced by Russia’s invasion of Ukraine, sent prices skyrocketing.
- The world must quickly transition itself away from carbon emitting sources of energy in order to avoid the worst possible outcomes of climate change.
One might reasonably conclude fossil fuels are a necessary evil in the immediate future, but in the medium to long term, greener energy will be the solution to the twin objectives of transitioning and energy security. If that is the case, it might be time to consider selling certain fossil fuel producers whose shares have performed particularly well this year.
With this in mind, let’s look at how U.S. oil and gas majors’ forecasted earnings per share (EPS) for 2025 compares with what it would be if there was a US$95 price imposed on a tonne of carbon emissions (the price under Canada’s federal system for 2025). Note that this could be an explicit price, that is, U.S. carbon price legislation is passed; or an implicit price, based on shifting preferences of investors, business and consumers (perhaps more likely).
The screen
We are looking for U.S. energy companies that:
- Have a market cap greater than US$50-billion;
- Have gained more than 50 per cent year-to-date on a total return basis. The YTD time frame captures the amount of time since the invasion of Ukraine (Feb. 24) as well as a period of about seven weeks beforehand when speculation about the invasion began driving up oil and natural gas prices.
For each of these companies we look at the difference between forecast EPS for 2025 in a business-as-usual scenario, and what it would be if a US$95 carbon price was applied, using the LSEG cost-of-carbon valuation model. The model allows investors to analyze how a company’s key valuation and profitability metrics are affected by different carbon pricing scenarios.
More about LSEG
London Stock Exchange Group PLC (LSEG) is a leading global financial markets infrastructure and data provider. We play a vital social and economic role in the world’s financial system. With our trusted expertise and global scale, we enable the sustainable growth and stability of our customers and their communities.We are leaders in data and analytics, capital formation and trade execution, and clearing and risk management.
What we found
The screen yields nine companies, and the average EPS reduction under a carbon price scenario is 53 per cent. Perhaps unsurprisingly, the two companies with the best performance year-to-date – Occidental Petroleum Corp. and Marathon Petroleum Corp. – are most at risk, with an EPS reduction of 120 per cent and 100 per cent, respectively.
It should be noted that these EPS reductions are conservative estimates, as only Scope 1 and Scope 2 emissions (those resulting from company operations and the power they purchase) are considered. Scope 3, which includes upstream and downstream emissions when the fuel is burned in a car, plane, furnace or power plant, represent the majority for the oil and gas industry but are less widely disclosed – only six of these nine companies disclose Scope 3 emissions. Chevron Corp., for example, which does disclose Scope 3, sees only a 5 per cent reduction when only Scope 1 and 2 are considered, compared with a 225 per cent drop if Scope 3 is included.
Investors are advised to do their own research before trading in any of the securities shown.
Hugh Smith, CFA, MBA, is director of sustainable finance and investing at London Stock Exchange Group.