Commentary: Even with energy prices set to soar, buying oil and gas stocks isn’t the best idea

SINGAPORE: As the Ukraine war and supply chain disruptions persist, oil and gas prices have soared, creating huge windfalls for fossil fuel producers – and investors who entered the market at the right time.

Net income is set to double to US$4 trillion (S$6 trillion) for oil and gas companies in 2022. With Western economies shunning Russian oil, along with others facing unprecedentedly hot temperatures this summer, some countries have fallen back on coal to meet energy demand.

These pressures will not let up, especially when winter hits the northern hemisphere. Investors expect that energy prices will stay high or possibly rise over the coming months.

Yet the need to decarbonise energy is still as imperative as ever, as will no doubt be discussed at COP27, the upcoming UN climate summit in Sharm El Sheikh, Egypt. ESG (Environmental, social and governance) investing is crucial in financing this transition.

But according to Refinitiv data, ESG funds saw their largest outflow of cash since March 2020 this September; a reversal of the surge of responsible investing that began during the pandemic.

Is there a case to be made for ESG investing amid sky-high fuel prices? Wouldn’t an investor looking to maximise returns choose fossil fuel over ESG stocks now?

PRICE GROWTH IN OIL AND GAS DOES NOT MEAN RETURNS ON INVESTMENT

Retail investors should keep some points in mind before adjusting their portfolios. There are financial and political factors that may jeopardise further price growth in oil and gas stocks.

While energy companies have raked in record revenues from high oil prices, such a trend may not be sustained, nor is it guaranteed that that windfall profits will be retained by firms and distributed to shareholders.

Energy prices arguably have limited room for further growth. Oil has been hovering at a fairly stable level for some weeks now. Gas prices are less predictable but appear to have turned away from record highs seen in late August. While a winter spike (especially in gas prices) may be on the horizon, this will recede as winter passes.

Meanwhile, pressure from governments and the responsible investing community may dampen Big Oil profits. On Sep 20, UN Secretary General Antonio Guterres called on developing economies to tax the windfall profits of fossil fuel companies, suggesting revenues be given to countries suffering loss and damage caused by climate change, and people struggling with rising food and energy prices.

On Oct 19, US President Joe Biden urged oil companies not to enrich shareholders further with their profits, but to increase production so as to bring down fuel prices for everyday Americans.

If fossil fuel companies take heed, it will not reflect positively on oil and gas stock prices.

A POSITIVE RIPPLE EFFECT FOR RENEWABLES

An additional financial consideration is that where active investors chase oil and gas for short-term returns, investment opportunities in clean and renewable energy may become relatively cheaper.

Climbing prices for oil, gas and coal are creating a positive ripple effect for renewables. Market re-organisation does not require renewables to become cheaper in absolute terms, just to be relatively more attractive than the alternative.

Renewable prices may be rising, but other prices are rising faster and further. As a result, renewables are increasingly preferred over fossil fuels, especially for new power generation. There may be an opportunity to buy good ESG stocks at a discount – an opportunity worth keeping an eye open for.

Then there is the ethical point of view. ESG investing is grounded in the principles of social responsibility and stewardship, that is to steer towards investments with demonstrable environmental or social benefits. Such principles have been the grounds for institutional investor divestments away from oil and gas companies even when they offer strong positive financial returns.

Retail investors may feel less obligated to adhere to ESG principles – or at least they will have fewer stakeholders pressuring them to do so. But it’s worth remembering that chasing oil and gas stocks for short-term returns requires a compromise on the non-financial values that govern responsible investing decisions.

KEEPING ESG INVESTING IN FOCUS

The current energy crisis is inadvertently offering retail investors incentives to purchase stock in carbon-intensive companies. A renewed commitment to ESG investing principles is warranted.

Tackling rising energy costs, ensuring security and resilience of energy supply, meeting net-zero targets and most importantly, ensuring better returns for investors will require a systematic balance of investment in clean energy along with investments that will enable a smooth transition of polluting sectors.

Warren Buffett famously said “never invest in a business you cannot understand”. Investing in high-quality companies with strong environmental and social performance, and well-developed governance structures ensures minimising risk and hence, better returns.

ESG investing has already become a mainstream practice. As long as the will to fight climate change persists, ESG investing will be needed.

David C Broadstock is Senior Research Fellow and Keerthana Gopinath is Research Associate at Energy Studies Institute, National University of Singapore.