Oil Industry’s Windfall Fails to Excite Wall Street

Fifteen of the 20 companies with the best returns in the S&P 500 index last year belonged to the oil industry, including

Occidental Petroleum Corp.

OXY -1.97%

, which had a 119% total shareholder return, according to Dow Jones data. After lagging behind every other sector from 2018 to 2020, energy has supplanted tech to lead the index for the past two years. 

Yet many investors are still keeping their distance. Energy’s weighting within the S&P 500 has grown to about 4.9%, up from about as little as 2% during the pandemic lows. But that is well below the sector’s peak weighting of 16.2% in the second quarter of 2008, according to S&P Dow Jones Indices.

Some shareholders deserted U.S. shale after incurring losses in the industry’s debt-fueled oil boom in the 2010s, and fear a repeat. Others such as pension funds, endowments and faith-based organizations have sold some or all of their oil-and-gas holdings, citing concern about the industry’s greenhouse-gas emissions.

The oil industry’s windfall has shown that global thirst for oil and gas remains strong, despite many governments’ and companies’ pledges to make a transition to cleaner-energy sources. Oil and gas prices climbed to multiyear highs when Russia invaded Ukraine last year, exacerbating years of underinvestment in fossil fuels. The cost inflation has been borne partly by consumers, as U.S. pump prices surged to record levels and Europe faced a natural-gas crisis.

“The entire universe of investors has clearly misunderstood the time it will take to wean off oil and gas,” said Brad Demicco, director of private markets at Southern Methodist University’s investment office.

The energy sector will continue to outperform the broader market for years while supplies remain tight, said Mr. Demicco, who helps invest SMU’s $2 billion endowment. While some investors might buy shares if an economic downturn weakens oil prices, he said, it appears many have exited for good because of their climate commitments. 

“The base of capital has shrunk permanently,” said Mr. Demicco.

This rift comes as

Exxon,

XOM 0.69%

Chevron,

Shell

and

BP

PLC weigh their long-term strategies as countries push to reduce their dependence on oil and gas. Big questions ahead are how they plan to spend their winnings and to what extent they should invest in their traditional oil-and-gas business or renewable energy. 

Just two years ago, the industry was on the ropes as the pandemic gutted fossil-fuel demand and some predicted that the end of the oil era was nearing. Exxon in 2021 lost a historic proxy fight with the investment firm Engine No. 1, which argued that Exxon had spent lavishly on low-return projects and had no long-term climate strategy, winning three seats on Exxon’s board.

Yet Exxon and Chevron both resisted pressure to pour money into renewable energy such as wind and solar, in which they would have no competitive advantage, they have told investors. Instead, the U.S. major oil companies have significantly cut spending from prepandemic levels and pursued modest growth in their oil-and-gas businesses. They have also launched new business units investing mainly in carbon capture, hydrogen and biofuels, while attempting to curb emissions.

Charles Penner,

a hedge-fund veteran and an architect of Engine No. 1’s proxy fight against Exxon, gives the U.S. major oil companies’ strategy some credit, saying most investors want to see large oil companies focus on their highest-return opportunities that produce oil quickly, such as the Permian Basin of West Texas and New Mexico. 

Those projects are likely to be profitable, even if oil demand declines in coming years, Mr. Penner said, and investors prefer them over mega offshore projects that were once the companies’ bread and butter. Those can take decades to recoup their investments, putting profitably in question if the world uses less oil. Otherwise, he said, most investors want to see companies “returning capital to shareholders or, if possible, investing in realistic and scalable diversification opportunities.”

So far, investors have rewarded that strategy more than those of London-based counterparts Shell and BP, which have more aggressively pledged capital to renewable and lower-carbon energy. Exxon’s shares are up about 37% over the past year, and Chevron’s are up about 25% in New York. Meanwhile, in London, Shell’s shares are up about 19%; BP’s are up about 20%.

European pension funds, governments and environmental groups have broadly applied greater pressure on European majors to cut climate-harming greenhouse-gas emissions, even as the same companies face demands to keep raising dividends and share purchases. European officials and the Biden administration have decried oil and gas profits, and both the European Union and the U.K. imposed a temporary windfall tax on the industry last year.

Another issue for investors is that it is hard to determine how any of the companies will expand their business over the long term. Exxon, Chevron, BP and Shell have all allowed their oil production to decline from prepandemic levels. Shell and BP have said they would cut theirs further, while Exxon and Chevron haven’t committed to substantial increases.

The companies say the new Inflation Reduction Act will boost cleaner-energy investments in the U.S. through tax credits that make some projects economical in ways they weren’t before. But the hoped-for wall of cleaner-energy spending faces hurdles including supply shortages, inflation and red tape, while some of the technologies the companies have committed to, including carbon capture and hydrogen, are unproven.

Write to Collin Eaton at [email protected] and Jenny Strasburg at [email protected]

Fifteen of the 20 companies with the best returns in the S&P 500 index last year belonged to the oil industry, including

Occidental Petroleum Corp.

OXY -1.97%

, which had a 119% total shareholder return, according to Dow Jones data. After lagging behind every other sector from 2018 to 2020, energy has supplanted tech to lead the index for the past two years. 

Yet many investors are still keeping their distance. Energy’s weighting within the S&P 500 has grown to about 4.9%, up from about as little as 2% during the pandemic lows. But that is well below the sector’s peak weighting of 16.2% in the second quarter of 2008, according to S&P Dow Jones Indices.

Some shareholders deserted U.S. shale after incurring losses in the industry’s debt-fueled oil boom in the 2010s, and fear a repeat. Others such as pension funds, endowments and faith-based organizations have sold some or all of their oil-and-gas holdings, citing concern about the industry’s greenhouse-gas emissions.

The oil industry’s windfall has shown that global thirst for oil and gas remains strong, despite many governments’ and companies’ pledges to make a transition to cleaner-energy sources. Oil and gas prices climbed to multiyear highs when Russia invaded Ukraine last year, exacerbating years of underinvestment in fossil fuels. The cost inflation has been borne partly by consumers, as U.S. pump prices surged to record levels and Europe faced a natural-gas crisis.

“The entire universe of investors has clearly misunderstood the time it will take to wean off oil and gas,” said Brad Demicco, director of private markets at Southern Methodist University’s investment office.

The energy sector will continue to outperform the broader market for years while supplies remain tight, said Mr. Demicco, who helps invest SMU’s $2 billion endowment. While some investors might buy shares if an economic downturn weakens oil prices, he said, it appears many have exited for good because of their climate commitments. 

“The base of capital has shrunk permanently,” said Mr. Demicco.

This rift comes as

Exxon,

XOM 0.69%

Chevron,

Shell

and

BP

PLC weigh their long-term strategies as countries push to reduce their dependence on oil and gas. Big questions ahead are how they plan to spend their winnings and to what extent they should invest in their traditional oil-and-gas business or renewable energy. 

Just two years ago, the industry was on the ropes as the pandemic gutted fossil-fuel demand and some predicted that the end of the oil era was nearing. Exxon in 2021 lost a historic proxy fight with the investment firm Engine No. 1, which argued that Exxon had spent lavishly on low-return projects and had no long-term climate strategy, winning three seats on Exxon’s board.

Yet Exxon and Chevron both resisted pressure to pour money into renewable energy such as wind and solar, in which they would have no competitive advantage, they have told investors. Instead, the U.S. major oil companies have significantly cut spending from prepandemic levels and pursued modest growth in their oil-and-gas businesses. They have also launched new business units investing mainly in carbon capture, hydrogen and biofuels, while attempting to curb emissions.

Charles Penner,

a hedge-fund veteran and an architect of Engine No. 1’s proxy fight against Exxon, gives the U.S. major oil companies’ strategy some credit, saying most investors want to see large oil companies focus on their highest-return opportunities that produce oil quickly, such as the Permian Basin of West Texas and New Mexico. 

Those projects are likely to be profitable, even if oil demand declines in coming years, Mr. Penner said, and investors prefer them over mega offshore projects that were once the companies’ bread and butter. Those can take decades to recoup their investments, putting profitably in question if the world uses less oil. Otherwise, he said, most investors want to see companies “returning capital to shareholders or, if possible, investing in realistic and scalable diversification opportunities.”

So far, investors have rewarded that strategy more than those of London-based counterparts Shell and BP, which have more aggressively pledged capital to renewable and lower-carbon energy. Exxon’s shares are up about 37% over the past year, and Chevron’s are up about 25% in New York. Meanwhile, in London, Shell’s shares are up about 19%; BP’s are up about 20%.

European pension funds, governments and environmental groups have broadly applied greater pressure on European majors to cut climate-harming greenhouse-gas emissions, even as the same companies face demands to keep raising dividends and share purchases. European officials and the Biden administration have decried oil and gas profits, and both the European Union and the U.K. imposed a temporary windfall tax on the industry last year.

Another issue for investors is that it is hard to determine how any of the companies will expand their business over the long term. Exxon, Chevron, BP and Shell have all allowed their oil production to decline from prepandemic levels. Shell and BP have said they would cut theirs further, while Exxon and Chevron haven’t committed to substantial increases.

The companies say the new Inflation Reduction Act will boost cleaner-energy investments in the U.S. through tax credits that make some projects economical in ways they weren’t before. But the hoped-for wall of cleaner-energy spending faces hurdles including supply shortages, inflation and red tape, while some of the technologies the companies have committed to, including carbon capture and hydrogen, are unproven.

Write to Collin Eaton at [email protected] and Jenny Strasburg at [email protected]