The oil & gas industry is now in a state of managed decline – but this doesn’t mean there aren’t opportunities for income investors in the sector, according to Job Curtis, manager of the City of London Investment Trust.
Even though Shell was the sixth biggest holding in the City of London portfolio at the end of June and BP was the 10th largest, these stocks still acted as net contributors to the outperformance of the trust when they halved in value as they make up a larger proportion of the FTSE All Share than the trust.
Performance of stocks year-to-date
Source: FE Analytics
The future for these stocks looks uncertain at best, with BP recently admitting that the world may have already seen peak fossil-fuel demand, yet Curtis (pictured) is not about to ditch them from his portfolio.
“You can still make money in a declining industry, but it depends how it manages that decline,” he explained. “It’s quite interesting, BP basically said it is going to reduce its exposure to the oil & gas side of things and grow in renewables and if it manages it in a non-aggressive way, it could be quite good for shareholders.
“Having cut its dividend by about 50 per cent, which was less than Shell’s 66 per cent, I’m a bit disappointed BP only committed to holding the dividend, with any excess cash flow going into share buybacks.
“But even after that cut, it is yielding 5 to 6 per cent, because of the share price decline.”
On 4 August, BP announced its transition from “international oil company to integrated energy company”, including commitments to increase low-carbon investment by 10-fold and decrease emissions by 30 to 35 per cent by 2030.
Yet even though Curtis accepted the oil & gas industry is probably now in decline, he is not convinced a switch of focus to renewable energy will be its saviour.
“It’s very difficult to judge how profitable it will be,” he continued. “It wants to become an integrated energy company and it does bring certain advantages, but it is not its core expertise.
“Everyone’s a bit sceptical: the proof of the pudding is going to be in the eating.
“I think the fact he [BP chief executive Bernard Looney] is saying that is quite positive in a way: he acknowledges the issue and he’s going to manage the business on that basis. It’d be worse if he were over-optimistic about oil demand going forward.”
Curtis is not the only one who is sceptical about the oil majors’ ability to pivot their business model towards renewable energy. In this month’s edition of Trustnet Magazine, Carbon Tracker strategist Kingsmill Bond pointed out incumbents always struggle when they face new competition that is completely tooled up for a new system.
“Just look at our own experience,” he said. “Why is it that we are using Zoom and not the BT equivalent? Why do we use Google and not the postal service equivalent? It’s quite normal in every sphere of life for incumbent companies to get wiped out by technology transitions.”
Yet Curtis is more focused on the income opportunities in the shorter term and said it is possible shareholders in the likes of BP and Shell could be pleasantly surprised once the world finally overcomes the coronavirus pandemic.
“If you do get more normalisation, the fact that money has been taken out of developments – not just from BP, but US shale etcetera – you could actually get a scenario where demand is improving as people fly more and drive more.
“And you could get quite a decent spike in the oil prices if your investment hasn’t gone into exploration and development in the short term.
“We are in a transition phase, I accept that. But there still are a lot of cars out there, we are all using a lot more plastic than we used to and when you look at the grand scheme of things, oil is still going to play a role in the global economy going forward, so I think well managed companies will prove to be good investments in that sector.”
Data from FE Analytics shows City of London has made 79.38 per cent over the past 10 years, compared with gains of 71.11 per cent from the IT UK Equity Income sector and 64.43 per cent from the FTSE All Share.
Performance of fund vs sector and index over 10yrs
Source: FE Analytics
It is trading at a discount to net asset value (NAV) of 2.18 per cent, compared with premiums of 1.44 and 1.61 per cent from its one- and three-year averages.
The trust is 12 per cent geared, is yielding 6.03 per cent and has ongoing charges of 0.36 per cent.