Table 1. Standard & Poor’s Companies 1980 — 2018*

IEEFA Update: The investment rationale for fossil fuels falls apart — — — Institute for Energy Economics & Financial Analysis

From an Article by Tom Sanzillo and Kathy Hipple, IEEFA, August 27, 2018

An outdated mindset that no longer lives up to its hype! For decades, the fossil fuel sector literally fuelled the global economy and powered the world’s investment markets.

This is no longer the case. The long-standing and now outdated investment thesis around fossil fuels—that such holdings would make large and reliable annual contributions to institutional funds—has crumbled.

The sector now lags the broader market, and the one-time assumption that an oil and gas company’s value equalled the number of barrels of oil, or reserves, it owned has collapsed alongside the core steady-returns rationale for investing in the sector.

A new paradigm is emerging: Cash, revenue, and profits matter, and risks cannot be ignored. Fossil fuel companies are responding in different ways to this shift, some more responsibly than others. But some companies (and their investors) ignore what’s happening, and they do so at their peril.

The absence of a coherent and honest industry-wide value thesis today places fossil fuel investors at a true disadvantage. The days of powerhouse contributions by such companies to investment fund bottom lines are over. The risks of continuing to invest in coal, oil and gas are formidable and unlikely to abate.

Given the industry’s lackluster rewards and the daunting risks it faces, responsible trustees and investors must ask: “Why are we in fossil fuels at all?” (See our recent report on that question here).

In the early 1980s, fossil fuel stocks comprised seven of the top 10 companies in the Standard and Poor’s 500 Index. Today, only one, ExxonMobil, is in that class, where it ranks seventh after having been number one as recently as 2010.

* – Table 1: Standard and Poor’s Top 10 Companies, 1980-2018 (Source:

For the past five years, the energy sector has lagged almost every other industry globally. Instead of bolstering portfolio returns, energy stocks dragged them down, and investors lost billions of dollars.

Paradoxically, the fossil fuel sector’s fall was caused largely by a drop in prices that grew out of a major technological innovation: hydraulic fracturing, or fracking, which increased the supply of cheap oil and gas and emerged as a new source of supply that disrupted the dominance of OPEC. After 2014, oil prices crashed, oil company revenues plummeted, expensive capital investments failed, massive amounts of reserves were written off as no longer viable, and major bankruptcies occurred.

THE SECTOR’S DECLINE EXPOSED WEAKNESSES IN THE OLD INVESTMENT RATIONALE, part of which was built on the assumption that a company’s value was determined by the reserves it owned.

According to this thesis—one promoted by the industry and supported by many analysts and investors —oil and gas companies had to maintain an abundant portfolio of reserves, no matter the cost. These reserves would allow companies to deliver returns in any investment climate, specifically by weathering price declines that were viewed as temporary, and then profiting from relentless global economic growth that would forever spur demand for more oil and gas. Hydrocarbon reserves thus became a key metric of long-term value (see “Private Empire: Exxon Mobil and American Power,” New York: Penguin Books, 2012, pps. 186-193).

This rationale worked for decades, and, as a result, many investors assumed that new reserves, even those acquired at great cost, would ultimately yield handsome rewards. The shale boom encouraged the oil and gas sector to double down on the reserve growth thesis, and Wall Street—long accustomed to viewing oil reserves as a key metric of financial value—bought into that mindset.

But fracking undermined the old reserve-based investment mindset in two ways. First, it rendered old estimates of total global reserves meaningless, as supplies of oil and gas were now viewed as abundant and no longer in short supply (at least not on a time frame that mattered to Wall Street).

Second, the price collapse caused by the new abundance of oil and gas actually destroyed the economic value of many reserves. Accounting rules define proven reserves in both geologic and economic terms: a reserve represents the amount of oil and gas that could be profitably extracted at expected future prices. But as expectations for future prices fell, many “reserves” were seen as suddenly unprofitable, forcing the industry to write off many of them as worthless.

As the old, reserve-focused investment thesis withered, oil and gas became just another commodity investment subject to the same short-term variables—prices, profits, cash flows, debt, dividends, and asset quality.

Cash is king now. And risk can no longer be ignored.

AS THE REWARDS OF INVESTING IN THE SECTOR HAVE DIMINISHED, RISKS HAVE RISEN—and will likely continue to rise. The sector is ill-prepared for a low-carbon future because of the many idiosyncratic factors of individual companies and an industry-wide failure to acknowledge—and plan for—the energy transition that is gaining momentum.

The global economy is shifting toward less energy-intensive models of growth, geopolitical tensions are creating near-daily volatility, fracking has driven down commodity and energy costs and prices, and renewable energy and electric vehicles are gaining market share.

Add to all that the fact that litigation on climate change and other environmental issues is expanding and campaigns in opposition to fossil fuels have matured. Such forces are now a material risk to the fossil fuel sector and an argument unto themselves for the reallocation of capital to renewable energy and electric vehicles.

These risks, taken cumulatively, indicate that the old investment rationale for investing in the coal, oil and gas sector has lost its validity. Successful investing in these industries now requires deep expertise, strong judgment, a hefty appetite for risk and a robust understanding of how individual companies are positioned with respect to their competitors both inside and outside the industry.

Where passive investors could once choose from a broad basket of oil and gas industry securities with little reason to fear they would lose money, that assumption no longer holds. Blue-chip stocks with stable returns are far more appealing, and—simply put— coal, oil, and gas equities are no longer worth the risk.

>>> Tom Sanzillo is IEEFA’s director of finance. Kathy Hipple is an IEEFA financial analyst.

SEE ALSO: IEEFA Update: How Gas and Oil Companies Are Starting to Look Like the Yellow Pages


Fracking causes many human impacts

Reply to George Ahern’s Op-Ed* of Naples, Florida:

George Ahern’s Op-Ed of August 29 has been the source of many guffaws here in Appalachia, where it is passed around among people far from Naples, Florida. It is written as though there was no negative side on the balance sheet of fracking.

The industry uses technology developed at the Morgantown Energy Center (West Virginia) for the DOE and first tried by George Mitchell with government financial assistance. It is so financially insecure both Bloomberg and the New York Times carried articles about difficulty getting funding for new projects. One of those articles says, “Some of fracking’s biggest skeptics are on Wall Street. They argue that the industry’s financial foundation is unstable: Frackers haven’t proven that they can make money.”

Fracking companies are going broke on a regular basis. Another quote from the same article, “The 60 biggest exploration and production firms are not generating enough cash from their operations to cover their operating and capital expenses. In aggregate, from mid-2012 to mid-2017, they had negative free cash flow of $9 billion per quarter. This article was published in the same month as Dr. Ahern’s. Only five of the top 20 fracking companies made more money than they spent in the first quarter of 2018!

Some of the reasons are quite simple. Fracking expense is tremendous and the wells decline rapidly. Conventional wells produce for decades, fracked wells don’t pay to pump beyond 6 or 7 years, and production has gone down by half in a couple of years. All the production in the first year makes a selling point to investors, and the rest, conveniently, isn’t mentioned. Several times as much water is used as oil produced in oil wells, and several times as much water returns to the surface. Five thousand tanker truckloads of water must be taken from a source and then much of it pumped back underground. This causes earthquakes.

Local Chamber of Commerce people benefit from the investment, and they love it. Rural people hate it when it arrives, and anyone concerned with it’s effect on the biosphere see mostly harm. Energy Retun on Energy Invested (EROEI) is quite poor.

When you look at the anti-fracking resistance you see many small groups working individually, composed of several interests. The first is composed of landowners who consider themselves abused by laws that allow extraction industry to “run over” them. A second consists of people who suffer illness from the chemicals used in fracking and brought up from the deep with “return flow’ from the fracked wells. Still others are environmentalists, afraid of the huge amount of soil disturbance caused by well pads, access roads and the endless network of pipelines and pump stations required to transmit the product. Dr. Ahern’s notion that it is unified is a product of the petroleum industry’s notion that to be effective it must be organized the way they are. Almost all anti-fracking workers are unpaid volunteers, supplying their own funding for travel and research.

Horror stories abound in Appalachia, Colorado, Texas, Oklahoma. Frequently surface owners do not own the oil and gas under their property. This is the result of law that allowed surface to be “severed” from minerals, a longstanding practice going back to the early days of oil and gas when lawyers were educated and landowners weren’t. This results in surface owners receiving arbitrary “settlements,” largely dictated by the company. Environmental damage is paid to no one, since the community owns the environment.

Part of the political appeal of fracking is the decline of petroleum reserves in the United States. We exported early and although blessed with reserves, they are gone. After all, the U. S. has only two percent of the dry land of the earth. The remaining conventional reserves lie in Russia and Iran (which “free world” companies want to confine) and the Middle East, with potentially shifting loyalty.

Finally, the piece Ahern wrote ignores the two devastating products of fracking: carbon dioxide and petroleum based plastics. One is ruining the atmosphere and the other the surface of the dry land earth and the sea. The blurb describing Ahern does not give the area of his Ph. D. expertise; perhaps it is not in science. If in Chemistry or Physics, the idea of radiation from the sun exciting carbon dioxide molecules, making sensible heat, what is measured with a thermometer, would not be strange. We all know microwaves make water molecules vibrate faster in a microwave oven. These heating and littering effects simply can’t be ignored by anyone with children or interested in continuing civilization.

An easy calculation shows 7708 tons of carbon dioxide have been added to the atmosphere on every square mile of the earth’s surface since coal was first used on any scale to produce heat and energy; and that we are now adding 203 tons more to each square mile every year. Some of this heat is transferred to the ocean, making it warmer, some goes to melting ice at high altitude and some to melting ice at the poles. This raises the ocean level.

Ahern couldn’t have done better in singing the praise of an industry that is exhausting it’s reserve of capitol and credibility on influencing legislation and enforcement and attracting reluctant investors. The ultimate irony of the article is that it was published in a coastal city in Florida. Rising sea level and intrusion of saltwater will get to it among the first.

Sincerely, S. Thomas Bond, Ph. D.

>>> Dr. Bond’s Ph. D. is in Inorganic Chemistry. Along with teaching he has maintained a farm in central Appalachia. He is a frequent contributor to newspapers, and the author of a book on life in Appalachia.

See also:

* — 1. “Commentary: The era of resistance to fracking is ending”, George Ahearn, Naples Daily News / August 29, 2018

2. “The Next Financial Crisis Lurks Underground

3. “Fracking: Do the Economics Justify the Risks?


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