One of the few numbers growing faster than dividends in energy stocks is the size of crowds convinced they are unsustainable. I have never seen such a negative consensus opinion on an entire sector as on traditional energy.
The debates are so one-sided that simple dividend indices are neglected, and the focus instead is on when traditional energy companies will cease to exist.
Yet dividends offer investors better proof of exactly what works than any crowd. As a professional portfolio manager since 1996, I’ve researched every conceivable factor of investment success, and found no other metric with such a long track record. A dividend comes with no opinions on what’s real — and that’s even more valuable when the confusion over energy stocks is at its highest.
The potential for paying out and increasing energy dividends has never been greater, largely because the sector is considered uninvestable by so many – a remarkable paradox.
Rather than single out individual stocks, it might be more helpful for investors if I could at least add a bit of curiosity to their view of the group, away from consensus conviction.
Start with a simple supply and demand. Crowds of votes, regulations and protests to end fossil fuels have resulted in at least CL.1 oil,
and natural gas NG00,
discoveries last year, since 1946. Yet the number of households worldwide has more than tripled since then, demanding more products, which in turn require more oil to produce.
By 2050, the United Nations goal of net zero carbon emissions, traditional energy demand will not only sustain dividends with more free cash flow, but can significantly increase those dividends in the future.
The biggest surprise could be a special climate dividend from the most unlikely sources.
Mathematics and stakeholder mindset
The dumbest notion of ESG investors protesting the ownership of energy stocks by large institutions was that forcing them to sell would limit the capital needed to operate.
Oil and gas companies have no problem raising money. In the past, they have been so reckless in issuing stocks and debt fueled by the greed of chasing higher prices that they may very well go bankrupt on their own. Speculative investors poured money into shale projects that never produced cash flow and destroyed capital. The shale boom was a great lesson in geology and terrible math.
Focusing on a dividend requires discipline and more conservative math. A few of the highest quality power producers have begun to formally align their interests with those of stakeholders, showing the calculations on which they base their dividend projections and using commodity price assumptions that are anything but greedy.
Lily: Exxon hits record profit and Chevron triples amid high energy prices, sending stocks soaring
Investors are overlooking this monumental mindset shift that has occurred since the last time oil and gas prices were this high.
Here’s an example of one of the many companies that have learned from boom and bust cycles to use more conservative math. The green lines are oil and gas price assumptions used to forecast their free cash flow for dividends payable (one-half and one-third of current oil and gas prices in July 2022).
Unlike previous cycles, the balance sheets of some energy producers are now clean; their long-term net debt has been reduced or eliminated. Couple that with increasing their own internal investment rates before considering new projects, and they’ve made the math so much harder for themselves. Stakeholders benefit directly.
The best operators I study have learned hard lessons. But, as a portfolio manager, I don’t take their word for it, I just stick to the math, which leaves no room for opinion.
Free cash flow springs, supporting more dividends and less speculation. Even better, they can be acquired at cheap prices relative to the overall market through forced selling pressure. This chart shows the current value of the business divided by the last 12 months of free cash flow. Each of the largest energy companies sits significantly below the average for all S&P 500 sectors, which is 35.
The other side of unencumbered truths
The energy dividends are increasing due to our diminishing ability to have honest dialogues in this country. Our democracy has chosen to make it difficult or impossible for energy companies to grow their business. So they do what they can with free cash flow: pay down debt, buy back stock and increase their dividends.
The crowds have made it increasingly difficult for energy companies to transport oil and gas and even more difficult to refine them. These gigantic pieces of the energy puzzle have a more direct impact on the daily expenses of American households than the price of a barrel of oil. Transporting energy safely and cheaply through pipelines requires a growing infrastructure that is now nearly impossible to build or expand.
A pipeline project with the greatest potential for increased capacity was finally scrapped in 2021, having been proposed in 2008, and fully backed by long-term contracts from producers in Canada. Instead, tar sands are loaded onto railcars and transported much less efficiently across the United States with greater environmental risks than pipelines.
I asked my good friend Hinds Howard, a great energy pipeline specialist, about any other recent developments that might have a chance. He pointed to another project that will fight to be completed after three years of permits. Initial cost estimates nearly doubled only because of legal work regarding additional regulatory delays.
The ability to refine energy is further restricted. Rather than simply dealing with years of no growth and regulatory delays, refiners have been eliminated. In the last three years alone, four refineries have been closed and two partially closed. Two others should be closed. Six have been converted to renewable diesel. That’s a net reduction of over a million barrels a day.
Today there are 129 refineries, in 1982 there were 250.
Are we then surprised when growing demand for tight supplies drives prices up? The historically unique opportunity for investors is the irony that throngs of voters and protesters who want to end the use of fossil fuels, have ended up making energy dividends from surviving operators of the highest quality safer than they never were.
Lily: What would it take for US oil companies to increase production? A lot.
The most surprising dividend
So far, I’ve relied on pure math, which I love because it leaves no room for any opinion, including my own. Here’s my only guess, based on capitalism’s cleanest motivation to reward problem solvers: Who better to lead us to cleaner energy than those who know exactly where it’s dirtiest?
I recently visited the CFO of an energy company and he was very excited about a closed loop gas recovery project to reduce flared gas. The company developed this one-of-a-kind technology to help solve a problem it created, and it’s been much more successful than expected.
The new stated goal is “zero” routine flaring by 2025 and the company has more than doubled its climate technology budget over the past three years to help meet that goal and try more projects.
Traditional energy was already becoming cleaner and more efficient. The number of kilograms of carbon emissions for every dollar of US GDP has been more than halved since 1990. This is not a solution, but it is the right direction and the common interest of stakeholders in this planet.
Innovation is more effective than regulation. Energy companies in the United States already have the best climate technology in the world, and it’s not even close, and they can still improve it significantly. We should look at our advantages here. Traditional energy companies play a huge role in a more sustainable future and will pay increased dividends to achieve it.
Ryan Krueger is CEO of Freedom Day Solutions, a Houston-based fund manager, and IT director of the company’s dividend growth strategy. Follow him on Twitter @RyanKruegerROI.
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