In November 2021, when the world was gathering in Glasgow for the COP26 climate change conference, the minds of the world’s leaders may have been ambitious for the future but were also firmly rooted in their then-presence conundrum. Which was, what can a fragile recovering global economy do about runaway crude oil prices that had jumped to a 7-year highs? Various attempts were made to tame crude prices – especially given that it was contributing the high levels of inflation and exacerbating the global supply crunch – but such attempts are never easy. But one group has tried to make the best of the situation: the energy supermajors, which managed to ride the price bonanza to record their highest levels of profits in years, and then using those profits to re-confirm their position as blue chip stocks intent on funding a carbon-zero future through a profitable energy transition.
Take Shell, for example. No longer Royal Dutch Shell after the company eliminated its dual-listing status by departing The Hague for London, Shell’s Q421 net profits reached their highest level in 8 years, rising to US$6.4 billion from US$393 million in Q420. Its annual net profit almost quadrupled to US$19.3 billion from US$4.85 billion. Quarterly results were well above the average analyst forecasts, which is a theme that was repeated throughout this financial season. In particular, Shell, as the largest LNG trader in the world, managed to capitalise on the amazing runup in European and Asian gas/LNG prices in Q4, ‘significantly boosting’ trading profits even if its LNG production actually decreased due to unplanned outages at its flagship Prelude FLNG project in Australia.
CEO Ben van Buerden called 2021 a ‘momentous year for Shell.’ And that’s true in more ways than one. While Shell’s vision of the future is one of an ambitious transition from dirty to clean energy, the velocity of that plan has been challenged. From a Dutch court ordering the company to accelerate its climate change emissions targets to an activist investor bidding to split Shell into two companies to Europe’s largest pension fund ditching the company and the sector, Shell has struggled with its public face in 2021. Van Buerden was reportedly told that Shell ‘was not welcome at Glasgow (COP26)’, underscoring how many view energy companies as persona non grata in the climate change debate. That, Shell would argued, is a fallacy. To create the energy transition will require enormous amounts of funds and expertise. Both of which Shell and its fellow supermajors can supply. But they can only do it if they have the support of investors. So Shell declared that it would be utilising its 2021 profits to lift its dividend by 4% in Q122, the fourth rise since it slashed rates in early 2020, while announcing new share buybacks totalling US$8.5 billion for the first half of 2022. The change in its incorporation status also simplifies Shell’s tax status and dividend payments, with the company now also assimilating its dual share structure into a single line of ordinary shares. This, Shell hopes, will be able to retain investor attention even if public relations remains challenging.
That story has been repeated in the boardrooms of energy majors since January. ExxonMobil, for example, reported a Q421 net profits of US$8.9 billion and an annual net profit of US$23 billion, both of which beat Wall Street expectations. CEO Darren Woods promptly announced that ExxonMobil had been focused on paring down debt and maintaining cost-saving measures instead of restarting its ambitious pre-pandemic growth/spending plans. In fact, ExxonMobil declared that it has already paid back most of the debt it took on in 2020, which had battered its share price then. That remarkable level of cash flow will go back to investors, accelerating a US$10 billion share buyback plan, but also into low-carbon solutions, following the success of climate change activist investor infiltrating the ExxonMobil board. Chevron, too, declared its best financial performance in 8 years. Q421 net profits rose to US$5.11 billion from a loss of US$665 million y-o-y, but was one of the rare cases where analyst expectations were not met. Despite this, Chevron said that it would increase its quarterly dividend by 6% and adjusted its share buyback programme to the high end of the planned US$3-5 billion. Oil will remain Chevron’s focus for the time being, particularly in the Permian, following its acquisition of Noble Energy but even it cannot avoid the climate change spotlight for too long.
Which is not an issue faced by the other European supermajors. BP saw its quarterly profit beat forecasts by jumping to US$4.1 billion to achieve a full year US$12.8 billion. This was ‘performing while transforming’ according to CEO Bernard Looney, calling the strong financials as an investment for the future. Along with share buybacks, to keep investors sweet, BP expanded its emissions reduction plan and is building ‘with discipline’ its low carbon energy business. Among the highlights includes exceeding 5 GWs in offshore wind projects, significant investment in hydrogen and a target to increase capital expenditure in ‘transition growth businesses’ to 40% by 2025 and 50% by 2030. This, BP says, should be able to generate US$9-10 billion in revenue by 2030 from five clean energy growth engines – bioenergy, convenience, electric vehicle charging, renewables and hydrogen. France’s newly-rechristened TotalEnergies concur. Its Q4 net profit of US$6.8 billion and full year figure of US$18.1 billion was its best performance since 2008, bouncing back from an annual loss of US$7.2 billion in 2020. As usual, dividends were raised and a new US$2 billion share buyback scheme was announced, while continuing its focus on shifting to cleaner sources of energy with renewables/electricity to account for nearly a quarter of planned capital expenditure for 2022.
If 2020 was an annus horribilis for the energy industry, 2021 was a bit of a wonder year. But the changing context of energy means that different challenges have arisen. Investors are no longer just interested in profits but on future intent, while activists grow more and more powerful. The supermajors are adapting to that, partially having their hand forced in creating a low-carbon future while trying to fund it from current operations as well as not becoming investment pariahs. With war drums beating in Ukraine, crude oil prices will remain high in the first half of 2022. Which will give plenty of room for the supermajors to continue keeping investors happy and to keep activists engaged.
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Supply chains are currently in crisis. They have been for a long time now, ever since the start of the Covid-19 pandemic reshaped the way the world works. Stressed shipping networks and operational blockages – coupled with China’s insistence on a Covid-zero policy – means that cargo tanker rates are at an all-time high and that there just aren’t enough of them. McDonalds and KFCs in Asia are running out of French fries to sell, not because there aren’t enough potatoes in Idaho, but because there aren’t enough ships to deliver them to Japan or to Singapore from Los Angeles. The war in Ukraine has placed a particular emphasis on food supply chains by disrupting global wheat and sunflower oil supply chains and kicking off distressingly high levels of food price inflation across North Africa, the Middle East and Asia. It was against this backdrop that Indonesia announced a complete ban on palm oil exports. That nuclear option shocked the markets, set off a potential new supply chain crisis and has particular implications on future of crude oil pricing and biofuels in Asia.
A brief recap. Like most of Asia, Indonesia has been grappling with food price inflation as consequence of Covid-19. Like most of Asia, Indonesia has been attempting to control this through a combination of shielding its most vulnerable citizens through continued subsidies while attempting to optimise supply chains. Like most of Asia, Indonesia hasn’t been to control the market at all, because uncoordinated attempts across a wide spectrum of countries to achieve a similar level of individual protectionism is self-defeating.
Cooking oil is a major product of sensitive importance in Indonesia, and one that it is self-sufficient in as a result of its status as the world’s largest palm oil producer. So large is Indonesia in that regard that its excess palm oil production has been directed to increasingly higher biodiesel mandates, with a B40 mandate – diesel containing 40% of palm material – originally schedule for full implementation this year. But as palm oil prices started rising to all-time highs at the beginning of January, cooking oil started becoming scarcer in Indonesia. The government blamed hoarding and – wary of the Ramadan period and domestic unrest – implemented a Domestic Market Obligation on palm oil refineries, directing them to devote 20% of projected exports for domestic use. Increasingly stricter terms for the DMO continued over February and March, only for an abrupt U-turn in mid-March that removed the DMO completely. But as the war in Ukraine drove prices even further, Indonesia shocked the market by announcing an total ban on palm oil exports in late April. Chaotically, the ban was first clarified to be palm olein only (straight refining cooking oil), but then flip-flopped into a total ban of crude palm oil as well. Markets went haywire, prices jumped to historical highs and Indonesia’s trading partners reacted with alarm.
Joko Widodo has said that the ban will be indefinite until domestic cooking oil prices ‘moderate’. With the global situation as it is, ‘moderate’ is unlikely to be achieved until the end of 2022 at least, if ‘moderate’ is taken to be the previous level of palm oil prices – roughly half of current pricing. Logistically, Indonesia cannot hold out on the ban for more than two months. Only a third of Indonesia’s monthly palm oil production is consumed domestically; the rest is exported. An indefinite ban means that not only fill storage tanks up beyond capacity and estates forced to let fruit rot, but Indonesia will be missing out on crucial revenue from its crude palm oil export tax. Which is used to fund its biodiesel subsidies.
And that’s where the implications on oil come in. Indonesia’s ham-fisted attempt at protectionism has dire implications on biofuels policies in Asia. Palm oil prices within Indonesia might sink as long as surplus volumes can’t make it beyond the borders, but international palm oil prices will remain high as consuming countries pivot to producers like Malaysia, Thailand, Papua New Guinea, West Africa and Latin America. That in turn, threatens the biodiesel mandates in Thailand and Malaysia. The Thai government has already expressed concern over palm-led food price inflation and associated pressure on its (subsidised) biodiesel programme, launching efforts to mitigate the worst effects. Malaysia – which has a more direct approach to subsidised fuels – is also feeling the pinch. Thailand’s move to B10 and Malaysia’s move to B20 is now in jeopardy; in fact, Thailand has regressed its national mandate from B7 to B5. And the reason is that the differential between the bio- and the diesel portion of the biodiesel is now so disparate that subsidy regimes break down. It would be far cheaper – for the government, the tax-payers and consumers – to use straight diesel instead of biodiesel, as evidenced by Thailand’s reversal in mandates.
That, in turn, has implications on crude pricing. While OPEC+ is stubbornly sticking to its gentle approach to managing global crude supply, the stunning rebound in Asian demand has already kept the consumption side tight to match that supply. Crude prices above US$100/b are a recipe for demand destruction, and Asian economies have been preparing for this by looking at alternatives; biofuels for example. In the past four years, Indonesia has converted some of its oil refineries into biodiesel plants; in China, stricter crude import quotas are paving the way for China to clamp down on its status of a fuels exporter in favour of self-sustainability. But what happens when crude prices are high, but the prices of alternatives are higher? That is the case for palm oil now, where the gasoil-palm spread is now triple the previous average.
Part of this situation is due to market dynamics. Part of it is due to geopolitical effects. But part of it is also due to Indonesia’s knee-jerk reaction. Supply disruption at the level of a blanket ban is always seismic and kicks off a chain of unintended consequences; see the OPEC oil shocks of the 70s. Indonesia’s palm oil export ban is almost at that level. ‘Indefinite’ is a vague term and offers no consolation to markets looking for direction. Damage will be done, even if the ban lasts a month. But the longer it lasts – Indonesian general elections are due in February 2024 – the more serious the consequences could be. And the more the oil and refining industry in Asia will have to think about their preconceived notions of the future of oil in the region.
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