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WHY NOT O&G? IS IT THE IEA WORLD ENERGY OUTLOOK?

This topic has some relationship to BRK. BRK has holdings of OXY and CVX. In addition, O&G is a large industry that could provide investment opportunities for sizeable amounts of BRK’s cash and cash flow. However, it’s much more pertinent to me because XOM is my second largest holding beyond BRK. It may be of interest to some of you.

The industry isn’t attracting much investor interest beyond those seeking dividend yields and buybacks. And most companies are concentrating on providing these to shareholders rather than growing their businesses. This shows in capex, XOM excepted. And Buffett isn’t investing even at prices below his original investments. And these haven’t done well.

Why isn’t the industry attracting investors? I’ve continued to try to understand this. In the following I’ll share a possible major reason. Fair warning – it’s a long post. Skip if this topic isn’t of interest.

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I got one solid lead from a June presentation by a senior VP of XOM in a “fireside chat” at the J P Morgan conference. The transcript is available. When asked about the outlook beyond 2030, he replied:

“I think this is probably the biggest issue that is out there in terms of modeling our company, valuing our corporation, because a lot of models from some of the sell-side analysts have a terminal value around 2030 in that time period that’s negative for us. So, the extent that we've talked about our earnings growth out to 2030, there's models – to get to our current valuation, you have to – if you accept that 2030 growth, you have to start saying we're immediately going to start declining from there, we'll immediately start reducing earnings, losing cash flow from there. And nothing could be further from the truth. We are very focused. We have our plans locked and loaded out to 2030. Like I said, we'll be flexible, we'll be opportunistic, but we have really good, solid plans out to 2030. It's not a target. It's a plan.”

This reflects maybe the general view of O&G analysts. That the O&G industry will peak early in the 2030’s and decline thereafter. That leads to a negative terminal value for DCF projections and devalues all O&G companies. I. e, current stock prices reflect a declining long term outlook.

I’ve tried to dig deeper into the source of this view. It seems to be based on the International Energy Outlook (IEA) recent World Energy Outlook (WEO). It presents scenarios which, they conclude, all point to reduced demand for oil beyond 2030. When combined with announced outlooks for new oil supplies coming on, they conclude that the world will be oversupplied by that period. That will reduce prices, O&G cash flows, and result in a declining industry.

My obvious next step. Try to understand the WEO. In so doing, I found this detailed critiques of the WEO:

https://energyanalytics.org/wp-content/uploads/202...

It is very detailed (32 pages) and addresses some 23 assumptions embedded within the WEO that the authors question as being reasonable. Some are considered dangerously misleading.

The Intro to the article provides the following:

“For decades, the International Energy Agency (IEA) was the world’s gold standard for energy information and credible analyses. Following the commitment of its member governments to the 2015 Paris Agreement climate accords, the agency radically changed its mission to become a promoter of an energy transition. In 2022, the IEA’s governing board reinforced its mission to “guide countries as they build net-zero emission energy systems to comply with internationally agreed climate goals.”

The IEA’s current preoccupation with promoting an energy transition has resulted in its signature annual report, the World Energy Outlook (WEO), offering policymakers a view of future possibilities that are, at best, distorted and, at worst, dangerously wrong.”

There’s too much to summarize it all. But in studying their critique, I found at least five major assumptions in the WEO scenarios that make me question this as a political document, not a reasonable projection of the future outlook for O&G.

1. They assume the Stated Policies Scenario (STEPS) as their base scenario. These are the policies that governments agreed to implement following the Paris Agreement on climate change. The other scenarios are more stringent – down to zero emissions by 2050. The WEO no longer include a BAU (Business As Usual) scenario. Yet this is the scenario that’s actually happening. The BAU leads to higher O&G needs by the 2030’s. This is not brought up in the WEO. It used to be before the policy change. The WEO doesn’t address the most probable outlook.

2. They assume that growth in O&G demand in underdeveloped countries will be offset by energy efficiencies in developed countries plus reduced O&G use in transportation. That includes not only EV’s for light transportation but even electrification of heavy trucks, airlines, and marine transport. There is no reasonable case for the latter, and declining support for the former in the USA and Europe. Of greater importance, they don’t assume significant improvement in the standards of living in underdeveloped countries. This will require energy, and fossil fuels still provide the most economic combination of high energy content, ease of transportation + distribution, and cost. Will they choose climate change over economic growth?

3. Re electrification, WEO assumes no real restraints in either supplies or costs of the materials and minerals needed for the rates of electrification assumed. Studies say otherwise. Windmills are made of plastics, cement, and steel. All need fossil fuels to manufacture because of high temperature requirements. And mining operations are heavy users of fossil fueled energy.

4. They assume 5-6% percent annual declines in existing fields. Yet newer production has much higher decline rates – ranging from 28% in the Permian to 13% in Brazil. XOM estimates the current decline rate to be closer to 15% without annual investments. This is a KEY point in projecting future oil supply needs.

5. WEO assumes that the needed finances to achieve the STEPS actions will be provided. These are being reduced rather than growing. Supports for EV’s are being withdrawn and many smaller O&G companies are pulling back on capex, favoring dividends and buybacks. Albeit, Shell and BP are reversing course on O&G. Are they now seeing a future different than WEO?

In contrast to WEO, XOM also puts out an annual energy outlook to 2050. This is their best estimate of what will ACTUALLY happen based on government actions, economic growth, technology advances, etc. et. al. This is no political document. It forms the planning base upon which they invest $25-30 billion a year in the future. It is not an aspirational scenario, it is the base outlook for the business. They then use higher and lower scenarios to stress test investments.

No economic outlooks are accurate – but they should reflect reality as much as possible. Below are the final comments from the critique executive summary:

“Debating the intricacies in flawed assumptions about energy scenarios is no mere theoretical exercise. The IEA’s legacy reputation continues to influence not only trillions of dollars in investment decisions but also government policies with far-reaching geopolitical consequences. The promotional aspirations and flawed assumptions underlying IEA’s peak-demand scenarios have serious implications, given the obvious global economic and security considerations in planning for and delivering reliable, affordable energy supplies. The IEA is damaging its long legacy as the world’s leading energy security watchdog by offering dangerously misleading outlooks.”

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Industry analysts and investors are supposed to be knowledgeable concerning the industry and the economic factors impacting it. So why would they be impacted by the WEO?

Being pragmatic, the SAFE course for industry analysts is to base outlooks on WSO scenarios. That provides good butt cover. The IEA is supposed to be the gold standard for evaluating the industry. (And it was prior to 2015, and especially the 2022 report.) Is this still true?

Conversely, there’s a case to be made that O&G could provide a significant added opportunity for investors to build a long term portfolio at reasonable prices today. Both Vickie and XOM executives have stated that they believe their stocks are significantly undervalued. XOM has been doing $20 billion a year buybacks without moving the market. How much could BRK do?

What seems to be happening is a “wait and see” strategy in an increasingly uncertain world. At what opportunity cost?

Just sharing some info and thoughts. As a note, I've also asked myself if the critique document I reference is over stating its arguments versus the WEO. In some cases, perhaps so. But I think I understand this area well enough that I accept the position of the article.

I did something similar recently. Looking at total global energy usage. 2023 = about 680 exajoules or 20 TW/hour energy generation.

About 52% was from oil and natural gas. If you assumed 3% growth in global energy usage, by 2050 the globe would probably being using double the energy used in 2023.

I can't imagine that the oil and NG portion is much below 40%.

The scale of infrastructure investment to shift that much energy consumption in 25 years is simply too vast imo.

I agree that prudent view of the future has to encompass (among other scenarios) the one that at present seems most likely.

As for whether the report is a cause of the current low cycle of valuation for the companies involved, that may or may not be a factor. Beats me. Stock prices do things for strange reasons.

there’s a case to be made that O&G could provide a significant added opportunity for investors to build a long term portfolio at reasonable prices today...

There are merits to the investment case, but to me the two main arguments against a big move of a portfolio into oil and gas are:

* There is no such thing as oil and gas production, merely oil and gas extraction. So the business, as it sits on any given day, is always in wind-down mode. To prevent that, it has to perpetually reinvent itself by getting access to additional stock. In that way it's a bit like a company selling high tech devices - the current product will no longer generate revenue after a while, so something new has to be found, over and over forever. Worse in this case, as every round gets harder and harder in O&G.

* Obviously, no control over pricing. Not fatal if you're the low cost extractor, but definitely not one of the qualities you WANT in a business.

Neither of these is fatal, but they are certainly the stand-out issues on why it's not the perfect line of business to be in. At least not "all in".

Jim

There are merits to the investment case, but to me the two main arguments against a big move of a portfolio into oil and gas are:

* There is no such thing as oil and gas production, merely oil and gas extraction. So the business, as it sits on any given day, is always in wind-down mode. To prevent that, it has to perpetually reinvent itself by getting access to additional stock. In that way it's a bit like a company selling high tech devices - the current product will no longer generate revenue after a while, so something new has to be found, over and over forever. Worse in this case, as every round gets harder and harder in O&G.

* Obviously, no control over pricing. Not fatal if you're the low cost extractor, but definitely not one of the qualities you WANT in a business.

On point comments Jim, and I agree these are the key points. XOM senior management keeps making the same two points - O&G are depletion businesses, and you need to be the low cost supplier. They know these points are key to investors.

They don't like the prices that XOM stock trades at, so they address these in their Investor Presentation days.

They point out that their reinvestment of cash flow into dividends and capex has declined from circa 60% in the 2010-19 period to circa 50% now. At current dividend rates, this is projected to decline to 40% by 2030.

Why? Even after a career in the industry, I have consistently underestimated the ability of the industry to find new reserves at attractive prices. This is due to technology advances. It continues. O&G is a high tech business.

First it was deep offshore. Who could have anticipated suspending a drilling rig a mile above the ocean floor, and then being able to drill another 2-3 miles into the earth to find oil - and then install the equipment via robots to produce it? And make good returns on investment?

XOM found some 11+ billion barrels of oil in Guyana (still much unexplored) after many companies had drilled some 50 dry wells trying to do so. How? Improved technology to understand the subsurface. In another "fireside chat" in May, their senior VP over the upstream stated that their new 4-D subsurface technology can now deliver results in 2 months that previously required 2 years to obtain. It was the early technology that found the Guyana reserves. Their new super-computer has 4X the capability of the one being replaced. AI is still in the early stages. These advances apply to all reservoirs.

Then came the shale "fracking" revolution. Shale was known to contain enormous original oil - even in my day three decades ago - but was considered too non-porous to ever be productive. Almost a metal, as Vickie describes. Now it has produced 90% of the growth in new oil production over the past decade, some 8 million B/D. And the industry is still only recovering 6-8% of the oil in place. The current goal is to double that - and there are many technologies being tested to do so.

What about investment returns? Both Guyana and the Permian will yield a 10% ROIC at sustained $35 oil. XOM is not opportunity limited - instead they're pacing capex with expected demand growth.


Being the low cost producer in a commodity business is always needed for success. But if you can make good money at prices that the very lowest cost producers can't afford, you're in good shape. The OPEC countries need certain oil prices to sustain/grow their economies. And they can't forget to fund the social programs their citizens require to not revolt.

All of this results in a turbulent market over time as geopolitics and economics interact. It's not for those who want to avoid ups and downs. And you must learn how to manage through these ups and downs. Keynes had the right idea back in 1935. You save money during the "good" times to build a strong balance sheet. You borrow, if necessary, during the "bad" times to keep the multi-decade projects going. Also, that's also when costs are lowest, the better properties are available at good prices, and you can negotiate good long term contracts because you are a steady customer. Focus on management. Exxon has been a counter-cycle investor for decades. Short focus investors want capex cuts during such periods in favor of dividends and buybacks. That's not the way to manage.

Returning to the beginning, you make the right points about O&G investing. But it's a lot more complicated than it might appear.

And it's hard to get the story across. As one friend commented, XOM has opened its kimona, and not many people are looking.

Depletion will ultimately win - but it will be many decades.

Texirsh

They assume 5-6% percent annual declines in existing fields. Yet newer production has much higher decline rates – ranging from 28% in the Permian to 13% in Brazil. XOM estimates the current decline rate to be closer to 15% without annual investments. This is a KEY point in projecting future oil supply needs.

Exxon has a high percentage of horizontal wells in tight formations so their decline will be higher. Most existing wells in the world are conventional, so a decline rate of 5-6% is reasonable.

With regard to their forecast, it may not be a political document but it is prepared by engineers who are subject to a subjective ranking system. After the initial estimates of future demand, it is reviewed by first line supervisors. The initial question is "are the assumptions inline with senior management viewpoints ". At that point the assumptions are massaged to match the employee incentive system and the report is passed upwards with similar ongoing questions.

Aussi who worked for XOM for 25 years and then as a consultant for another 5 years.

Aussi who worked for XOM for 25 years and then as a consultant for another 5 years.

Aussie,

I hear you. I also worked these preparations for the last 9 years of my career. And helped run the subordinate businesses before that.

We took the Exxon ethics code very seriously. We never stated anything we couldn't backup. As Cliff Garvin explained: "We don't want liers as managers."

I hope you had a better experience.

Not liars, but it is pretty easy to assume a decline curve for world wide production that initially starts at 5% to progress to 6.5% which makes a large difference in a 25 year forecast. Similar with demand, a half a percentage here, a half a percent there and soon you can have increasing demand instead of falling demand.

I think Charlie said that if you show him the incentives he will know the answer.

Aussi

I note that OXY is trading at roughly half the price to free cashflow of CVX and XOM, likely why he's gone in big on this one as well as the management alignment with buybacks and focussing on FCF generation.

Even after a career in the industry, I have consistently underestimated the ability of the industry to find new reserves at attractive prices. This is due to technology advances. It continues. O&G is a high tech business.

This point can not be overstated. A common misperception is that oil is buried in little tanks in the ground, and after we have emptied them, it runs out. In the real world, oil extraction has behaved mathematically closer to an infinite supply than a finite supply. A resource pyramid explains this conundrum.

The original oil "wells" were seeps at the surface. This supply represents in infinitesimally small percent of the available oil, the tip of the pyramid. Lets go back and look at the origin of that oil.

Oil comes from organic matter in sedimentary rocks. Seventy-five percent of the earths surface is covered by sediments. They average 1% organic matter, which adds up to a heck of a big pile of hydrocarbon. In a small percentage of the rocks, the organic content is higher, with the extreme cases being oil shales and coals. In a few of those cases, pure liquid or gaseous hydrocarbons ooze out of those rocks. Most remains locally, some moves to the surface and is quickly broken down, some migrates into closed traps of rocks of 6-18% porosity and forms oil and gas fields. Some of those accumulations are accessible by drilling and have been located. We currently successfully extract an average of 30% of that hydrocarbon.

The oil business started at the fresh seeps, a rare occurrence. From there they drilled the structures which could be seen at the surface. Many more structures exist which can only be detected by seismic exploration, and those images have improved (compared a tv and an adding machine from the 1950's to what we have today). But the structures are only a very small part of the total hydrocarbon. The oil that did not migrate from the source rock is still sitting there in quantities far greater than the dribble that happened to end up in the traps. Horizontal drilling with multi-stage fracking has made some of that oil accessible.

At every stage of this evolution, the volume of producible oil and gas increases. Additionally, we get better at extracting it at every stage. The seeps are being produced in unprecedented volumes at the Canadian oil sands. The structures once gave up 20% of the oil in place now can provide as much as 80% through water floods, fracking, steam floods, CO2 injection etc. The horizontal shale production is evolving fast. A friend recently wrote me about a company drilling a 28,000 foot horizontal well in 48 hours, and said that much drilling would have taken a year when he started.

I used to give a talk comparing a mature, thoroughly explored American oil district to more lightly drilled international places. Over a hundred years ago oil companies would ask the local sheepherders where to find a good structure. The sheepherders, and later the geologists found a lot of them, the most famous of which caused the Teapot dome scandal. After they found and drilled all the surface features they assumed they had found all the oil, fired all the geologists, and declared it a dying region. Then the seismic crews came, found hidden structures, and a second boom ensued, ending with them find a lot more oil, and then firing all the geophysicists. The area was written off again, until after 40 some dry holes a geologist proved that most of the oil in the area was trapped very subtle stratigraphic traps, wedge-outs of porous sands. The horizontal fracked shale production is just starting.

Back in the 1970's the Saudi oil minister Yamani stated that the stone age didn't end due to lack of stones, and the petroleum age won't end due to lack of petroleum. Fifty years later, I see no reason to doubt him.

of this results in a turbulent market over time as geopolitics and economics interact. It's not for those who want to avoid ups and downs. And you must learn how to manage through these ups and downs.

Inflation adjusted the cost of oil is about the same as it was after the OPEC shock of the 70’s. During that past 50 years that cost has occasionally doubled, occasionally halved. Using the retail price is fraught, because there are a lot of other steps in the value chain, but it’s reasonable to think that the cost / BBL will be somewhere in that range for the next X years.

That said, there are challenges afoot. Solar price for electricity generation has dropped by 90% since the early days, and wind is coming down too, although it’s in the middle of a rough financing patch at the moment. XOM oil is not a big player in electricity production, but makes it up on the natural gas side. Still, half the volume of refined oil ends up in car engines, and that’s decreasing - more slowly in the US than in the Nordic countries and China, but expect that trend to ramp as China exports superior EVs all over the planet.

While it’s comforting to look at the history of oil, it’s also good to remember the history of wood, and of coal, showing that nothing is forever, at least in the kinds of quantities that make XOM a global leader. I don’t think we’ll ever get to “no oil left to extract” but mostly because other technologies will obviate the need for ever growing inventories of oil. Nuclear is potentially resurgent, solar, wind, and even hydro are making gains. Oil will be around a long time, for sure, (I hope, I enjoy the dividends), but if other technologies continue to get cheaper and oil doesn’t, well…

Everybody knows Moore’s law for chips, there’s another for solar I forget the name, but it’s something like the price goes down 20% for every 20% more gross global production, or something like that. The more there is, the better it gets. We can drill baby drill, but I hope we also are looking forward, not just back to the 19th and 20th centuries as they recede in the rear view mirror.

2. They assume that growth in O&G demand in underdeveloped countries will be offset by energy efficiencies in developed countries plus reduced O&G use in transportation. That includes not only EV’s for light transportation but even electrification of heavy trucks, airlines, and marine transport. There is no reasonable case for the latter, and declining support for the former in the USA and Europe.

You may have some valid points, but this isn’t one of them.

In 2017 global gas vehicle sales were 89 million cars. Last year the number was 69 million. That’s a 20% drop in 8 years, which is a pretty “reasonable case” that something is going on. Part of it is 11 million EVs, and other parts of it could include pandemic bounce, ride sharing apps, or other factors. Gas cars are also getting better mileage, thanks to the carrot-stick wielded over the past decade (that may go away in the US but it won’t in the rest of the world), and better mileage more than makes up for the concurrent increase in miles traveled.

No, I wouldn’t worry about airlines or marine transport in the short term, but “passenger cars” are 50% of the use, and that’s under pressure.

“ Back in the 1970's the Saudi oil minister Yamani stated that the stone age didn't end due to lack of stones, and the petroleum age won't end due to lack of petroleum. Fifty years later, I see no reason to doubt him.”
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Looking at this cute WEB Site it seems the French have decided to start ending the petroleum age & at least turn the night lights on with Nukes.

Flick the switches to see where the world would go dark without fossil fuels,

https://www.gocompare.com/gas-and-electricity/what...



ciao

Very interesting graphic!

https://www.gocompare.com/gas-and-electricity/what...

You may have some valid points, but this isn’t one of them.

Googyhoofy,

I respect your comments about growth in light EV's. And I'll accept the challenge about them slowing down.

I think it's now a horse race in the US and Europe. I don't think the same in less developed countries. They're more starting from scratch, so they can build an EV based power distribution system. The US and Europe already have a fossil fuels system that works. So EVs face both a replacement challenge, higher prices, and the wait for a competitive power supply system. That's still to come.

Existing EV owners in the US and Europe seem to like their vehicles, and 90+% plan to buy a new one, based on surveys. Yet these were fueled by generous subsidies that seem to be going away in the US. What will the next wave of replacement into the ICE market bring?

And resale price are collapsing without incentives. Do the basic economics without the subsidies favor EV's?

Markets are different. China is still evolving theirs, so they can build mostly from the ground floor. And they're leading the world in EV technology. I see that continuing - that's why I said the US and Europe.

The latter are a different story. They had both the early adopters and with major incentives in the US. Will this hold up in the next wave? Resale prices for EV's in the US are collapsing. European EV manufacturers are pulling back from a sole EV future.

Here are results from a June 2025 survey by Shell Oil:

LONDON (Reuters) -Drivers are becoming more reluctant to switch to electric vehicles from combustion engines and the trend is more pronounced in Europe than in the United States, a survey published by Shell on Tuesday showed.

</\i>The main obstacle is cost, according to the survey of 15,000 drivers across the world, including Britain, China, Germany and the United States.

"Europe surprised us," said David Bunch, Shell's chief for mobility and convenience. "The single biggest barrier to entry is the cost of the vehicle. Range anxiety is still there but it's diminishing."

Electric vehicles are on average up to 30% more expensive than internal combustion engine cars.

This year, 41% of respondents in Europe said they would consider switching to an electric car compared with 48% last year, while in the United States the number fell three percentage points to 31%, the survey showed.

In terms of the pace at which the charging experience is improving, only about half of European drivers said public charging had improved in the last year, below China's 74% and 80% in the United States.

Only 17% of European drivers asked said public charging offered value for money, compared with 69% in China and 71% in the United States.

So, at best, I'll consider it a horse race still to be run. Low cost EV vehicles from China may simply just force the local companies out? Will this be permitted/

So I'll accept your challenge. As an aside, light vehicles only make up circa 25% of oil consumption. So it's going to take a really big penetration by EV's to offset growth in other consumptions.

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