Opinion: Energy stocks have a sustainable future: It lies in their dividends

One of the few numbers that’s growing faster than energy stock dividends is the size of the masses who are convinced they’re unsustainable. I have never seen such a negative consensus on an entire sector as I have on traditional energy.

The debates are so one-sided that the simple clues of dividends are being overlooked, and instead more focus is being placed on when traditional energy companies will cease to exist.

But dividends offer investors better proof of what exactly works than bulk investing. As a professional portfolio manager since 1996, I have studied every imaginable factor in investment success and found no other metric with such a long track record. A dividend is paid free of opinions about what’s real — and that’s even more valuable when confusion about energy stocks is at an all-time high.

The potential for paying and growing energy dividends has never been greater, in large part because the sector is viewed by so many as uninvestable — a notable paradox.

Rather than single out individual stocks, it might be more helpful for investors if I could at least make their views on the group a little more curious, far from the consensus belief.

Start with simple supply and demand. Masses of votes, ordinances and protests to end fossil fuels have resulted in least oil CL.1,
and natural gas NG00,
Discoveries last year, since 1946. But since then, the number of households worldwide has more than tripled and demands more products, the production of which in turn requires more petroleum.

By 2050, the United Nations goal of net-zero carbon emissions, demand for traditional energy will not only support dividends with more free cash flow, it can significantly increase those dividends in the future.

The biggest surprise could be a special dividend for climate from the most unlikely sources.

Stakeholder math and mentality

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 required to operate.

Oil and gas companies have no problem finding money. In the past, they were so reckless in issuing stock and debt, fueled by greed for higher prices, that they could go bankrupt all 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. Some of the highest-quality energy producers have begun to formally align their interests with stakeholders, showing the math they base dividend forecasts on and using commodity price assumptions that are anything but greedy.

Read: Exxon posts record earnings and Chevron triples amid high energy prices, sending shares higher

Investors are ignoring this monumental shift in mentality that has taken place since the last time oil and gas prices were this high.

Here’s an example from one of many companies that have learned to use more conservative math from boom-and-bust cycles. The green lines are oil and gas price assumptions used to forecast their free cash flow for dividends to be paid (half and one-third of current oil and gas prices as of July 2022).

Unlike previous cycles, the balance sheets of some energy producers are now pristine; their net long-term debt has been reduced or eliminated. Combine that with raising their own internal investment hurdles before considering new projects, and they’ve made the math that 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 is buoyant, which supports more dividends and less speculation. Even better, they can be purchased cheaply compared to the overall market thanks to forced selling pressure. This chart shows current enterprise value divided by trailing 12-month free cash flow. Each of the largest energy companies is well below the average for all sectors in the S&P 500 SPX,
this is 35


The downside of uncrowded truths

Energy dividends are increasing due to our decreasing ability to have honest dialogues in this country. Our democracy has chosen to make it difficult or impossible for energy companies to expand their operations. So they’re doing what they can with free cash flow: paying down debt, buying back stock, and growing their dividends.

Crowds have made it increasingly difficult for energy companies to ship oil and gas and even harder to refine it. These gigantic energy jigsaw pieces have a more direct impact on the daily spending of American households than the price of a barrel of oil. In order to transport energy safely and cheaply through pipelines, a growing infrastructure is required that can hardly be built or expanded today.

A pipeline project with the greatest potential for capacity expansion was finally abandoned in 2021 after being proposed in 2008 and fully supported by long-term contracts from producers in Canada. Instead, oil sands are loaded onto railroad cars and shipped to the US much less efficiently, with greater environmental risks than pipelines.

I asked my good friend Hinds Howard, a leading expert on energy pipelines, about other recent developments that have a chance. He pointed to another project that, after three years of approval, will struggle to ever finish. The original cost estimates have nearly doubled from the legal work alone of additional regulatory delays.

Energy’s refining capacity is even tighter. Instead of just suffering years of no growth and regulatory delays, refiners were eliminated. In the last three years alone, four refineries have been shut down and two have been partially closed. Two more are to be closed. Six have been converted to renewable diesel. That’s a net reduction of more than 1 million barrels per day.

Today there are 129 refineries, in 1982 there were 250.

Then are we surprised when the growing demand for limited supplies leads to higher prices? The historically unique opportunity for investors is the irony of masses of voters and protesters wanting to end the use of fossil fuels, resulting in energy dividends from the highest quality surviving operators becoming more secure than ever.

Read: What would US oil companies need to ramp up production? A lot of.

The most surprising dividend

So far I’ve relied on pure math, which I love because it leaves no room for any opinions, including my own. Here’s my only guess, based on capitalism’s cleanest-burning motivation to reward problem-solvers: Who better to lead us to clean energy than those who know exactly where it’s dirtiest?

I recently visited an energy company CFO and he was very enthusiastic about a closed loop gas recovery project to reduce gas flaring. The company developed this unique technology to help solve a problem they created themselves, and it was far 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 achieve that and try more projects.

Traditional energy has already become cleaner and more efficient. Since 1990, the number of kilograms of carbon emissions per US dollar of GDP has more than halved. This is not a solution, but it is the right direction and the common interest of the planet’s stakeholders.

Innovation is more efficient than regulation. Energy companies in the US already have the best climate technology in the world, and it’s nowhere near it, and they still have a lot to improve on. Here we should rely on our advantages. Traditional energy companies play a big part in a more sustainable future, and will pay higher dividends in return.

Ryan Krueger is CEO of Freedom Day Solutions, a Houston-based money manager, and CIO of the firm’s Dividend Growth Strategy and Freedom Day Dividend ETF. Follow him on Twitter @RyanKruegerROI.

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