One of the oldest components of the Dow Jones Industrial Average disappeared from the popular market benchmark at the end of August. ExxonMobil Corp., a member since 1928 (when it was Standard Oil of New Jersey) and the world’s most valuable company as recently as 2011, had fallen in value over recent years, but it was finally ousted for technical reasons. That month, Apple Inc. announced a 4-for-1 stock split. The subsequent drop in the iPhone maker’s stock price narrowed its share of the price-weighted Dow. The index provider opted to adjust its component companies—booting out Exxon—to maintain the information technology sector’s weighting.
In a year of record-low oil prices, the fossil fuel giant’s demotion might seem like a harbinger of bad news for the energy sector. Yet a more profound rebalancing was already under way. In 2008 energy was the S&P 500’s second-largest sector by weight, right behind information technology. Energy, one of the S&P 500’s 11 sectors, is made up entirely of oil and gas and oilfield services companies in the index, and over the past 12 years its heft has diminished. In August, after dropping below utilities, then real estate, and finally materials, energy is now the smallest sector by weight in the S&P 500. Shrinking from almost 16% to barely more than 2% of what’s arguably the most-followed stock benchmark raises a multitrillion-dollar thought experiment for investors: What value will energy companies add to a technology-driven and increasingly electrified world?
Six years ago, I wrote a white paper titled “Fossil Fuel Divestment: A $5 Trillion Challenge,” which attempted to explain why investors concerned about climate change might not be able to dump their energy stocks so easily. My argument was that divesting from oil and gas (but not so much coal) would be challenging given four key attributes of the sector: scale, which was greater than $4.5 trillion at the time; liquidity; growth; and yield. Then, oil giants in particular were some of the largest listed companies in the world. They were widely traded, making it easy for investors to enter and exit at will. Oil-focused companies’ market value surged during crude price runups, and they provided double-digit returns on equity. They made healthy dividend payments that, in the case of Exxon especially, rose for decades. From 2007 to 2013, the energy sector’s market capitalization was higher than technology’s.
Six years later, the only part of my thesis that remains true is that big energy companies’ stocks are still liquid. Divestment is no longer the $5 trillion challenge it once was. Energy isn’t simply smaller than technology. As of the end of September, the combined market cap of the entire oil, gas, and coal sector was a half-trillion dollars smaller than that of only three technology companies: Amazon.com, Apple, and Microsoft.
In terms of growth, there’s no apparent penalty for removing fossil fuel companies from indexed investing. The S&P 500 Fossil Fuel Free Total Return index has outperformed the S&P 500 Total Return index since the former’s inception in 2012.
Finally, what of energy’s dividends? For years, oil majors have been the kings of payouts to shareholders. That’s changing. Exxon has maintained its dividend this year despite oil’s low price; BP Plc and Royal Dutch Shell Plc both slashed theirs in 2020. Meanwhile, companies outside the sector have ramped up their dividend payments substantially. The result: On a trailing 12-month basis, Microsoft Corp. pays out more dividends than Shell or Exxon.
All these trends challenge the way I viewed divestment in 2014, but not in the way that I’d examined them at the time. Now it’s clear the focus should be less on divestment from the fossil fuel sector and more on reallocation to companies that are planning to create value from the low-carbon transition. That doesn’t necessarily exclude the energy sector.
One way to think of reallocation is by science, not sector. Instead of information technology, electricity, and oil and gas, it’s bits, electrons, and molecules. Climate change is a factor affecting everything for companies and investors.
The technology sector that dominates the S&P 500 today is in the realm of bits. It’s not without a physical footprint, of course, and companies such as Apple have enormous supply chains that create complex environmental puzzles. It’s a sector, though, where companies can credibly make commitments to be 100% carbon neutral in their supply chain and products within a decade, as Apple did. That’s because, more and more, the electrons that charge the technology sector and all industries that rely on electricity are becoming greener. Last year, for the first time, solar and wind made up the majority of the world’s new power generation, according to research by BloombergNEF.
Oil and gas and the many industries that depend on the energy density and chemical richness of hydrocarbons are in the realm of molecules. Decarbonizing the world of molecules is tremendously hard. It means not only substituting electrons for them wherever possible, such as in electrifying road transportation, but also making innovations in molecules themselves, including creating new carbon-neutral aviation fuels.
Shell, which aims “to be net zero on the emissions from the manufacture of all our products” by 2050 at the latest, has committed itself to reorienting its business in a way that challenges the chemical and physical realities of its business today. The 13 airlines in the OneWorld alliance, who’ve pledged net zero carbon emissions in the same time frame, are tackling a number of technology changes: developing new fuels, electrifying flight, building radically more efficient airframes, and creating carbon offsets on a massive scale. Any one of these things is a decade-long undertaking in its own right.
To give credit where credit is due: Reducing the emissions of some of the world’s biggest producers and consumers of liquid hydrocarbons to zero, even over three decades, is a transformative business agenda. It also presents an immense opportunity for growth at a time when it’s needed most. As their strategies evolve, the world’s biggest emitting companies could steer into new business realms such as power generation, power networks, and technology development and deployment.
Companies without ambitious emissions plans stick out for all the wrong reasons. In early October, Bloomberg News reported that internal documents about Exxon’s $210 billion investment strategy show the company’s yearly emissions rising 17% over the eight years leading to 2025. The largest U.S. oil producer hasn’t set a date to become carbon neutral.
Investors must decide which strategies and technologies are most likely to create value in a world that has to fight climate change. They should allocate capital accordingly.
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