The Rockefeller Family Fund Thinks Investing in Oil Is a Mistake. Is It Right?

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The Rockefeller name is synonymous with oil. John D. Rockefeller founded Standard Oil more than a century ago, making him at a time the richest man in the world. Standard Oil eventually gave birth to large parts of ExxonMobil (NYSE: XOM), Chevron (NYSE: CVX), and ConocoPhillips (NYSE: COP), which are three of the largest energy companies in the world today.  

While the original Rockefeller made his fortune from oil, the Rockefeller Family Fund, which is a fund the Rockefeller family created, has evidently moved on. The fund recently said in no uncertain terms that it makes little financial sense to continue holding fossil-fuel companies. Given the statement, is holding fossil-fuel companies a mistake?

Reasons why the Rockefeller Family Fund might be wrong
The Rockefeller fund principally makes a ethical argument why it makes little sense to hold fossil fuel companies. Here's the relevant excerpt:

While the global community works to eliminate the use of fossil fuels, it makes little sense -- financially or ethically -- to continue holding investments in these companies. There is no sane rationale for companies to continue to explore for new sources of hydrocarbons. The science and intent enunciated by the Paris agreement cannot be more clear: Far from finding additional sources of fossil fuels, we must keep most of the already discovered reserves in the ground if there is any hope for human and natural ecosystems to survive and thrive in the decades ahead.

While the Rockefeller fund stated that it makes little financial sense to hold fossil-fuel companies, it didn't provide a reason in the press statement. This is where things get a little fuzzy, though, because today it's still pretty hard to make the argument that oil isn't a sound financial investment.

 Crude oil is a depleting resource. Production declines over time if there is no replacement. There is a natural run off of 4 or 5 million barrels per day per year due to that depletion (out of 95 million barrels produced every day). The low crude prices have disincentivized a lot of investment. Few projects outside the Middle East are economical at $40 per barrel when incorporating capital expenditure costs. There is also geopolitical risk in the Middle East if prices stay low for too long. The strike in Kuwait is an example of how supply might fall if financial conditions decline. The lack of investment and the geopolitical risk in the Middle East could lead to production falling significantly below demand in the future. That would lead to substantially higher prices.

When prices rise, production will not increase to fill the gap overnight. Many conventional oil projects require years of lead time before they come online. Many shale producers will need to hire their laid off workers back. The bankers who were burned lending money to finance the marginal projects will need to become more risk-taking again. All of that takes time and ensures a longer period of higher oil prices.  

Electric vehicles will not be as big of a threat to crude demand as the bears portray, at least not within the next decade. While electric cars will eventually be cost competitive as technology advances, emerging markets such as India need to grow their economy now and that means buying conventional cars that consume refined crude products for fuel. The citizens in India and other emerging markets can't afford to wait 10 years and not develop. Moreover, because current electric vehicles consume over 40% of the electricity that an average American home consumes, it will take substantial grid building and optimizing for the electric grid to support electric cars in numbers that would dent crude demand. 

 Given their lower income, emerging-market utilities will have a hard time financing the upgrades necessary to support meaningful numbers of electric vehicles, and emerging countries may have no choice but to continue to use conventional vehicles. Because of the emerging market demand, analysts still expect crude demand to rise by around 1 million barrels per year up until 2020.

Because of their low numbers today, electric vehicles won't be a threat to crude oil for many years. At their current growth rate of 60% a year, projections say that electric vehicle use would remove 2 million barrels a day of crude demand by 2023. Because growth typically slows down when the numbers get bigger, more realistic projections say that electric vehicle use would remove 2 million barrels a day of crude by 2028. That compares with the current crude demand of 94 million barrels per day.

Due to the above factors, economically, the world has no choice but to rely on crude oil as a transportation fuel for another decade or two. That means companies such as ExxonMobil and Chevron that earn good returns on capital at low normalized prices of crude will be good investments. ExxonMobil, for example, currently has enough free cash flow to finance its dividend at current crude prices, while Chevron will be able to sustain its dividend at $52 Brent by 2017. Given that many shale projects aren't economical at $50 per barrel when factoring in capital investments, $50 Brent is probably on the lower end of a normalized crude range.

Potential wild cards
There are some wildcards that could change the demand equation for crude. Given that projections made over long timelines can be off by a lot, demand for electric cars might be totally different than what analysts predict now. Low oil prices could slow electric vehicle adoption and postpone the time when electric vehicles become a threat to crude demand. Or electric car adoption could accelerate if emerging market governments subsidize their adoption or if electric car technology improves faster than expected. Distributed power generation and storage costs could also fall faster than expected and reduce electric vehicle's burden on the grid.

Investor takeaway
Although there is a lot of uncertainty in terms of crude demand in the future, the Rockefeller Family Fund's argument that investing in oil companies is a financial mistake doesn't hold a whole lot of water. Given the low investment in crude, crude prices will likely rebound to a level that will allow Chevron, ExxonMobil and ConocoPhillips to earn a decent return on capital.

The three companies can also adapt. Just as AT&T transformed itself from a landline network to a broadband and mobile provider, ExxonMobil, Chevron, and ConocoPhillips can change. All three companies have done extensive research on biofuels that might one day become an alternative viable transportation fuel that emit less carbon. Chevron has done research into solar and wind and is one of the leading geothermal energy producers in the world.

All three companies have also produced substantially more natural gas as a percentage of their total production in recent years. Given its status as a cleaner-energy fuel than coal, natural gas demand will probably grow even when electric cars hit critical mass. The increase in natural gas demand can offset some of the decrease in crude demand.