Investors Dropped Oil Due to Underperformance and ESG Concerns. Now They’re Reconsidering.

“It feels concessionary to be ESG investing now,” says Kane Brenan, chief executive officer at TIFF Investment Management.

Konstantinos Tsakalidis/Bloomberg

Konstantinos Tsakalidis/Bloomberg

Underperformance and environmental concerns drove investors away from oil and gas investments for years. But now, as the market paradigm is shifting, some investors are reconsidering that decision — and what they should do next.

From 2015 through 2019, the oil and gas sector underperformed, making it easy for investors to choose to exclude those investments from their portfolios. But with oil futures at over $100 per barrel, that’s changing.

“Investors are like wait, it feels concessionary to be ESG investing now,” said Kane Brenan, chief executive officer at TIFF Investment Management.

Those that stayed in the game — like the Alaska Permanent Fund — have made quite a bit of money on the asset class. According to Brenan, some are reconsidering their move away from the sector.

Traditional energy stocks are performing well in the short term thanks to demand for non-Russian oil and higher gas prices generally, according to recent research from asset manager BlackRock. According to the International Energy Agency, Russia is one of the world’s top three crude oil producers, and the world’s second-largest producer of natural gas. It is the world’s leading exporter of gas as well. The United States and the United Kingdom have banned all Russian oil imports, while the EU plans to reduce Russian gas purchases by two-thirds by year-end, BlackRock reported.

“Russian energy production cannot be diverted elsewhere overnight, so global energy supply is effectively being reduced, driving huge energy price spikes,” the asset manager said.

On Thursday, President Joe Biden announced that the United States would be releasing one million additional barrels of oil daily from the Strategic Petroleum Reserves for the next six months. Both Brent Crude and WTI Crude futures fell on the news, although prices remained above $100 per barrel midday Thursday.

A couple days prior to Biden’s announcement, Investcorp co-chief investment officer Hazem Ben-Gacem said he believed oil prices could stay around those levels. “Is oil going to be settling in the $100 plus range?” Ben-Gacem asked. “Yeah, I think so.”

According to Marcus Frampton, chief investment officer at Alaska Permanent Fund, “the unfortunate reality is that people haven’t weaned themselves off of fossil fuels.”

“We never divested,” Frampton added. “Oil and gas are sectors we’re overweight in and have been over the past two years, which has been a nice boost.”

Allocators who left the sector may be reconsidering that decision now.

“When you think about investors coming back into the market, you have to think about what drove them away in the first place,” said Adam Waterous, founder of the eponymous private equity firm, Waterous Energy Fund. “In our view, first and foremost, it was poor returns,” Waterous said. He added on Monday that ESG concerns played a minor role in investors’ departure from the space.

In 2019, before the Covid-19 pandemic hit, oil was trading at around $57 per barrel on average, Waterous said. The U.S. oil and gas industry returned two to three percent on capital invested. “That was a broken industry for returns,” he said. “Having said that, $100 oil solves a lot of those problems.”

During the oil rout, Waterous doubled down on its strategy, taking a value approach to identifying attractive investments. The firm tries to keep production costs at $44 per barrel, meaning that even in a lower price world, the firm would turn a profit.

Investing in crude oil directly isn’t the only approach investors could take to capitalize on shifting market dynamics.

For example, renewable energy companies are also performing well in this market. Data from BlackRock shows that when Russia invaded Ukraine, both the MSCI World Energy Index and the S&P Global Clean Energy Index ticked up in tandem. But traditional energy stocks are still trading at higher prices than renewables, the data shows.

According to Ben-Gacem, fracking could be on its way back too. A process for oil extraction used by companies like Chevron and Halliburton, fracking has a production cost of about $80 per barrel. Once oil prices settled at around $50 to $70 per barrel, the practice became less popular. As oil prices rise, Ben-Gacem said, he expects fracking to pick up as well.

TIFF’s Brenan noted that investors can also look for assets that are correlated with energy. Metals, copper, neon, and propane are all commodities that may make sense to add to the portfolio, Brenan said. Hydrocarbon, too, is “an easy trade,” he said. Those assets have lately been unpopular among investors, according to Frampton.

“So much money has come out of metals, mining, materials, oil, and gas,” he said. “I think those industries will react to the price environment we’re in.”