Since hitting their 21st century nadirs in October 2020, shares in Shell (SHEL) and BP (BP.) have been on what, for the ever-volatile oil sector, amounts to a near-uninterrupted tear.
The rising price of oil, a standard litmus test for anyone selling the stuff in supermajor quantities, has of course helped. Cast your mind back to those cramped, unnerving days of April 2020, and you might recall that crude prices briefly went negative. Days later, Shell slashed its dividend for the first time since the second world war, with BP following suit by the end of the summer.
And yet, it hasn’t been a one-way street for producers. After two years of gradual gains were given the adrenaline shot of war in the first half of 2022, forecasts of sustained triple-digit prices have since failed to materialise. Today, at $81 a barrel, Brent is 27 per cent off that recent peak.
This hasn’t stopped London’s majors pushing higher still. With total returns of 16 and 20 per cent since June 2022, when oil prices topped out, Shell and BP are well up on the index. Indeed, it’s likely that without their outsized contribution, any remaining gloss to the FTSE All-Share would have been rubbed out. So why (or how) has this momentum been sustained?
Surging gas demand has contributed to the investment case. Ditto lower gearing, and the enormous, suddenly apparent value of integrated models and trading divisions. A belated acknowledgement of the incumbent energy system, after a giddy period in which the solution to our fossil fuel addiction appeared to be a year-long vaccine race, may also have helped.
But cast around the explorer-producer mid-market, and you’ll find a lot of long faces. Over the same 20-month period in which Shell and BP posted double-digit returns, the shares of FTSE 250 names Energean (ENOG), Tullow Oil (TLW) and Harbour Energy (HBR) have all sunk deep into the red.
One big difference with Shell and BP is the presence of two major buyers of their shares: the supermajors themselves. Since they both recommenced their buyback programmes in 2021, Shell and BP have repurchased around $40bn (£31bn) and $24bn (£19bn), respectively. That's in the context of market capitalisations of around £115bn and £60bn when the programmes restarted, a time when the duo were crawling back into profitability.
Nor does the market expect the buying to slow down. Over the next five years, analysts expect BP’s purchases to average $5.5bn a year, with slightly more than that in 2024 and 2025 before capital spending increasingly takes priority in the second half of the decade.
Meanwhile, Shell’s buyback frenzy in 2022 – which contributed to the Anglo-Dutch group spending more on repurchases and capital expenditure than its entire discretionary cash flow for the year – has been taken as a signal that this will remain central to its capital allocation plans. Consensus forecasts are for buybacks to consistently average $13bn a year until 2028, just shy of the current run-rate of $3.5bn a quarter, but above what Berenberg thinks is feasible based on its own commodity price assumptions.
Shareholder returns
Of course, the wide and fundamentally unknowable range of possible commodity prices in the years ahead means we need to apply a large grain of salt to projections even a couple of quarters out. But the accuracy of the forecasts matters less than the focus of shareholder returns, and how this has been signalled by recent policy.
In the case of Shell, for example, buybacks now appear to take precedence over the dividend. While variations in forecasting methodologies mean we can’t assume share counts have been adjusted for future buybacks, analysts expect Shell to pay out 120p in dividends per share over the next five years. Assuming all things are equal, that’s an average of $9.8bn a year, although it wouldn’t be a stretch to conclude that with buybacks retiring some 6 per cent of shares a year, this absolute figure is likely to fall.
Expectations for BP aren’t far behind. Consensus forecasts for the annual dividend to average 26.1p per share during this period equate to roughly $5.6bn in cash at today’s exchange rates, meaning they are more or less equal to those buyback projections.
For a duo synonymous with dividends, this marks something of a transition. It’s also one that some shareholders might question, given the wisdom of repeatedly buying back shares whose earnings ultimately derive from a volatile commodity market.
BP’s track record here is instructive. Although its capital allocation priorities during the last decade were hugely skewed by the fallout from 2010’s Deepwater Horizon disaster, the group was not a prescient buyer of its stock. Based on BP’s own disclosures, its average purchase price between 2008 and 2020 was around $7.74 a share on a weighted basis, or approximately £4.93 when contemporary exchange rates are applied.
Despite their recent rally, BP shares remain below this level, meaning these historical purchases essentially resulted in a drag on capital values.
Since then, however, the record has been a little stronger. In simple price terms – which overlook the positive effect buybacks can have on earnings and dividends per share – the shares BP has repurchased since restarting its buyback programme in 2021 are on average now worth 8.5 per cent more in the open market. Shell, having gone very hard on its programme in late 2022, has done slightly better, retiring shares that are today worth around 10 per cent more, on average.
Despite this, an analysis of the companies’ daily share repurchases suggests neither appears to operate a strict policy of only buying when the shares are below a certain level. Yes, Shell’s purchases did appear to spike when earnings yield forecasts were at their peak in 2022, but we might point to the returns on shares purchased around that time (see chart) as evidence that this was the period when sentiment was at its frothiest.
To date, the supposedly accretive impact on earnings and the share price (a key reason why financially-incentivised executives are so fond of them) appears marginal. We can also question the commitment to a total return strategy when contrasted with the security of regular income distributions. Shell's share price, as if investors need reminding, has in five years gone on a round-trip from £25 to less than £10 and back above £25. The academic justification for buybacks – that they are a more efficient use of cash than dividends – looks much shakier in the example of an undecided income seeker forced to trim their holdings at a time of crisis and steep capital losses.
Why are Shell and BP so hot on retiring their outstanding stock?
A good starting point is to look at who this is all for. While we think of both as core UK plc institutions, the international nature of their investor bases and peer groups mean they are measured in different ways and face more clamour for tax-neutral shareholder return policies. Equally, though, it matters little to private investors in the case of these companies, big shareholders like the added liquidity that buybacks provide.
But does the existence of a perma-buyer make for a convincing investment case? While Shell and BP will naturally argue that their stocks are deeply undervalued, buybacks don’t offer an escape from the commodities cycle. Moreover, when set against the volatility of earnings, the growing commitments to buybacks suggest the groups are alert to growing institutional investor uncertainty about the future of the sector.
Quite why those investors should seek an off-ramp, rather than growth opportunities in an incumbent-led energy transition, is unclear. If they opt for the former, it at least offers a retort to the notion that buybacks deprive economies of productive capital. After all, the likeliest place for investors to recycle their cash, once Shell or BP has bought their shares, are capital markets.
Should the supermajors do more to keep investors on board? This, in essence, is the key tension in the investment cases for these companies: the question of whether they are multi-decade cigar butt stocks, or growth engines capable of pivoting into a new energy dawn. But that’s another topic for another time.
