For Big Oil’s Future, Look To Big Tobacco’s Past

If you want to know the future of Big Oil, look to the past of Big Tobacco. Depending on who you believe, they will be either greenwashed money machines or transformed businesses dedicated to reversing the damage done by their old products to the planet and health. Confusingly, they might be both.

From the 1980s until a few years ago, Big Tobacco was a money machine. Cigarette sales fell a little pretty much every year, but prices rose more than enough to compensate and profit margins were, well, to die for. New technology changed everything. The development of e-cigarettes, and to a lesser extent heated tobacco, overthrew the business model and the marketing. Now, Big Tobacco is trying to present itself as a leader on environmental, social and governance issues—and even health.

“We think of ourselves as having an ‘H+’ ESG strategy: ‘H’ for health,” says Kingsley Wheaton, chief marketing officer at British American Tobacco, or BAT, the biggest tobacco company by sales. “It’s the sine qua non of our transformation.”

ESG, environmental, social and governance investing, has swept into the world of finance and according to its adherents can help change the world. I’ve taken a critical look at the ESG trend in a series of Streetwise columns. Tobacco offers a guide because 40 years ago it faced similar challenges from investors who took a moral stance against its products and governments who wanted to tax and regulate it out of existence.

Oil has proved as addictive for the economy as nicotine is to smokers. Environmentalists and governments want to wean customers on to alternatives, especially electric cars but potentially also hydrogen or simply lower consumption. Just as the prospect of ever-increasing regulations, combined with limits on marketing, made it almost impossible to launch a new tobacco company, the prospect of action on fossil fuels has hit investment in new drilling. Many investors believe the limited expansion of supply means high oil prices could last.

The oil industry and its investors are now split between the two approaches taken by Big Tobacco.

On one side are those who think the route to lower oil consumption will look like tobacco did from the 1980s to the 2000s. Volumes will fall but higher prices will boost profit margins. Addicted customers meant that cigarette sales continued even when marketing spending was slashed due to legal restrictions. Gasoline sales will continue for many years, but oil companies might not spend the vast sums they did in the past exploring and drilling new wells, leading to higher prices and fatter margins even as existing wells are run down.

As with tobacco, this strategy cannot last forever—but if governments are serious about their 2050 net-zero emissions promises, there’s no future in drilling anyway. And in the meantime the oil companies could pay shareholders the fat dividends offered for decades by tobacco stocks.

Most of the firms following this strategy are privately-held, buying assets being sold off by listed companies trying to cut their emissions. In practice, emissions simply continue under new ownership. But creating a standalone limited-life oil producer was part of the pitch of hedge fund activist Daniel Loeb, who is pushing to break up British oil major Shell.

On the other side are oil majors, mainly in Europe, who think the future involves a steady switch from oil to new energy such as wind farms. Just as with Big Tobacco recently, they are using some of the profits from selling oil to pour money into the new areas.

Like Big Tobacco, these oil companies trumpet their environmental projects, as well as social projects and corporate governance. That disgusts activists, who label it “greenwashing,” designed to distract customers and investors from the harm they do. BAT even removed the word “tobacco” from its brand in 2020, as well as dropping the tobacco leaf from its logo and adding the slogan “A Better Tomorrow.”

“Despite all the prominence the newly re-branded BAT is placing on ESG, what is quite clear is that although the leopard may have changed the colours of its spots from black to green, BAT is still a leopard,” says Andy Rowell from the Tobacco Control Research Group at the University of Bath in England.

Mr. Wheaton bridled at the suggestion that its efforts were all about distraction, during an interview at BAT’s London headquarters. “If you knew the sheer energy that goes into building the new business you wouldn’t think it was greenwashing,” he said. “When you leave the office I’m not going to say ‘hahaha, he believed all of it’.”

At least some of the agencies that rate companies on ESG characteristics do believe it. BAT last year was ranked as third-best in the FTSE 100 by Refinitiv, and Sustainalytics, part of Morningstar, rates it medium risk, 88th out of 598 companies it rates in what it calls the “food products” industry globally. S&P Global thinks BAT is among the best tobacco companies, while MSCI doesn’t buy the story, rating BAT as only average within the tobacco industry. But MSCI thinks Shell is great for an oil company, giving it AA, its second-best rating, while Refinitiv says Shell has the best governance in the world.

The historic arguments used by both industries developed the same way: first, denial (of cancer or climate change), then fierce lobbying campaigns to head off restrictive laws, in some cases triggering accusations of outright bribery. The current argument is that people will want or need cigarettes and fossil fuels for many years, so they need to be provided – and are better provided by a big public company than by private firms with no transparency.

Some in Big Tobacco have reached the acceptance stage, that eventually cigarettes will vanish, and their business needs to change or die. Not every oil company is there yet, but the debate is on. Shell and others in Europe are spending heavily on change. But at least some investors prefer the die option, with fat profits to be made along the way and perhaps a longer life than environmentalists wish.

ESG investors expecting big carbon emitters to get their just deserts should think again. There’s plenty of money to be made from oil before the dirty fuel is no longer needed, just as there has been from cigarettes. And that money might end up going to investors who just don’t care about ESG.

The U.S. and Chinese governments should take action to lower future borrowing, as a surge in their debts threatens to have “profound” effects on the global economy and the interest rates paid by other countries, the International Monetary Fund said Wednesday.

In its twice-yearly report on government borrowing, the Fund said many rich countries have adopted measures that will lead to a reduction in their debts relative to the size of their economies, although not to the levels seen before the Covid-19 pandemic.

However, that is not true of the U.S. and China, which will continue to see a surge in borrowing if current policies remain in place. The Fund projected that U.S. government debt relative to economic output will rise by 70% by 2053, while Chinese debt will more than double by the same year.

The Fund said both countries will lead a rise in global government debt to 98.8% of economic output in 2029 from 93.2% in 2023. The U.K. and Italy are among the other big contributors to that increase.

“The increase will be led by some large economies, for example, China, Italy, the United Kingdom, and the United States, which critically need to take policy action to address fundamental imbalances between spending and revenues,” the IMF said.

The IMF expects U.S. government debt to be 133.9% of annual gross domestic product in 2029, up from 122.1% in 2023. And it expects China’s debt to rise to 110.1% of GDP by the same year from 83.6%.

The Fund said there had been “large fiscal slippages” in the U.S. during 2023, with government spending exceeding revenues by 8.8% of GDP, up from 4.1% in the previous year. It expects the budget deficit to exceed 6% over the medium term.

That level of borrowing is slowing progress toward reducing inflation, the Fund said, and may also increase the interest rates paid by other governments.

“Loose US fiscal policy could make the last mile of disinflation harder to achieve while exacerbating the debt burden,” the Fund said. “Further, global interest rate spillovers could contribute to tighter financial conditions, increasing risks elsewhere.”

A series of weak auctions for U.S. Treasurys are stoking investors’ concerns that markets will struggle to absorb an incoming rush of government debt. The government is poised to sell another $386 billion or so of bonds in May—an onslaught that Wall Street expects to continue no matter who wins November’s presidential election.

While analysts don’t expect those sales to fail, a sharp rise in U.S. bond yields would likely have consequences for borrowers around the world. The IMF estimated that a rise of one percentage point in U.S. yields leads to a matching rise for developing economies and an increase of 90 basis points in other rich countries.

“Long-term government bond yields in the United States remain elevated and sensitive to inflation developments and monetary policy decisions,” the Fund said. “This could lead to volatile financing conditions in other economies.”

China’s budget deficit fell to 7.1% of GDP in 2023 from 7.5% the previous year, but the IMF projects a steady pickup from this year to 7.9% in 2029. It warned that a slowdown in the world’s second largest economy “exacerbated by unintended fiscal tightening” would likely weaken growth elsewhere, and reduce aid flows that have become a significant source of funding for governments in Africa and Latin America.

An unusually large number of elections is likely to push government borrowing higher this year, the Fund said. It estimates that 88 economies or economic areas are set for significant votes, and that budget deficits tend to be 0.3% of GDP higher in election years than in other years.

“What makes this year different is not only the confluence of elections, but the fact that they will happen amid higher demand for public spending,” the Fund said. “The bias toward higher spending is shared across the political spectrum, indicating substantial challenges in gathering support for consolidation in the years ahead, and particularly in a key election year like 2024.”

For Big Oil’s Future, Look To Big Tobacco’s Past

There’s plenty of money to be made from oil before the dirty fuel is no longer needed, just as there has been from cigarettes.

Says U.S. and China, which will continue to see a surge in borrowing if current policies remain in place.