Big Smoke offers Big Oil tips to avoid dodo status

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LONDON, June 9 (Reuters Breakingviews) - Big Oil is staring dodo status in the face. Recent assertions by the International Energy Agency that crude production needs to drop 75% by 2050 to control global warming will have investors in private energy groups like Exxon Mobil (XOM.N) and Royal Dutch Shell (RDSa.L), wondering if their companies will become extinct. A glance at the similarly troubled tobacco sector might ease some of their nerves.

Tobacco’s dodo moment came in 1998, when U.S. prosecutors signed the Tobacco Master Settlement Agreement, requiring the sector to pay extensive health damages. In the immediate aftermath, smoke stocks slumped from trading just adrift of the S&P 500 Index at around 15 times earnings to 5 times, while the wider market ballooned to 25 times in the dot-com bubble. Things didn’t stay that way.

In the 15 years between 1998 and 2013, the gap between tobacco and the S&P 500 narrowed until the former frequently traded at a premium to index, Bernstein research shows. Hard cash suggests why. In nine of those years, tobacco shareholders’ total distributions, including buybacks, meant their dividend yields exceeded the market’s, often markedly so. Oil companies TotalEnergies (TOTF.PA) and Exxon, whose chunky dividend yields currently do the same, are heeding that lesson.

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The other lesson from cigarettes is not to hang about. Philip Morris International (PM.N) counts a quarter of its revenue from so-called IQOS (“I Quit Ordinary Smoking”) products and aims for these less-harmful “smoke-free” brands to exceed 50% of net revenue by 2025. British American Tobacco (BATS.L) is merely hoping for its so-called New Categories brands to hit 5 billion pounds – 20% of current revenue – by then. In the last five years PMI shares have substantially outperformed BAT’s. BP’s (BP.L) quicker pivot away from oil seems equally popular. Over the last three months its shares have outperformed slower-to-pivot Shell.

The risk for PMI is that transition products like IQOS are less bad but are still viewed as unhealthy. Since 2017, tobacco has lagged relative to the S&P 500 as investors embraced environmental, social and governance considerations. Oil majors like Shell and Total, whose transitions hinge on ramping up natural gas that is merely less polluting, face a similar problem. That suggests they should make a wholesale shift to renewable energy. Unlike new-age tobacco products, it’s a more straightforward win for ESG investors.

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- Royal Dutch Shell will seek ways to accelerate its energy transition strategy and deepen carbon emission cuts following a landmark Dutch court ruling last month, Chief Executive Ben van Beurden said on June 9, a move that will likely lead to a dramatic shrinking of its oil and gas business.

- Shell plans to appeal the May 26 court ruling that ordered it to reduce greenhouse gas emissions by 45% by 2030 from 2019 levels, significantly faster than its current plans.

- But the court ruling applies immediately and cannot be suspended before the appeal, van Beurden said in a LinkedIn post.

- British American Tobacco said on June 8 it would aim for 5 billion pounds of revenue by 2025 from New Categories product like tobacco heating products and vapour. In 2020, the company made 25.8 billion pounds of revenue.

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