Royal Dutch Shell & The Reasons For American Outperformance

We thought we would unite two of our long running themes this week and try and talk about why they are both independently important but also mutually self-reinforcing.

They are:

  • The first is that indexing is always important but which index you purchase is the critical question.

  • The second is how and why the US stock market continues to outperform its peers and rivals elsewhere.

These are both very "Pebbly" themes in the sense that they try and point out both the virtues of our approach and also some of the potential pitfalls.

Indexing is great, in other words, but as a strategy only as good as the actual index you are tracking. Passive indexing might have been a very different experience for someone who bought, say, the FTSE 100 in the United Kingdom over the last 10-15 years.

This isn't always appreciated in the rush to preach passive over active.

Indexing is still, after all, a financial product. It inherently tracks an index. That fact comes with choices and also opportunities for exploitation. If you buy one that is expensive or unbalanced or poorly constructed then you risk undermining a lot of your saving and investing goals right from the outset.

Furthermore, a similar outcome can occur if you buy an index for a country with a depreciating currency or one concentrated in certain sectors and industries. If you had owned the London-based FTSE 100 the last 10 years instead of the S&P 500 you might feel a whole lot less cheery right now.

It is also true that companies can change indices. Or entirely new sectors of the economy might come along,. So, what index you own is actually a moving target. The Dow or the S&P 500 might be a great for many decades but slowly but surely the Nasdaq has taken over.

Recently, we talked about a lot of this when it came to the Japanese-owned but British-founded chip company Arm, relisting itself in New York rather than London.

There were specific reasons for Arm's decision. They were taken private by the its new owners, SoftBank and obviously when re-listing that Japanese company had very little loyalty to listing in London and a keen interest in maximizing their profit. After all, they have investors too.....

What can you really expect?

And it isn't just highly profitable tech hardware companies flocking to North American addresses and North American stock markets.

The latest to announce it might be moving is Anglo-Dutch oil giant: Shell.

The company's CEO, Wael Sawan, hinted very loudly that the oil company may consider changing its listing to New York from London. Shell isn't alone. TotalEnergies Patrick Pouyanné has already been tasked by his board to explore a similar move.


There are a few drivers to this.

First off, there is a globalization angle:

This may seem dissonant in an age of resurgent economic nationalism but global companies are not very interested in country first decisions when it gets in the way of greater profits. In the same way that SoftBank didn't really care about Arm's British roots or large British-based work force, neither does Shell. It is a global company, with a global work force and, much more importantly, a global investor base.

Those investors, many of them from large pension funds and other institutions, have a fiduciary duty to maximize returns. if you were to ask a Texan teacher or a Norwegian mail carrier if they care where there pension is invested and they will no doubt answer: wherever it will get better returns. Well, the same is true for those who invest on behalf of those individuals.

Nationalism is often inefficient and costly and these companies are predicated on achieving the exact opposite of that.

Even in today's age of industrial policy and "country first" policies, capital can still flow to where it is most appreciated.

This brings us to a second point. There is a very real valuation component here.

Companies like Total and Shell are valued at levels considerably beneath their American peers such as Chevron and Exxon. The gap is roughly around 40-50% and has stayed stubbornly wide for many years.

Interestingly and importantly, this valuation gap is far more significant than the broader index between Europe and the US. This suggests that there is something specific to European energy and Shell that is at play here.

The question then obviously becomes: how much of this gap is because of their European listing and how much for other reasons?

This brings us to a likely candidate: the very different regulatory environment for companies like Shell.

It isn't just that European states and investors are increasingly unfriendly to the fossil fuel industry. They are, of course.

And no doubt, the companies' climate pledges also do not help. You can see how mistaken they were by the fact that Shell is already walking back some of their most aggressive targets.

But the bigger problem is how the Europeans are going about their effort to decarbonize. If Shell (or BP or Total) is to have a hope of transitioning into being a clean energy giant AND competing with other global giants, then they need flexibility.

Only by being nimble and pragmatic do they have a hope of navigating a fiendishly difficult, costly and uncertain process that will constantly evolve over time. It is hard enough to change the direction of a big company. It is practically impossible with one hand tied back behind your back.

So, flexibility is paramount here.

Shell is getting the exact opposite right now.

All European energy companies are being slowly hemmed in by regulations on all sides: politically, fiscally, financially, production, you name it. Individually these rules all might be sensible. Who doesn't want Shell to be ambitious about limiting emissions? Or investing in renewable projects? Or paying windfall taxes to help defray the costs of losing access to Russian gas?

But in concert all these rules and regulations are a strait jacket that keeps Shell from being able to make quick and pragmatic decisions.

In business, flexibility isn't everything but it is a lot.

The biggest outcome from this regulatory hamstringing is that Shell is an oil company that is not expected to produce much oil. Between now and 2030 its production of fossil fuels is expected to be roughly flat.

That is fine perhaps. It could even be a good thing for the climate and it could be a good thing for the company as well. But the problem is it means if oil demand doesn't fall off a cliff like European regulators expect then Shell can't do anything about it.

Further, what that lower production also means is that Shell has less capital this quarter and every other quarter going forward. They - and any other oil or energy firm - need huge amounts of money to make the transition. That requires massive amounts of investment which has to come from somewhere.....

Finally, there is a competitive aspect of this.

Shell doesn't exist in a vacuum. In the same way that it is competing in global oil markets, it is also competing in other areas just as fiercely.

A global investor base (or a global work force or a top tier executive team) has other choices, after all. If a large portion of your compensation is paid in stock and those shares are underperforming the broader energy space or your peer companies.....

The broader context is even worse.

In a global market why would you want to hold Shell or Total or BP when you could hold Chevron or Exxon or even Saudi Aramco? There are good reasons you might, of course. For instance, you might love their climate pledges or think that in a few years fossil fuel consumption will drop off a cliff and their lack of investment will look savvy. All of that could be true.

But for those that do want to have exposure to global energy giants, Shell will be one of the last companies on a relative basis.

That is the key to remember. Yes, some European investors already can't invest in the likes of Shell and Total. Other do not want to. That is completely within their right. But the fact that so much is so against the legacy energy sector in the European content means that they can't win. No one else globally wants to be part of the Shell story either.

That won't keep oil in the ground. It just means others will be pulling it out. And it probably won't keep Shell European. They will follow the incentives and simply move their listing and then eventually their headquarters and finally a lot of their work force to a place where they are wanted.

Putting all this together it isn't terrible surprising that the powers that be look at this and think that action should be taken to remedy the situation.

Hello Houston!!

You might love this. Or you might hate it. Regardless, just be aware that for a European pensioner invested in European energy names - renewable or otherwise - they are surrendering some % of their profits to the likes of Saudi Aramco (or Exxon).

The likes of Exxon and Chevron don't just have more ability to make the world burn. They also have the flexibility to raise capital in deep capital markets, they have the ability to change from developing more oil to doing something else, whether it be hydrogen or solar or something else entirely.

That is something to remember as we become utterly convinced that every single successful industry we have must be taxed, regulated and controlled until we have complete control over how and where and why companies can spend and make their revenues.

That control is a negative almost unilaterally. It also is an illusion. And it isn't the only area where we are deluding ourselves sadly....


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