Shell (LSE: SHEL) shares have risen by 48% in just 12 months. I have never invested in Shell or other fossil fuel companies. Although this now fills me with regret, I believe my reasoning is sound. I don’t believe that oil and gas companies will continue delivering value and outperform the wider stock market in the long term. That’s why I still don’t plan to invest in Shell today.
My view contradicts that of Martin Walker, manager of the Invesco UK Opportunities fund. The fund is up 18.99% in the last five years, well above its benchmark, the Investment Association UK All Companies Sector, which is up just 2.69%. Interestingly, Walker believes that Shell is still a bargain today. Am I wrong on Shell and the energy sector?
Why I haven’t invested
Shell reported adjusted earnings of $9.45bn for the third quarter. That is its second-highest profit ever. I’m convinced that such high profits are not sustainable. I’m also concerned that the company is using these record profits to deliver short-term shareholder gains rather than long-term growth.
In the first half of 2022, Shell invested 6.3% of its £17.1bn profits into low carbon energy. It invested nearly three times more in oil and gas. The world will need to move away from fossil fuels both for energy security and to reach net-zero emission targets. I’d prefer to see greater investment on renewable energy. However, I understand its approach to an extent due to existing geopolitical and macroeconomic conditions.
I am less understanding of its announcement of a $4bn share buyback programme in late October. Rumours are growing that the government will extend the windfall tax on oil and gas companies in this month’s autumn budget. Huge share buybacks make such a tax an increasingly popular one to help stabilise the UK’s public finances. It would also hit the company’s earnings.
Shell shares remain a bargain?
So what about the bull case? BP and Shell are Martin Walker’s two largest holdings and he expects both to continue delivering strong returns. That’s based on the law of supply and demand. Walker said the following to The Telegraph: “Looking ahead, we see a number of constraints associated with increasing oil supply. Assuming we see some growth in the global economy over the next five years, oil demand should continue to rise“.
If that assessment is correct, strong oil prices over the next five years may not be priced in to Shell’s share price. Additionally, Shell is generating significant amounts of cash and Walker predicts this will further boost share performance. He said, “I don’t know how long these conditions will persist, but when companies are generating 20% of their market capitalisation in cash in a year you do not need these conditions to persist for very long to have a meaningful impact on their performance“.
Shell’s enormous profits may well continue for a while yet. Therefore, I do see a short-term bull case but also suspect that performance in the long term will be underwhelming. A windfall tax or a welcome end to the war in Ukraine could quickly weaken earnings. I won’t be investing today but would consider doing so if I see a greater focus on renewable energy investments and long-term growth.
