Thread by @ArjunNMurti

1 of 10/ From Not-For-Profit to a New ROCE Super-Cycle for Traditional Energy

Structural ROCE deep dive post #1: Capital allocation more important than oil price over long run

2/ I believe 2021 will mark the start of a new ROCE super-cycle era for traditional energy, with 2020 the end of a crushing 15 year ROCE downturn (2006-2020). This post is about ROCE, not oil prices.

3/ Energy was a not-for-profit sector generating a 0%—zero!—ROCE over 2016-20; extending to 2011-20 was not much better at a muni bond-like 4%. The end of the Super-Spike era and onset of the shale oil revolution has been a disaster for traditional energy.

4/ In contrast, ROCE was a healthier 11% during the pre-Super-Spike era of 1991-1999 and averaged 14% if you extend to 2010 and include the boom period. The 1990s prove that acceptable profitability levels are not dependent on booming oil prices.

5/ Energy’s S&P 500 weighting was 12% in 1991, 12% in 2010, but crashed to 2% in Oct 2020 and is now just 2.8%. While oil prices and “transition” concerns get all the attention, IMO, the sharp deterioration in sector ROCE is the main driver of diminished relevance.

6/ I believe that capital allocation is the most important determinant of sector profitability. If a sector (or company) doesn’t ultimately earn a competitive return on capital, it does not deserve to perpetuate.

7/ Though important over the short-term, long-term ROCE cycles are ultimately not driven solely by oil prices as most think. I do not personally use the “super cycle” moniker to describe my 2020s oil price outlook—“high and volatile” seems more apt.

8/ Structural energy ROCE cycles are measured in 10-15 year increments and should be differentiated from shorter-term trading noise driven by oil price vol or company-specific items.

9/ Capital allocation appears to be improving, with reinvestment rates on-track to fall sharply vs history, supporting higher ROCE. I am encouraged by what I have seen in the first three quarters of 2021; 17 more to go and Energy will have an excellent five-year track record!

10/ The full length version of this post can be found here.
arjunmurti.substack.com/p/from-not-for…