Ignore your conscience: big oil still beats green power

If you are the kind of person who believes the things the City says, you might by now be almost convinced that we don’t really need oil any more.

If you are the kind of person who believes the things the City says, you might by now be almost convinced that we don’t really need oil any more. Within seconds of the publication of the Stern report every analyst in town had become an expert on green energy, and investors were being advised to put their money in everything from wind, solar and wave power to fuel cells and biomass electricity plants, all of which were being put about as perfectly viable alternatives to fossil fuels. The problem is that, at present at least, they aren’t.

Wind power is famously inefficient. Wave power is a very nascent technology. Solar power is expensive. And the best of the lot, fuel cell technology, while making encouraging progress, isn’t there yet. Vast amounts of money are pouring into renewable energy projects — $50 billion worldwide in 2005, about 10 per cent of the total global investment in energy — and I’m sure that one day all that money will yield a return both to investors and to the planet in terms of an energy source that really is cheaper, more efficient and better for the environment than oil. It just hasn’t happened yet and probably won’t in the next decade. Whether the green energy lobby likes it or not, we still need oil and we need ever increasing amounts of it.

It doesn’t matter how successfully we in the West are bullied into giving up big cars, air travel, televisions on standby and nightlights for toddlers to reduce demand for fossil fuels and carbon emissions: any slack we create will be taken up by China in a matter of seconds. The average rate of growth in China for the last 20-odd years has been over 9 per cent and, as James Kynge reminds us in his book China Shakes the World, urbanisation there has only just begun: 400 million people live in Chinese cities now, but that number is forecast soon to hit a billion. We can’t begin accurately to predict how much oil that shift is going to consume but we can be sure it’s going to be a lot: think of the amount needed just to power the machines building the infrastructure for those cities — never mind the 500 million cars, 300 million fridges and 4 billion light bulbs owned by those who will settle in them.

China has built enough power plants since 2004 to supply all the electricity needs of a developed country the size of Spain. It’s going to be building a lot more. The oil price has fallen from its highs recently and is often volatile but there is little doubt that, without the sudden arrival of a green energy miracle, the long-term direction is up. This means that, while it might in some way be morally satisfying to invest in wind farm complexes, if you actually want to make any money out of energy, you really need to be investing in the oil sector.

Good news, then, that doing so is practically free at present. While the average green energy firm trades at well over 30 times its earnings (if it has any earnings), Shell is on a price earnings ratio of only 9.2 times and BP trades on a mere 10 times. Shell offers a dividend yield of 3.6 per cent; BP 4 per cent — something you’ll be waiting a very long time to see from your green investments.

These two firms have their own problems. There is concern, for example, that they aren’t replacing their reserves as fast as they use them and that they therefore effectively constitute wasting assets. It is also true that they signed some very bad deals around the world back in the 1990s, with the result that they sacrificed some of the current upside in oil prices to foreign governments.

But I’m not sure that either of these factors should be putting you off. Only a small proportion of their production is subject to these bad deals and, while much is made of the issue of falling reserves, we don’t know with any accuracy how much anyone or anywhere has of them: the calculation is more guesswork than science. It’s also worth remembering that new technology coming on stream means that many depleted oil fields may well be worth opening up again.

The final worry about investing in the big oil companies right now is that you may find momentum going against you in the next six months or so: if the US economy keeps going downhill as it is at present, the oil price will probably fall a little further and big oil will fall even further out of favour than it has already.

However none of this changes the basic facts: oil is expensive and oil stocks are cheap, something which tells me that we should probably buy them and hold them for the long term.

Merryn Somerset Webb edits MoneyWeek.