Exxon and Chevron’s Pains Won’t Easily Translate to Gains

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Developments in the past couple of weeks showed that the two American supermajors—Exxon Mobil and

Chevron

CVX 0.91%

—can no longer kick the can down the road when it comes to addressing climate risk. While the heat is on the oil giants, though, their market share won’t exactly be easy pickings for other producers.

On May 26, the two largest U.S. descendants of Rockefeller’s Standard Oil empire both had a reckoning of sorts. Exxon lost director seats to nominees put forth by the sustainability-focused activist investor Engine No. 1, an upstart fund with a fraction of its shares. On the same day, another activist group successfully persuaded the majority of Chevron’s shareholders to demand more emissions cuts.

Since then, both Exxon’s and Chevron’s shares have gained about 5% on the back of higher crude prices, but they lagged behind producers not affected by activist-related headlines.

Devon Energy

DVN -0.23%

and

Occidental Petroleum

OXY 0.10%

have both gained at least 15%, while

ConocoPhillips

COP 1.10%

and

EOG Resources

EOG 0.41%

gained close to 10%.

That might be in part driven by an expectation that the limits placed on the industry’s giants will lead to market-share gains for others. Scrutiny of Exxon and Chevron will almost certainly place a higher hurdle on their future investments. In some cases, it might lead to divestments if certain assets don’t meet return hurdles or emissions targets.

In theory, independent exploration and production companies are in a solid position to step in. Many of them have proven to have better well performance and productivity compared with supermajors in previous years, according to Scott Hanold, analyst at RBC Capital Markets. That is in part because the independent E&P companies tend to focus primarily on oil and gas production and are optimized for it; major oil companies have a more sprawling business model that includes hydrocarbon transportation, refining and petrochemicals. The concentrated business model of independent E&Ps could, in some cases, shield them from investor pressure to stifle new production. After all, there is only so much shrinking a pure-play oil producer can tolerate; without new wells, their revenue sources dry up quickly.

It won’t be easy for those independent E&Ps to seize the moment, though. The recent sustainability pressure comes from investors with a keen eye on the bottom line. They want to do well by doing good, and they haven’t been pleased with Exxon’s performance in particular. Yet independent E&P companies’ record has been less than stellar in recent years. That alone will make it difficult for those companies to start a spending spree.

Five-year average returns on invested capital as of 2019 were lower for many independent E&P companies compared with Exxon and Chevron, including ConocoPhillips, EOG Resources, Devon Energy, EQT and Occidental Petroleum. Those firms also lack the distinct advantage of being completely integrated with cash flows that can provide a buffer when oil and natural gas prices are low.

And the activists’ might show up at their doors, too. Earlier in May, Follow This, the investor behind the push to reduce Chevron’s emissions, successfully put forth resolutions at ConocoPhillips to set concrete emissions targets. So it seems as though companies large enough to capitalize on the supermajors’ slowdown will find it tough to step in. Smaller companies—especially those in private-equity hands and immune to such pressure—could be the ultimate beneficiaries, but it will take a lot longer for them to start making a dent in the larger peers’ market share.

Investors who pivot too quickly to smaller producers to escape the heat could end up with a hot potato on their hands.

Write to Jinjoo Lee at jinjoo.lee@wsj.com

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