Demand and supply. That’s the fuel that powers the economic cycle.

When demand outstrips supply, prices rise. Higher prices encourage companies to invest in more production. They inevitably overinvest, and so supply outstrips demand. That pushes prices down, and so the whole cycle starts again.

For many years, the energy industry has generally followed this cycle, raising and cutting investment, chasing prices up and down. However more recently, that cycle has broken.

“Yet for the first time in decades, it looks like energy companies are unlikely to chase higher prices with higher production.”

In the years coming into Covid, energy companies had already been restraining their investments, only to cut investments further as demand collapsed during the Covid lockdown.

As the global economy has reopened, energy demand has recovered, and at the same time, Russia’s invasion of Ukraine has cut oil and gas supply.

In response, energy prices that were already rising in the last year have rocketed. 

Yet for the first time in decades, it looks like energy companies are unlikely to chase higher prices with higher production.

So, what’s changed?

Well, the first point is pressure from shareholders. In the past cycle, energy companies would pursue production growth without much regard for cost. Having been burned by reckless investment in the past, investors in energy companies now far more prefer cash returns than the promise of some grand project.

“Those forces have forced energy companies to invest more carefully, despite generating more cash.”

But this isn’t the only pressure that energy companies are facing from shareholders today. As more investors focus on climate issues, energy companies are finding capital to be far less abundant and far more costly, particularly those projects with the highest emissions.

The third factor is the question about demand. As governments around the world adopt policies to move away from fossil fuels, it makes little sense for an energy company to invest in a 30-year oil project that may not be viable in the future.

Those forces have forced energy companies to invest more carefully, despite generating more cash. And that discipline should make high commodity prices more persistent. Today, the fundamentals of these companies look far better than they have previously.  

Yet the stocks remain cheap. At today’s oil and gas prices, the sector trades at around a 20% free cash flow yield. But spotting the cheap valuation is the easy part.

“The challenge is distinguishing the deservedly cheap from the attractively undervalued.”

The challenge is distinguishing the deservedly cheap from the attractively undervalued. A 20% free cash flow yield doesn’t count for much if a company has no future. And some energy companies probably don’t. But we believe some producers, like Shell, Chesapeake, Inpex, and infrastructure firm and pipeline operator Kinder Morgan will have a role to play in the years to come.

Our largest energy holdings have one thing in common: they are more focused on gas than on oil, and that’s a crucial distinction, because the demand picture for oil and gas look different than they do in past cycles. For the first time, the world is trying to optimise the global economy not just for efficiency, but also for emissions.

It would be great if we could just flick a switch to transition to a cleaner economy. But the reality is we can’t. That would just turn the lights off.

The good news is that we are improving. In the developed world, energy use per person and the emissions intensity of that energy use has been declining. And worldwide, we are using energy more and more efficiently to support economic growth.

“With free cash flow yields as high as 20%, the bar to be certain about the long-term outcome falls with each dividend or buy back.”

But energy demand overall remains robust, particularly in the developing world. Some one billion people still live in energy poverty, consuming less energy annually than a typical American fridge. As developing countries become wealthier, their need for energy will continue to grow.

The challenge then is to meet the world’s continuing energy needs while shifting to cleaner fuels. And this is where we think gas as a transition fuel has a key role to play. Gas has almost half the emissions and almost none of the particulate pollution of coal and serves as a great complement to intermittent power sources like wind and solar.

And if the world continues to need gas, gas prices will need to be high enough to attract an appropriate level of production, although that level will be far lower than what it was in the past. With lower investment needs, that means companies can return more capital to investors.

And that’s why we are excited about our energy holdings. With free cash flow yields as high as 20%, the bar to be certain about the long-term outcome falls with each dividend or buy back.

There are risks of course. Regulations can change. The world can transition away from fossil fuels far more quickly than we expected, and extreme prices can attract windfall taxes. But we believe these risks are more than priced in by the market.

At their current valuations, we believe our energy holdings have a positive role to play in both the portfolio and the world’s energy transition, and that’s a far better outcome than simply switching off the lights.


Past performance is not a reliable indicator of future results. The value of investments in the Orbis Funds may fall as well as rise and you may get back less than you originally invested. It is therefore important that you understand the risks involved before investing. This report represents Orbis’ view at a point in time and provides reasoning or rationale on why we bought or sold a particular security for the Orbis Funds. We may take the opposite view/position from that stated in this report. This is because our view may change as facts or circumstances change. This report constitutes general advice only and not personal financial product, tax, legal, or investment advice, and does not take into account the specific investment objectives, financial situation or individual needs of any particular person. This report does not prohibit the Orbis Funds from dealing in the securities before or after the report is published.