Decarbonization Trends Will Erode Oil Sands Asset Viability

Key Takeaways

• Global decarbonization trends, alternative energy adoption, and increased ESG scrutiny threaten demand, compress margins, and raise funding challenges for Imperial Oil.
  
• Persistent environmental liabilities and regulatory costs risk eroding cash flow, impairing asset values, and diminishing long-term returns despite operational improvements.
  
• Investments in efficiency, renewables, and export infrastructure, alongside strong cash flow and shareholder returns, position Imperial Oil for sustained growth amid evolving market conditions.

Catalysts

Engages in exploration, production, and sale of crude oil and natural gas in Canada.

• Intensifying global policy momentum towards decarbonization and more aggressive net-zero timelines are poised to erode oil demand structurally, leading to sustained downward pressure on Imperial Oil's revenues and significant long-term risk to the recoverability and economic value of their high-cost oil sands assets.
  
• The accelerating adoption of electric vehicles and alternative energy sources in North America and globally threatens to reduce gasoline and diesel consumption, creating persistent headwinds for demand in Imperial Oil's downstream business and likely resulting in meaningful volume declines and compressed refinery margins over time.
  
• Widening ESG scrutiny and continued investor divestment from fossil fuel companies are expected to further elevate Imperial Oil's cost of capital and restrict access to project funding, undermining the company's ability to sustain investment in growth and putting future cash flows and shareholder returns at risk.
  
• The company's large exposure to legacy environmental liabilities and expensive compliance obligations for oil sands reclamation means growing cash outflows are probable, pressuring net income and free cash flow, particularly as environmental regulation becomes stricter and more costly.
  
• Despite operational improvements, Imperial Oil faces the reality that long oil project lead times and the capital intensity required leave it inflexible to respond to rapid demand shifts, raising the likelihood of impaired asset values and stranded resources, with negative long-term impacts on net asset value and return on invested capital.

Imperial Oil Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on Imperial Oil compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming Imperial Oil's revenue will decrease by 11.0% annually over the next 3 years.
• The bearish analysts assume that profit margins will shrink from 9.5% today to 8.3% in 3 years time.
• The bearish analysts expect earnings to reach CA$2.9 billion (and earnings per share of CA$6.13) by about August 2028, down from CA$4.7 billion today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 14.2x on those 2028 earnings, up from 12.4x today. This future PE is greater than the current PE for the CA Oil and Gas industry at 12.4x.
• Analysts expect the number of shares outstanding to decline by 5.01% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 5.95%, as per the Simply Wall St company report.

Imperial Oil Future Earnings Per Share Growth

Risks

• Imperial Oil is making major investments in operational efficiency initiatives such as digitalization, automation, and the deployment of autonomous haul systems, which have already lowered oil sands unit costs by nearly two dollars per barrel compared to the prior year, supporting higher sustainable net margins.
  
• The company has completed and begun ramping up its large-scale renewable diesel facility at Strathcona, providing both an immediate earnings uplift and long-term alignment with regulatory trends and customer demand, supporting revenue resilience even as decarbonization pressures increase.
  
• Production volumes have reached multi-decade highs, and Imperial's asset base has multiple growth levers with projects at Kearl, Cold Lake, and Syncrude, positioning the company for sustained long-term output expansion and increasing cash flows.
  
• Successful expansion and optimization of export infrastructure, including new capacity on the Trans Mountain pipeline, has already boosted refined product sales and improved market access, which is likely to support revenue growth and higher realized margins.
  
• Imperial Oil maintains a conservative capital structure with substantial free cash flow, enabling both substantial and growing dividend payments alongside sizable accelerated share repurchases, directly enhancing earnings per share and total shareholder returns over the long term.

Valuation

• The assumed bearish price target for Imperial Oil is CA$80.0, which represents the lowest price target estimate amongst analysts. This valuation is based on what can be assumed as the expectations of Imperial Oil's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of CA$129.0, and the most bearish reporting a price target of just CA$80.0.
  
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be CA$35.0 billion, earnings will come to CA$2.9 billion, and it would be trading on a PE ratio of 14.2x, assuming you use a discount rate of 6.0%.
  
• Given the current share price of CA$114.9, the bearish analyst price target of CA$80.0 is 43.6% lower.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.