In the coming years, virtually all forms of energy will have significant tailwinds, but the source of those tailwinds will be energy source-specific.
Russia’s invasion of Ukraine highlighted issues surrounding the energy complex, which were primarily already known. In Europe, in particular, in the immediate panic following the Russian attack, there has been a period of urgent reflection where considerations such as baseload power and energy logistics have necessarily come to the fore. However, after the gift of an unseasonably mild winter, it already feels like politics is potentially taking the lead over the economic realities of the energy crisis. This is important to note because that tells us that governments will probably continue a more populist policy agenda, perhaps at the expense of future energy security.
There is a backdrop of politicians seeking political capital from the complex and dynamic energy transition. This brings added complications for the fund managers who see companies such as BP and Shell as part of the potential solution rather than the problem. For several years, we have held the Man GLG UK Equity Income fund, which Henry Dixon manages, across our Income and Core ranges. Here, Henry captures some of the complexities of the energy and commodity markets as well as providing us with some excellent historical context and perspectives.
Henry Dixon, CFA
Portfolio Manager, Man GLGFirstly, we need to stop referring to this sector as ‘Big Oil’. Most of their earnings come from gas, which has a far reduced carbon footprint to both oil and coal.
Secondly, the cash flow characteristics have improved dramatically in recent years, while the cost of capital has recently increased for other market participants. This means that the sector is now the natural provider capital to transition projects. BP’s joint venture with Tesla last year on charging stations was a good example of this.
Thirdly, upcoming regulation will provide earnings stream that do not exist today. For example, sustainable fuel requirements are emerging within European aviation. In the coming years planes landing in Europe will require a substantial portion of their fuel loads to be of biofuel in nature. The sector has a huge competitive advantage in providing these solutions.
Fourthly, technology has the potential to reinvent depleted oil and gas fields, that are currently set for expensive decommissioning, into either storage facilities or carbon capture projects. The final point on carbon capture is an area being explored in detail at the Man Institute, in collaboration with Oxford University.
An appropriate historic analogy would be how we arrested the decline of the ozone layer in the 1990s. CFC gases within deodorants were the key perpetrator of the decline. Today, deodorant remains part of human culture, but we removed the damaging CFCs. The same mindset needs to take hold with the removal of carbon from fossil fuels, rather than the outright removal of fossil fuels.
Finally, valuations at circa 5x earnings are compelling. Should any of the points set out above gain traction then there is the potential for a significant rerating. *
Here at IBOSS, we feel the tailwinds for wind, solar, and wave-created power will be beneficiaries of governments’ worldwide attempts to decarbonise the economies. These sectors benefit from government subsidies, and spending on renewable energy plays well with most of their electorate, especially in countries like Germany. Unless some new form of energy creation comes in from the left field, broad-based support for renewable energy sources will unlikely diminish for the foreseeable future. Therefore, ongoing investment opportunities will persist via passive index tracking funds or employing managers searching for the underlying winning companies.
The tailwinds for fossil fuels are undoubtedly more controversial but no less compelling from a pure investment perspective. The demonisation, in particular surrounding the use of oil and coal and, to a slightly lesser extent, natural gas, has naturally coincided with decades of underinvestment in what are generally termed baseload energy sources, i.e. they are not intermittent like solar and wind-generated power.
The world’s population can probably agree that humankind should try to stop utilising fossil fuels, but for the time being, that doesn’t seem to be economically possible. Therefore, companies that invest in or produce oil, gas and coal have the tailwind of economic necessity at their back. Some significant unknown factors, such as changes to government rules, tax treatment and advancement of renewable energy technology, all play a part in the case for the investing limitations in these controversial areas. However, the supply and demand dynamics remain a strong pillar of support for investors comfortable investing in these areas.
The final area which could have a potential renaissance is nuclear power. Again, having suffered years of mainly negative mainstream media coverage, the actual energy it can produce and the true environmental impact have often been discounted in favour of less contentious and emotive forms of energy. However, cheap Russian oil and gas have permitted the scaling back of nuclear power, again most prominently in Germany. Even if, for now, the immediate pressure is off to reassess nuclear power following the mild winter, relying on the weather is a precarious investment strategy. To summarise, we think that virtually all forms of energy will be winners in the next decade, and there are not many sectors you would say that about.
*Important Information: This material is provided to IBOSS at your specific request for information only. Communicated by Man Solutions Limited (‘MSL’), authorised and regulated by the UK Financial Conduct Authority. The information has been prepared from sources believed to be reliable but we do not accept any liability for its accuracy or completeness. Past performance is not indicative of future results. The value of an investment and any income derived can go down as well as up and investors may not get back their original amount invested. Alternative investments can involve significant additional risks. This material does not constitute an offer or invitation to invest in any product. It is not intended to constitute advice nor an investment recommendation. Organisations, financial instruments or products mentioned are for reference purposes only. This material is proprietary information and may not be reproduced or disseminated without prior consent. © 2023
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