Market data:

Energy Evolution

The energy sector has been in great turmoil since the Great Repricing of crude oil at the end of 2014. Two major themes have upended what until then was a volatile yet fairly predictable cyclical business:

  • shale production success in the US
  • climate change

The success of domestic frackers to rapidly increase production of crude and natural gas not only counter-footed traditional producers such OPEC or Russia but also changed the funding and timing of the classic E&P cycle. Shale has much shorter cycles, much higher depletion rates and much lower initial capital requirements.  Shale was able to reverse a downtrend in domestic production that seemed unstoppable and that had influenced much of domestic and international politics for decades.
The success of shales was initially welcomed as the revolution that could finally bring the US to energy independence. Immediately, such new dynamic sparked a historical reaction by the leader of OPEC, Saudi Arabia, which, instead of acting as a balancing force in the supply-demand equation, decided to leverage its cost advantage in order to drive US shale producers out of business.  Such decision caused the price of the commodity to collapse in in 2015 all the way to the mid $20s. Crude has since recovered to a range between $50 and $60.
Currently, the economics of shale production are being questioned as the model requires constant drilling and recurrent working capital, a resource that investors and bankers are less and less willing to provide unless drilling plans become more focused on profitability rather than production.
Shale has been a boon also to natural gas whose demand is increasing as we decommission more and more coal plants and we also focus on exporting it in the form of liquefied gas. 
Concurrently with such major transformations in the supply side, the climate change crisis is taking center stage as it has become clear that a more diversified energy solution platform is now required to deal with the need to accommodate rising energy needs globally while avoiding climate related disasters.
The convergence of these two themes is forcing the energy sector into a much needed evolution. From an investor’s perspective, times of change bring about as much risk as opportunities.  A forward-looking strategy must include companies that can guarantee the energy supply chain by also incorporating those evolving trends such as the electrification process and the growth of renewables.
One solution we have identified a long time ago was the role of natural gas as the companion of renewables, given the intermittent nature of wind and solar and the still limited storage technology.  The role of natural gas as a positive influence on climate change is illustrated by the success the US has had in lowering its CO2 emissions in the last 20 years in spite of growing energy demand. If such switch could be implemented globally, positive results would quickly materialize. This opportunity leads to a policy of more exports of LNG by US producers where the supply of natural gas is vastly overtaking our needs.
The reduction of CO2 emissions will occur also thanks to a faster penetration of renewables, an accelerating trend in the energy landscape.  For instance, opportunities are emerging in solar panel manufactures and wind turbine providers.
Changes to the supply chain greatly affect utilities which must respond to the new paradigm with efficiency and long-term operational strategies.  Utilities such as NextEra have so far executed on the new trend achieving good results.
We offer a few datapoints that can help investors visualize the current situation:

  • Global energy demand is expected to grow by 50% by 2050
  • Demand for electricity is expected to double by approximately the same period
  • Power generation represents that largest component of CO2 emissions at 38% of total; agriculture follows at 25%, transportation at 19%, industry at 17%
  • US energy exports are expected to double by 2025 and almost triple by 2030
  • Energy demand has grown in 35 of the last 36 years
  • The market cap for the new energy sector is approximately $2.7 trillion; $1,144 billions in renewables, $824 billion in low carbon suppliers and $693 billions in energy infrastructures companies

(sources: Tortoise)
Efficient, predictable and now cleaner energy supplies are the backbone of successful societies and help improve people’s lives. Energy as an investable sector is not disappearing but it is structurally changing and such trends must now be recognized in evolving portfolios.