IBDRY - Clarity In Energy Materials And Infrastructure (With Video)

2023-11-16 05:25:00 ET

Summary

• Macroeconomic shifts are being felt from interest rate increases, with continued restrictive policy relative to recent decades.
• The oil market fundamentals reflect lock-step supply and demand and prices are range bound.
• The transition to cleaner energy sources is facing challenges (and inflationary forces). Power generation in renewables is revealing the costs and inefficiencies as more capacity is added.
• Large incumbents are well-placed in the "transition."

Last week, after attending the Federal Reserve Banks of Dallas and Kansas City joint energy conference, I offered some takeaways and investment theses related to the macroeconomy. First, the monetary policy environment is restrictive, and a soft landing is the desired outcome. The drive toward a 2% inflation rate is the target and we're burning closer to 3%. Another headwind to the "energy transition" is that the push toward a cleaner energy mix is inflationary. This has been discussed since early 2023 in articles and videos. The interest rate, as it stands, reflects the economic consensus of the value of money, and by extension, the implications for capital investment.

Bloomberg noted recently:

Two Federal Reserve officials said the US economy still hasn’t felt the full effect of past interest-rate increases, suggesting more slowing is yet to come. “In aggregate, we are still not seeing the full effects of policy,” Richmond Fed President Thomas Barkin said Thursday during a fireside chat in New Orleans. Speaking at the same event, Atlanta Fed President Raphael Bostic said he agreed.

Video: "After the Fed: Hybrid World, Circular Economy and Capital Market Liquidity"

More key points regarding the various markets related to energy follow:

Fundamentals

Oil market supply and demand are tracking each other more closely than in years past. The general setup ahead is tight supply unless demand really drops out. But there is still a floor of inelastic demand and supply.

OPEC's supply growth increasingly comes from Asia and its own relevant economies. Demand growth is largely derived from the developing world and its increasing standards of living.

Reducing Emissions

The reality of the decarbonization drive is reflected in the chart on the left. Fossil fuels continue to supply the lion's share of energy. Renewables are making headwinds owing to increased electrification. Power generation across the globe is projected to double by 2050, with a preference toward electricity. Regardless, fossil fuel sources are sticky.

Capital Drivers

Oil and gas can be characterized as upholding a capital discipline regime. In 2021, my feature about Pioneer (PXD) reflected this. Today, analysts are still discussing it in their presentations.

The majors are leaning into more sustainability plays, with efficient production and operations alongside innovation. The e lectron revolution faces the same issues, and government incentives may face nuanced results. There have been many Minsky moments of exuberance and now interest rates may pop the investment bubble, though the IRA legislation incentivizes the opposite.

Countries, cities, and firms will keep the mantra of net zero; though the current reality is "as clean as possible." Net zero may not be the best metric in all cases for all things, which I've been saying for a while, and finally, someone else concurred publicly.

The green energy economy is focused on renewables, EVs, and the various and expansive new tech developments connected to them. Much of the needed materials are critical minerals. And China dominates much of the processing and refining capacity in the space. Below is a presentation by Ford ( F ) included this slide:

Adding renewables to the grid is revealing headwinds. The famous "duck curve" of solar speaks to the intermittency issue, namely that the peak times of solar power generation are mismatched with the highest peak demand. In Texas, that bridge is being crossed by adding more dispatchable generation via natural gas-fired power. Billions are now earmarked as the economy grows and more renewables are added to the grid. A Moody's study says that $500 billion will be spent by 2030 to deal with the reliability costs creeping up as greater renewables capacity is added to grids, globally.

And so, curtailment costs are a proxy for the problem. In Texas, I note that $3 billion was spent in one year, and costs passed along to ratepayers and taxpayers.

Capital allocators are grappling with tough choices. While battery storage sounds easy, the economics become uneconomic over time. (This was explained by two different experts in renewables.) Yet, battery storage capacity is expected to increase.

Investment returns indicate a mixed agenda for the "transition." The following chart reflects the rationale behind majors Exxon ( XOM ) and Chevron ( CVX ) staying the course when other global majors veered toward renewables and charging stations. Their respective acquisitions of Pioneer Natural Resources and Hess ( HES ) illustrate important investment choices and outlooks. However, they too have transition plans of diversification based on competencies. Think Exxon and its recent lithium-related interests and Chevron with sustainable fuels. Oil and gas firms will be able to leverage their assets, operational competencies, and balance sheets to invest, identify performance, and participate in an expanding mix with new opportunities.

With an energy mix changing, new opportunities are arising to solve the problems of needed density and efficiency in power. Grid integration is requiring engineering, science, and technological advances. Greater efficiencies in resource extraction, like shale, are occurring as well; the Exxon-Pioneer acquisition offers a proving ground for new developments. I had a detailed conversation with CEO Sheffield in June about this, well before the Exxon announcement. While carbon capture and sequestration - CCS - is expected to play a role in the hydrocarbon side and the power generation side of the equation, its development is nascent but happening.

Reduced use of energy from demand management and supply-side efficiency are two promising arenas. Now, what's investable? In the oil and gas space, the U.S. majors and well-run independents offer a good runway. On the electron and efficiency side, one can look to large and diversified utilities such as Iberdrola ( OTCPK:IBDSF ) and firms like Hannon Armstrong ( HASI ). Personally, I do not use focused ETFs in the green space, but do so in tech when I have high conviction.

As mentioned in the video, the 10th and 11th districts of the Fed that convened the conference comprise a $4.5 trillion economy, equivalent to a top five global economy. Energy leadership and innovation are seated in these geographies. My report reflects a small snapshot of some of the findings and developments.

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