CTRA - Global Energy Transition: Methods And Soft Landings (Video Interview)

Summary

• The Texas economy offers a best case example of a soft landing. A Dallas Fed Texas economic outlook presents the reasons why.
• Oil and gas fundamentals are favorable in light of demand, supply, and geopolitical factors. Russia's invasion changed the calculus.
• Infrastructure funds are one way to play the energy transition, alongside their diversification attributes in an inflationary world view.

In a video interview Seeking Alpha 's Michael Hopkins speaks with Jennifer Warren about the economic outlook in energy and adapting a portfolio to soften volatility.

Video Interview "Global Energy: Inflation, Dislocation and Diversification" on YouTube

The following ideas are covered in depth in the interview, with a short list of slides below.

Texas economic outlook

In a Feb. 3 Dallas Fed event, the economic outlook and how inflation is trickling through sectors emerges.

Job growth in energy is quite apparent Texas and US-wide in 2022. And below, interest-rate sensitive sectors are responding to interest rate rises accordingly.

Texas has unique factors that contribute to a soft landing, as discussed in more detail in the video. Growth is still expected unless the country falters into a deeper trough.

Oil and gas fundamentals and firm strategies

The demand for oil and gas and renewables are favorable, alongside the transition initiatives that include sustainable fuels, carbon capture and hydrogen. As previously discussed, U.S. legislation via the Inflation Reduction Act is offering tailwinds (and links to details at the end of this article).

The global natural gas trade favors the U.S. as a producer and supplier, with Asia-Pacific a key export destination. The U.S. is helping Europe as well as it diversifies from Russian pipeline imports. ( Solving Europe's Energy Crisis )

Oil majors such as Chevron ( CVX ), Exxon ( XOM ) and BP ( BP ) are detailing the return profiles of their differing strategies in the energy transition.

Exxon will now spend $17 billion on low carbon ventures from the $15 billion stated previously. The interview offers a little color on the returns from Exxon's operating segments. BP suggests that bioenergy will yield 15%, and their renewables lines returned 6-8% unlevered. "The market" preferred the strategy of U.S. majors. But, BP has been rewarded of late with their revisions, which include more short-cycle oil and gas capital spending.

The Russian war in Ukraine has upended the energy map and outlook. BP details how GDP could decline as a result.

On the financial side, XOM has a 50:50 buyback and dividend strategy. Pioneer Natural Resources ( PXD ) is mainly a dividend strategy, while Chevron is mixed. BP's underperformance relative to peers caused a revision to the pacing of their integrated energy company direction. I expect a good deal of varied performance and strategies with dislocations offering investment opportunities.

Infrastructure as energy transition play

Infrastructure funds are one way to diversify an energy portfolio and soften the volatility inherent in oil and gas.

Brookfield Infrastructure Partners ( BIP ) is an example of such a fund. They note three themes that are beneficial to their future performance, which also happen to be inflationary.

Deglobalization trends (noted in the last many videos) are offering new investment opportunities for infrastructure funds.

Brookfield's renewables fund ( BEP ) offers another route to capture renewables growth within a diversified portfolio construction. Decarbonization is one of their rationales. The transportation segment is a new power generation segment which was nonexistent in 2018. (Note this is a "high" case, i.e., best case scenario.) As I mention in an article about grid and transition dynamics in Texas, it's really hard to say how 2050 looks.

A little color on the challenge...

Our North American Gas Storage business had its best fourth quarter on record as we captured the benefit of higher natural gas prices along the U.S. West Coast, stemming from curtailed gas supply and volatile winter weather conditions. The reliable energy supply provided by our gas storage infrastructure is playing a critical role in the shift toward intermittent energy sources that need to be matched to elevated demand usage during periods of extreme temperatures. -- Brookfield executive in earnings call, 2023

And why infrastructure as an asset class...

Although inflation appears to be cresting in most countries, it's possible that certain structural dynamics prove hard to abate such as the effect of deglobalization, energy security and a tight skilled labor supply. This may result in continued near-term market volatility and downward pressure on corporate earnings with cyclical exposure. Investments in infrastructure assets, such as utilities, pipelines, ports and telecom towers are essential for the function of the economy and society. While not agnostic to the macro environment, they typically perform well through all parts of the market cycle and notably outperformed during economic troughs. This ability to generate steady long-term returns is driven by several key characteristics.

Now first, their highly contracted or regulated revenue is generally long duration, and therefore, provide sustainable cash flow predictability. Second is their embedded inflation indexation. Combined, these attributes make the asset class and appealing investment choice in all market conditions.

Digitalization is another macro force driving investment.

In summary, I suggest a methodical approach to energy investing that cuts down on volatility. The secular forces of decarbonization, digitalization, and near-shoring - all inflationary - are tailwinds for infrastructure. However, that is not a general tailwind for everything else. I still maintain a strong position in U.S. majors and independents. The dislocations arising from higher interest rates and changes to the energy mix offer opportunity for patient, watchful capital.

More on green policy and the energy transition

See: Energy Drive: Efficiency, Scale And Collaboration (Video Interview)

Energy Transition Intricacies: Dynamics And Investment Themes (Video)

For further details see: