The charts look terrible. In the ruthless court of equity markets, the verdict is clear: The energy business – whether oil, gas, coal, solar, wind, nuclear, clean-tech or no-tech – is broadly guilty of delivering subpar returns to investors over the past five years.
So it’s no surprise that, “Why should I invest in energy?” is a routine question I hear.
Looking at baskets of companies for various primary energy groupings, I have to admit it’s difficult to argue with investors who shun putting dollars into companies that generate megajoules but destroy capital. I’m inclined to say, “You would have been better off investing in Antarctic real estate.”
Yet the question is not so much, “Why invest in energy?” but, “How to invest in energy?”
On the surface, it’s not obvious. While the broad S&P 500 Index has basically doubled since 2010, Exchange Traded Funds (ETFs) that represent peer groups of publicly-traded energy companies have seen returns ranging from barely breaking-even to negative 77%. Solar stocks are at the bottom of the return spectrum, losing 77% on average since 2010. If you invested in coal stocks, your portfolio is down 67% over the same period. Oil and gas have been volatile, but have done comparably better at a 10% loss. Peer groups of wind and nuclear are at par. All are unimpressive when compared with the alternative of putting money in the S&P 500.
Superficially, the poor performance of energy equities is puzzling. An old finance adage says, “the market pays for growth.” Yet growth is not a problem in energy. Daily headlines trumpet fantastic deployment rates of renewables. Connecting the dots to companies, the rapid uptake of solar and wind power should make their equities mimic tech returns – more like Facebook and less like Remington Typewriters.
Oil growth remains robust too. New barrels are still being demanded at a gluttonous pace. The numbers should pinch anyone’s common senses: Places like India are putting 9,000 new gas guzzling vehicles on the road daily. In any other industry those numbers would make a financial advisor “back up the truck” for more stock.
Yet it’s folly to think that energy is like the tech industry where new products kill incumbents like a bad virus. Yes, music libraries and two-year-old mobile phones quickly become antiques in a market invaded with compelling new digital products, but energy doesn’t work that way. New capacity layers onto the stubborn old.
When new megajoule-generating devices like wind turbines enter the market, the establishment doesn’t retreat politely. Drilling rigs, coal mines and nuclear reactors mobilize against the new entrants. It’s a full-on battle for market share that has already led to oversupply, price cuts and shrinking margins.
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Rapid innovation is compounding the oversupply.
Take solar panels. The good news is that the costs have been cut in half in the past six years, due to the combination of greater conversion efficiencies and lower cost manufacturing. That means a dollar invested today results in twice as many shiny panels. Wind turbines are generating more power with larger blades and better aerodynamics. But who says innovation is limited to renewables? In North America the amount of oil and gas coming from each drilling rig has increased as much as seven-fold in the last half-dozen years, the gains have been powered by the combination of faster drilling times and higher production rates.
The world’s energy systems are in an ugly family feud to outproduce each other. Economists call it an “Energy Transition.” The tech guys call it, “Disruptive Innovation.” Environmentalists speak of “Decarbonization.” Call it what you want. In the world of business there are no euphemisms; it’s called things like, “Competition,” “Market Share Battle” and “Price War.”
Coal is fighting natural gas, and both are fighting renewables in generating electrons. Nuclear is in the fray too. Then there is the infighting, most pronounced in the oil fray, where low-cost competitors like Saudi Arabia are gunning to put their peers out of business.
Falling prices. Thinning margins. Dribbling cash flow. Is it any surprise that energy equities are getting hammered?
But not all companies are bruising. Those that are reducing their costs as fast as, or faster than, prices are falling, are beating their peers. Their reward is superior market returns, in many cases beating the S&P 500.
There are big winners and big losers in each primary energy grouping. Important factors in fighting a market share battle are lowering costs; innovating products, improving process efficiency; and adapting to policy. Energy companies executing on those tactics are posting big wins. Conversely, enterprises that are laden with debt; too dependent on subsidies; laggards in technology; or sloppy with their costs are dragging their group’s average down like a supertanker’s anchor.
Market share battles serve an important purpose – they clean out inefficiencies and promote innovation. The war is far from over in energy. Battles for tomorrow’s megajoules are going to get more difficult for all players over the next few years until Charles Darwin’s ghost takes care of the weak by culling out high-cost, inefficient producers from each supplier group. When the cleanup ends, the energy ETFs should rise again.
Hyper competitive periods are a great time to invest in companies. But the how-to-invest strategy is not to indiscriminately buy low and sell high. Whichever energy system you favour, buy the best in the group and the odds are you will sell higher.
By Peter Tertzakian for Oilprice.com
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