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Leonard Hyman & William Tilles

Leonard Hyman & William Tilles

Leonard S. Hyman is an economist and financial analyst specializing in the energy sector. He headed utility equity research at a major brokerage house and…

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Reading The Tea Leaves In Energy Markets

  • The Republicans are not able to repeal the Inflation Reduction Act.
  • John Kerry’s idea to finance carbon reductions might stand a chance.
  • Oil and gas companies will have difficulty competing with renewable resources that have fixed capital costs but no variable costs.
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The U.S. public opinion “experts” and pundits pontificated before last week’s election. Then they pontificated afterwards. explaining what they got wrong. They get paid both times. Nice work if you can get it. Well, if they can do it, why can’t we? Here is how we read the tea leaves with respect to energy and electricity policy based on recent events.

  1.  Give up on dreams that the Republicans will repeal the Inflation Reduction Act. They haven’t got the votes to do so, and by the time they might have the votes, the players in the energy sector will have gotten used to all the benefits in the form of tax credits or other handouts. Whether it’s the oil depletion allowance, ethanol subsidies, or simple farm support payments for example—industries and groups are extremely reluctant to relinquish attractive economic benefits. And if you were betting that a politically resurrected Donald Trump returns chanting “Drill, baby, drill,” please note that the owner of the major conservative news outlet, Rupert Murdoch along with politically prominent others, seem to have lost interest in his candidacy, so don’t count on that either.
  1. John Kerry’s idea to finance carbon reductions might stand a chance. Kerry’s plan would require large corporations to pay for carbon emission reductions at overseas electric power grids in lieu of reductions at home —details are fuzzy. (This idea closely resembles the notion of a carbon offset purchase where an industrial polluter in say Gary, IN purchases and preserves a rainforest in Indonesia to save it from logging and of course maintaining robust carbon sequestration.) It doesn’t sound like a great idea except there are a lot of old, fully depreciated electric power generating stations burning coal that could be economically replaced with great environmental benefits if the host country had the capital to do so. We see this as a serious attempt to achieve substantive carbon emission reductions through a trading or swapping scheme that produces real emissions reductions, as opposed to planting slow growing trees somewhere in a dying forest that may burn down anyway due to climate change. This sort of transnational approach addresses the problem of what we might call pollution arbitrage, where pollution intensive industries simply relocate to places where it is relatively cheap to pollute. Wishful thinking? Critics say the plan is not enough, but that's a start.
  1. Public relations can substitute for substance only for so long. The fossil fuel industry and its advocates have mounted a colossal public relations campaign centered at the UN climate conference in Egypt. They no longer deny the reality of climate change or the adverse impact of fossil fuels usage, but instead, offer non-solution solutions. To us, this campaign indicates at least some level of corporate concern. Why else invest in this extensive public relations effort? But then they offer the usual remedies: plant trees, burn natural gas (though some of it disguised as hydrogen), and more carbon capture (which to us still seems like vaporware). Four Republican members of Congress attended the climate conference, offering their Conservative Solutions to the Global Climate Challenge. They argued that the problem is not carbon fuels but their emissions so they offered some complicated and expensive ways to reduce emissions. One would think that, as conservatives, they would devise a simple, low cost, and minimally intrusive solution, which would suggest avoiding burning fossil fuels in the first place. Conceding causality may have been a strategic mistake.
  1. Real investment accountability needed. The investment and banking approach to net zero has been denounced as “claptrap” in the world’s premier financial publication. Now, some of you may have come to that conclusion a while ago, and maybe we were slow to get the message. But it looks as if a multitude of clever bankers and consultants may have found a way to profit from climate change, look virtuous, and accomplish nothing concrete at the same time. Why should we care about what might be described as low level financial chicanery? Well, US securities regulators are tasked with ensuring that investors are not intentionally misled. Regulators may set standards, which might lead investors to really cut back on investments in fossil fuel producers which would raise their cost of capital. (How could investors not invest in such a vital economic sector as energy? Easily, because oil and gas stocks constitute only about 3% of the value of U.S. equities. This is down from about 15% in 2008.)

Here’s the basic problem for consumers. The Ukraine war and the overreach by OPEC have raised oil and gas prices. These two events may give local fossil fuel production a boost, but only temporarily. Why? Because in the long run, persistently high energy prices make non-fossil energy (renewables, green hydrogen and even new nuclear) more competitive. There’s an old Wall Street saying, the solution for high prices is high prices (i.e. creative people find cheaper substitutes). Once non-fossil fueled energy resources are in place, they will remain in use for decades. Oil and gas companies will have difficulty competing with renewable resources that have fixed capital costs but no variable costs. Once they lose market share to renewable energy resources, they will never get it back. From a business perspective this fight is indeed existential for the fossil fuel industry.

Will a divided Congress mean a government that is unsympathetic or merely indifferent to energy interests? Are there possible breakthrough technologies in nuclear energy and battery technology that can become game changers for energy production and storage? One losing strategy, the unconvincing public relations campaign in place of substantive environmental remediation, will hopefully be retired. Even investor greenwashing is likely to be under increased regulatory scrutiny—and this is saying a lot as the same regulators steadfastly ignored calls to regulate crypto exchanges that have caused investor losses in the billions. As a result, we can confidently say the tea leaves predict a murky future. Thus speak the pundits. 

By Leonard Hyman and William Tilles for Oilprice.com 

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