26th Oct '21 by Edmund Shing

5 comments 1354 reads

Market Musings 26/10/21:
Don’t Focus on Today’s Energy Crisis, But Tomorrow’s Solutions

Recent podcasts you may care to listen to:

Is today’s energy crisis the price we have to pay for the energy transition?

Oil and Gas Prices May Be Peaking Now

So last week I extolled the virtues of adding commodity exposure to one’s portfolio for the future, especially as a hedge against inflation rates remaining higher for longer.

Just to even things up a little, I would like to add a short-term note of caution over the current energy price run-up.

The chart below illustrates the similar run-up in crude oil prices that occurred in 2018, a good analog for today’s rally. Note how in 2018, oil prices peaked in October, at around the same levels that we sit at again today.

Beware the Brent Spike

ERxK6xGC3oJQ2QkhgUq5CR0INrfE1R-bsvZLbf3bc9FoLUSNf1MIXHOPhRLPXoS9vTcsCP2WCsTm0pO2miGElHUG9zOWokYVxGADYhCWmrsCbKNcXiRCWiWnlI6-SojBUfEHJ1JD=s1600

Source: stockcharts.com

All analogs must be taken with a heavy pinch of salt. As Mark Twain is reputed to have put it: “History does not repeat itself, but it rhymes“.

There is a huge debate over the true level of spare capacity within the OPEC oil-producing nations, i.e. to what extent they could actually supply more oil to the markets if they wanted to. Many suggest that OPEC nations have over-stated their true accessible oil reserves for OPEC oil quota technical reasons, and that, in fact, global oil reserves are nothing like as large as is often stated.

In any case, today’s high prices and the associated dearth of petrol on UK forecourts is driving renewed growth in demand for electric and hybrid cars, which evidently cuts the long-term demand for refined oil products in the future.

More importantly, I wonder how long the OPEC+ nations (including Russia) can resist over-producing crude oil to cash in on these multi-year high price levels. Either way, in the absence of a truly cold winter to boost heating oil demand, we could see a calming of oil prices sooner rather than later.

For that reason, I would favour investment in high cash flow, high dividend yielding mining companies to oil & gas companies at this point, as I see the supply constraints on a number of key base metals like copper, zinc and tin remaining very high in the short- to medium term. The demand for these battery…

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Hartshay

26th Oct '21

With renewables you need a good base load of. Electricity. Picture a windless night. Batteries won’t be enough, coal, oil and gas produce co2 so what to do? Only option is nuclear. But there is a structural deficit in supply prices of uranium need to rise for new mines to start which can easily take ten years..

Hence investment in uranium and battery metals is a sure fire winner

ACounsell

29th Oct '21

Hi Ed

Relevant to the energy transition discussion in this article is John Authers Bloomberg newsletter today on the subject of fund management/ institutions and ESG related investments. He refers to MSCI’s tool that gives the Implied Temperature Rise, Decarbonization Target, ESG Rating, and ESG Rating history of all 2,900 companies in the MSCI All-World index.

https://www.msci.com/our-solut...

This highlights the contradictions in this whole arena. For example if you enter Royal Dutch Shell (LON:RDSB) (I hold along with £BP as a matter of interest!) in the search facility you will discover that MSCI rates them very highly on all these criteria and considers them a leader in the industry. (£BP is less positively viewed)

Despite this institutions in the UK (Church of England, ESG focused Fund managers, University endowment funds, Cambridge Colleges, etc.) are all advocating and enacting divestment of oil and gas companies. To cap it all there is also the ongoing case in the Netherlands brought by Environmental groups against Royal Dutch Shell (LON:RDSB) https://www.bbc.co.uk/news/wor...

Climate change is obviously an existential problem for the planet but there is a continuing need for oil and gas, as the recent petrol panic in the UK and the high percentage of gas usage in energy generation particularly when the wind doesn't blow and the sun doesn't shine demonstrates:

https://grid.iamkate.com

The activists and environmental campaigners appear to want to switch instantaneously from a 'fossil fuel' driven economy to a clean energy driven one. If this, or anything close, comes to pass we will see sky high oil and gas prices which will feed through to inflation and probably initiate significant protests along the lines of the 'Gilet Jaunes' in France or worse. Perhaps there is some merit from an investment point of view in the recent statements by the activist investor Third Point https://www.ft.com/content/b4f... This approach may address many of the issues that concern investing institutions.

Apologies for the ramble but I thought it was an interesting topic to discuss.

Rusty2

Royal Dutch Shell (LON:RDSB) has done a lot of work reducing it's emissions. It also is an energy supplier in the UK market, all of which is from renewables. Yes the greens want everything to change today but it can't happen, it takes years to change power supplies. Look at Germany with it's coal power stations, what is it going to switch to, nuclear is out, it is not that windy there apparently. Yes renewals are not very consistent with producing energy unless you have hydro, even that can be hit by water shortages. Still cloudy, freezing cold days that we can get for days or even weeks in winter would be a major issue if we just had renewables. Lots of people may want green energy energy but I'm not sure they want the huge prices increases that we are seeing now. Gas is around 10x this year.

With nearly everything switching to electric power in the next 20 years, then there will be even more demand to generate power, cars will switch from oil to electric and so will heating homes.

NeilS

31st Oct '21

Great article as ever Edmund!

I took a look at Gresham House Energy Storage Fund (LON:GRID) and whilst it’s planning to try to remain one of the market leaders in electricity storage I am struggling to find any kind of moat to provide a bit of longer term security other than the scale of what they are trying to achieve. The business seems very vulnerable to government legislation and policy change and in particular vulnerable to how National Grid decides to purchase electricity e.g. the move to buying 4 hour slots.

Does anyone have any in depth knowledge that would help my understanding?

Many thanks! Neil

Zipmanpeter

I also looked at Gresham House Energy Storage Fund (LON:GRID) and ultimately decided to invest.

I think their moat / competitive advantage are

that are already market leader (they claim 20% mkt share and say they intend to keep this until 2025 which the fund raise and related access to debt should enable)
- one would expect they have had access to sites with long term super-rent potential and/or to make super-normal returns for a while which can fund other early investments and/or mean capital is a paid for sunk cost by the time they arrive
years of accumulated data on optimisation of strategy
they claim some experience learnings about how to do projects and benefits from scale although I think this argument is weak as later players can mostly buy the knowledge or start from a better design
Funding has been put in place - interest rates may be higher for later investors
Other non-moat benefits are that cashflow is to a degree certain; costs are now clear and some demand is contractual or self balancing ie a grid melt down is possible but a melt up unlikely and returns are to do with volatility not absolute price levels
I like their "revenue stack" ie several means of earning money on the asset - reduces risk

The main risks I see are

complete change of govt policy away from electrification eg if COP26 is a disaster and the Tory sceptics gain even more influence and slow wind farm expansion in particular
massive grid changes that reduce need for regional balancing - possible but would take decades to implement practically and economically
technological risk - someone come up with such a storage cost breakthrough that their CAPEX is made redundant. (their are candidates but not within 10 yrs IMHO)

I clearly see the balance of risks as favourable for something promising an unspectacular 5% divi.

Market Musings 26/10/21: Don’t focus on today’s energy crisis, but the solutions

Market Musings 26/10/21:
Don’t Focus on Today’s Energy Crisis, But Tomorrow’s Solutions

Oil and Gas Prices May Be Peaking Now

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About the Author

Edmund Shing

5 comments

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Market Musings 26/10/21: Don’t focus on today’s energy crisis, but the solutions

Market Musings 26/10/21: Don’t Focus on Today’s Energy Crisis, But Tomorrow’s Solutions

Oil and Gas Prices May Be Peaking Now

Unlock the rest of this article with a 14 day trial

About the Author

Edmund Shing

5 comments

Unlock the metrics for all these stocks and more...

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Market Musings 26/10/21:
Don’t Focus on Today’s Energy Crisis, But Tomorrow’s Solutions