Crystal Ball Series: The Coming Capital Crunch

You might be tired of hearing about how clean energy stocks are weathering the pandemic better than oil and gas stocks. Here is what is important: There’s new intelligence about why clean energy stocks are outperforming — and it foreshadows trends for the future of investment in oil and gas.

Both of these things are true:

  • Today’s evolving pandemic challenges require all of our energy, wit, and capacity
  • If we want to define the energy future, we have to understand why clean energy is outperforming oil and gas as an investment.

The situation:

I wondered if the clean energy stock narrative was real: It is. Since the start of 2020, the popular iShares Clean Energy ETF (ICLN) has risen 15.9%, while the oil-heavy Vanguard Energy ETF (VDE) has declined 40.1%. Their respective beta values—1.05 for iShares Clean Energy and 2.01 for Vanguard Energy—indicate that clean energy securities are in-step with market trends while oil securities are collectively twice as volatile as the market.  

Goldman Sachs published a really interesting report in June, a redacted version of their December 2019 report, “Carbonomics: The green engine of economic recovery.” This report highlights a couple of paradigm shifts relevant to leaders in the oil and gas industry:

  • Renewable power will become the largest area of spending in the energy industry in 2021, surpassing upstream oil and gas for the first time in history.
  • Clean tech could drive $2.1 trillion of annual green infrastructure investments and create 15 million to 20 million jobs worldwide.

And most interesting of all: It is not demand that is shifting investments away from hydrocarbons; it is the rising cost of capital. 

It is worth spending a few minutes unpacking that. Oil and gas companies could suffer more from lack of investment than lack of demand for oil and gas products. How could that be? Here are some key considerations, taken from the Carbonomics report:

  • For investments in long-term energy projects, investors are requiring a significantly higher rate of return for oil and gas projects (up to 20 percent) than for renewable projects (3 to 5 percent).
  • In the last five years, capital expenditures for long-term oil projects have declined by over 60 percent.  
  • As I flagged in the first Crystal Ball series, climate-related shareholder resolutions have changed the power dynamic for corporate ESG action. In a recent interview available on the Energy Thinks Podcast, Goldman Sachs’ Michele Della Vigna, author of the Carbonomics report, stated that “climate change shareholder resolutions have doubled in the last five years, but more importantly, shareholder support has tripled.”
  • Without investment, the debate about “stranded assets” has shifted away from one in which regulators will prevent you from accessing those resources to one in which companies do not have the investment capital.

Yes, but … I know what you are thinking. With structural underinvestment, the price of oil will rise, thereby incentivizing further investing. Both the Carbonomics report and one of my favorite podcasts, ARC Energy, take this on. My crystal ball says that higher oil prices could further incentivize fuel and feedstock switching, thereby creating a reinforcing cycle that undermines oil and gas demand.

It matters because:

By recognizing the “seismic shift in capital allocation,” as described by Goldman Sachs, we have to reconcile numerous forces at play, and that reconciliation will create a new paradigm for oil and gas investment. Interest and even activism in climate issues are no longer a sideshow or a detour on the road to the energy future. They are now interwoven with the forces driving lending and investing. Prudent oil and gas leadership is thinking not only about how to mitigate social risk but also how it will attract capital to build the energy future.

The critical mistakes not to make:

Thinking the move toward clean energy is entirely a social, political, or cultural trend. Investors can now point toward higher returns and lower volatility in clean energy investments compared to those in oil and gas. While popular sentiment may indicate the move toward clean energy resources as a social movement, there is emerging quantitative evidence clean energy is a better investment.

Seize the dayOil and gas leaders of every size are doing the following:

  • Embrace ESG. In 2020, a pragmatic and authentic ESG program will be the price of admission to investment conversations. If you haven’t already started your three-year strategy, hit reply and let’s explore how we can help you.
  • Talk to your investors. Every class and size of investor has a different tolerance for oil and gas returns — and different levels of patience for implementation of an ESG strategy. Your company may not need to pivot to a net-zero strategy as long as it understands the expectations of today and anticipates those of tomorrow.
  • Innovate into the energy future. In a world of both diminishing capital and diminishing demand, the last companies standing will have one eye to the future. Your company needs to articulate its place in the energy future for your stakeholders and employees as well as your investors. 

Does the Carbonomics report jive with your experience of investor expectations right now? Right or wrong, I want to hear about it.

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