Wednesday, January 6, 2016

The Changing Landscape of the Energy Sector

Energy. Simply put, we cannot live without it. We use energy in different forms for different purposes. We need energy for transportation, industrial use, residential & commercial usage and electric power. This may come from various sources such as petroleum, natural gas, coal, renewables, nuclear energy etc. While each source goes up and down depending on the supply and demand and other market dynamics, we are on the verge of starting to see a shift in policy and a push towards cleaner fuel sources as we realize the effects of climate change. The recent Climate Change Conference in Paris is seeing renewed pledges for a push towards renewables and a continued shunning of dirty fuel sources such as coal. This article delves into the changing landscape of the energy sector.

The Changing Landscape of the Energy Sector

We have gone through some amazing fast-paced changes over the past few decades. After living on resources such as wood, steam, coal etc for thousands of years, we discovered oil (& gas) and went through a golden age of petroleum-based energy through the 19th and 20th century. With the availability of cheap oil came the freedom of cheap/affordable and fast transportation. Even to this day, petroleum remains the defacto source of energy for transportation.

We derive energy from various sources and use them for various applications, as mentioned in the introduction above. In fact, we can see a criss-cross of sources and economic sector usages from the image below – which indicates the usage in USA and presented by the US Energy Information Administration (EIA).
What does the global picture look like? The following image (source) shows the trend upto 2013 and still shows that all sources including dirty fuel (coal) usage is increasing thanks to adoption by emerging economies. However, the rhetoric is increasing and more education of the effects of climate change is causing politicians to take action – as has been evident with the latest press coverage from the Climate Change Conference in Paris.

The Trends

  • Coal: Some coal companies have either gone bankrupt or are facing existential crisis. Goldman Sachs has gone on record to say that 2013 was the year of peak coal and will never come back. While the volumes have not fallen off a cliff, we have noticed a steady decline in volume month after month and the decline is expected to remain absolute (see my discussion on the impact on railroad sector here). Morgan Stanley and Wells Fargo recently announced that they will cut back on lending to the coal industry – and as we know – once you are cut off from the credit markets, its game over! Not just that, but the energy giants such as Big Oil companies have been terminating their investments in coal – with BP plc (BP) quit in 2003, Chevron (CVX) quit in 2012, Total SA (TOT) shut down its coal mining operations in last year. This is not to say that we have weaned ourselves off of coal completely – the emerging economies continue using coal as its a cheap source of energy – but with falling energy prices from oil to natural gas to other sources, coal has increased competition.
  • Oil: Oil is the most traded commodity in the market. It remains in the media’s focus day and night. There is better money to be made by midstream and downstream companies instead of the exploration & production (E&P) companies. This does not mean that upstreams are a bad investment…if oil prices do go back up, we can see more E&P projects starting back up. I am a big fan of the midstream companies (pipelines such as Kinder Morgan (KMI), Enbridge (ENB), TransCanada (TRP) etc) – which is essentially a toll road business model. Downstream is another great business and Warren Buffett has gone on record to show his support for this business model by investing in Phillips 66 (PSX). Petroleum has been the defacto source of energy for transportation and we are starting to see a push towards either a hybrid or purely electric-based transportation. While Tesla (TSLA) remains the focus of everyone in this space, investors have to remember that the rest of the auto industry has been moving resources into this space as well.
  • Nuclear: The Fukushima disaster scared the Europeans enough to start shutting down projects and the industry has been in a bit of a decline. New reactor projects have been cut and old reactors saw shutdowns across Europe from France to Germany to other western EU countries. However, more reactors are expected to go online in China and other energy-hungry countries.
  • Renewables: We are seeing mandates from the government to move away from dirty fuels such as coal and nudging investors towards renewable energy sources. Governments across the world have given tax breaks and credits towards the growth of renewable energy space. As more money and research had gone into developing solar photovoltaic systems and wind systems, the cost to generate electricity has fallen spectacularly over the years, and has now reached a point where it can compete with traditional sources. Pension Pulse had a great article featuring an original article from Wall St Journal which looked at how pension funds are now being forced by government policy to invest in renewables and other green alternative investments. Whether it is right or wrong of the government to mandate pension funds is a matter of political debate. But the fact remains that they have to stick to the policy guidelines. In a sign of times to come, even Alberta’s pension fund, which has relied on the heavy tarsands oil for its fortune is now investing in renewables.
Note that one single type of fuel will not be relied upon as we move forward. We already use a mix of energy sources, but we can expect more balance and shift towards greener resources – esp if technology develops enough to move the big consumers such as transportation to use electricity instead of fossil fuels. Car manufacturers are playing catch up with Tesla, but some of the high performance supercars are already using electricity to increase power output – similar to the systems used in Formula 1 racing cars (again, a bellweather to watch on where car technology is heading in the coming years and decades). The following video from Bloomberg provides a great overview of the outlook for the energy sector.

Video Source: Bloomberg

How/Where to Invest?

  • Coal: Avoid coal. Period. While coal usage is not going to stop overnight, the trend is definitely downward. The developed world is seeing a policy shift that has taken the direction of coal downward. The emerging economies are still seeing some growth – so, the export coal is one part of the coal traffic seeing some pulse.
  • Oil: Oil and natural gas arent going anywhere anytime soon – but with the low oil prices, E&P companies are stretched. The midstream and downstream companies are more profitable these days. However, if oil prices go back up, upstream companies may see better returns.
  • Nuclear: One company stands out in the nuclear industry – the largest uranium miner – a Canadian company: Cameco Corp (CCJ, CCO.TO).
  • Renewables: Renewables are the growth industry, but investors have to be careful on what they pick. Simply buying into solar PV manufacturing companies does not guarantee a good return as we have seen time and again with companies failing or falling from their peaks. Companies such as First Solar (FLSR) and SunEdison (SUNE) come into mind. This space is extremely diverse and a green energy focus can range anywhere from: Energy companies (First Solar (FSLR), Canadian Solar (CSIQ), SolarCity Corp (SCTY) etc), Tech industry (SunEdison (SUNE), Vestas Wind (ETR:VWS) etc), Utilities (any utility company that has a focus on renewables – such as Next Era Energy (NEE), Brookfield Energy Partners LP (BEP)) , Consumer industry (Tesla, Tesla Energy, or SolarCity) or Industrial sector (with a focus on energy efficiency such as General Electric (GE), Emerson Electric (EMR), Schneider Electric (EPA:SU), Johnson Controls (JCI) etc). Goldman Sachs recently had advise for investors to concentrate on 4 subsectors in the renewable energy: solar photovoltaics, onshore wind, LED lighting and electric cars.
Considering that the renewable and green energy sources come in so many different various forms, one resource that may help investors looking for ideas are the newly created Bloomberg indexes for clean energy. There are six indexes:
  • NYSE Bloomberg Global Solar Energy Index (Bloomberg Ticker: SOLAR)
    • Tracks companies active across the solar energy value chain.
  • NYSE Bloomberg Global Wind Energy Index (Bloomberg Ticker: WIND)
    • Tracks companies active across the wind energy value chain.
  • NYSE Bloomberg Global Energy Smart Technologies Index (Bloomberg Ticker: EST)
    • Tracks companies active across the advanced transportation, digital energy, energy efficiency and energy storage sectors.
  • NYSE Bloomberg Americas Clean Energy Index (Bloomberg Ticker: CLEANAME)
    • Tracks companies domiciled in North and South America
  • NYSE Bloomberg Europe, Middle East & Africa Clean Energy Index (Bloomberg Ticker: CLEANEME)
    • Tracks companies domiciled in Europe, Middle East & Africa
  • NYSE Bloomberg Asia Pacific Clean Energy Index (Bloomberg Ticker: CLEANAPA)
    • Tracks companies domiciled in domiciled in the Asia Pacific region
The top-10 holdings of each and composition of funds are shown below.

Top 10 Components and Sector/Region Breakdown for SOLAR, WIND and EST
Top 10 Components & Sector/Region Breakdown for CLEANAME, CLEANEME & CLEANAPA
What are your thoughts on the changing landscapes of the energy sector? Do you own any of the stocks or funds mentioned above? Are you investing in the green movement – share your thoughts below.

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