Once
deemed uncorrelated, sovereign energy policies combine infrastructure
development with corporate capital investment accounting for both scalability
of renewable sources over the next 25 years and commodity strip pricing in the
short-term. Reflecting
continued private investment in public policy, simple audit of global
multinational corporate profiles features integrated wind and solar operations—a
dedication
of business segments operations within industrial
portfolios including oil and gas.
Applying commonly
correlated expectations, lower relative oil and gas prices
increase the profitability of companies in capital intensive and consumer sectors. The
introduction of economic and growth oriented proxies demonstrate this shared
rationalization, seemingly unrelated to the corporate innovations embedded in
emerging technologies and independent of industry verticals rooted in renewable
energy policies. Certainly from a long
view, illustrated by a binary 10-year pairing of ETF benchmarks USO - United
States Oil Fund LP and PBW - PowerShares WilderHill Clean Energy Portfolio, no
meaningful divergence in total return performance is evident:
Foremost to consider when
examining the drivers of valuation is reconciliation of global
oil supply elasticity with the inelasticity of renewables demand represented by
sovereign/federal/state/municipal energy mandates, specifically as it relates
to potential limitations on renewables investment in a low-cost energy
environment. Issues of elasticity are academically
well-defined with conventional wisdom suggesting the swing producer status
sought by US shale exploration and production companies in the present
geostrategic price-volume battle diminishes marginal demand requisite for stability and
growth of renewables capital investment.
After all, even at historically high prices of oil and gas, past efforts
advocating a higher per unit carbon price to levelize the cost of energy have proven to be a tactically weak strategy easily
forgone during periods of economic stress.
Fortunately
baseline
policies are defined and measurable,
mathematically comprising
one energy equation. Protocols
established by the US Department of Energy provide period projections in a
contextual framework along with percentage parameter
allocations. In the end, sources of electricity generation and uses of energy consumption
are two sides of the same coin. Accordingly, the US DOE Energy Information Administration’s
Annual Energy Outlook 2015 forecasts electricity generation by source
into 2040:
Natural gas 31% (+15% from 2013, +94% from 2000),
Renewables 18% (+39%, +100%), Nuclear 16% (-16%, -20%), Coal 34% (-13%, -35%)
and Petroleum 1% (unchanged, -67%).
On the demand-side, the AEO 2015
details energy consumption:
Natural gas 29% (+7% from 2013, +26% from 1990),
Renewables 10% (+25%, +43%), Liquid biofuels 1% (unch., +100%), Nuclear 8%
(unch., +14%), Coal 18% (unch., -22%) and Petroleum 33% (-8%, -18%).
Renewables represent one-third of new generation
capacity led by growth in wind (40% of all renewable generation, 2013-2040) and
solar (+6.8% average annual growth rate).
Spurred by federal investment and production tax credits in addition to
state renewables portfolio standards, capital investment runs in tandem with
populist if not scientifically-based initiatives and against looming incentive
expirations. Natural gas serves as
marginal supply-side player per kilowatt hour, demand-side driver of reduced
cost inputs and merits a plurality of end-use applications from industrials to
transportation. Based on AEO 2015
estimates, US carbon emissions in 2040 remain below 2005 levels primarily due
to the prevalence of domestic natural gas resources despite sustained increases
in domestic unconventional oil production.
Taking a global view, the International Energy
Agency details projected portfolio power
generation capacity composition in this infographic:
Against the backdrop of global population growth
(+1.1% compound annual growth rate) and with global energy demand rising by
37%, the IEA World Energy Outlook 2014 projects
a fourfold increase of wind (utility scale) and solar (distributed generation)
assets in its New Policies Scenario followed by increased demand for natural
gas (+50%), oil (+16%) and coal (+15%). WEO-2014
estimates worldwide demand for oil rising to 104 million barrels per day in
2040 on a doubling of automobile volume demand predominantly in developing
countries. Both opportunity and
challenge for the energy complex, disparities between mature and developing
countries improve and persist evident notably in Africa where one billion
people gain access to electricity by 2040 though still leaving 500 million
people without.
Solving simultaneous electricity capacity
supply-side and energy consumption demand-side equations borne by sovereign
policies requires consideration of the differentiated growth rates across
economic sectors, geography and asset classes.
Recent boom-to-bust (then recovery) cycles in Energy-Oil & Gas and
Alternative Energy reveal the often fragility of a defined investment thesis. From a capital market perspective, Alpha
generation demands the application of analysis apart from institutionally
defined sector research, assigned performance benchmarks and
traditional portfolio construction.
Based on the premise of a one energy equation, refined
peer group analytics and valuation techniques present an opportunity to utilize
benchmark Exchange-Traded Funds as complete composite Energy sector and
subsector proxies. The
comparative 10-year chart below incorporates XLE
- Energy Select Sector SPDR Fund, UNG - United States Natural Gas Fund LP, KOL
- Market Vectors Coal ETF, NLR - Market Vectors Uranium & Nuclear Energy ETF
and PBW - PowerShares WilderHill Clean Energy Portfolio as component members:
Efforts to exploit the current debate within the
equation reveal an overriding theme of trend capacity growth rates and rotation
above or below macro, sector, policy and peer provider levels. Thematically demonstrating Energy ETF subsector proxy parameters, XLE composite
deconstruction is characterized by sustainability (exploration and production),
volume (oil field services), infrastructure (pipelines), consumer (refining)
and M&A (distressed) providing for benchmark portfolio analysis and component
member screening. In our
hypercompetitive global economic and investment environment, simply contesting
a mere 1-2% market share of marginal oil supply may impact corporate valuations
by half or greater. Also distinct are
the dramatic growth rates of wind and solar, equally sensitive to economic
change and externalities in bull and bear markets. Displaying the effects and volatility
associated with the marginal supply of energy among unconventional oil, wind
and solar companies, represented below are Energy subsector proxies FRAK - Market Vectors Unconventional
Oil & Gas ETF, TAN - Guggenheim Solar ETF and FAN - First Trust Global Wind
Energy ETF:
Comparative performance (3-year TAN +179% > FAN
+101% > FRAK 9%) is perhaps counterintuitive as conventional wisdom dies hard or at least is outperformed. Technological innovations in unconventional
shale plays and renewables are concurrent within a singularly defined energy
policy. Surveying a matrix of valuation drivers against perceptions
in today’s capital market environment sets forth new parameters of decision making, marking points
of inflection on near-
and intermediate-term charts.
An oversaturation of proprietary third party research in a mainstream investment sector such as Energy-Oil &
Gas typically illuminates 'known knowns' while effectively supporting
development of a lead/lag/input/output/industrial/consumer matrix time-laddered
investment strategy. For instance,
deconstructing FRAK and evaluating its component members enables determination
of a lower bound price for WTI of $40 (breakeven production) plus parameters of
capital market expectations for returns $42.60 (debt @ 6.5%) and $45 (equity @
12.5%) based on corporate and resource profiles to match anticipated interim
price targets of $50-$60-$70 per barrel.
The demand-side of
the equation is continuously tested, as growth drivers again become risk
factors, by incorporating scenario/sensitivity
analysis in financial models per company per
basin per well. This equity strategy
returned 23.5% - 47.4% among
FRAK Top 10 performers YTD (051515) during a period when companies realized cost
efficiencies and maximized performance along an improving price
curve across oil and gas fields throughout North America (Bakken, Permian,
Eagle Ford, Marcellus, the Rockies, California, Oklahoma, Michigan, Illinois,
Louisiana and Canada).
Conversely, an undercovered and underserved investment
universe necessitates removal of structured constraints to exploit
generalizations against convention. To illustrate, possibly as a matter of expediency
two of the leading major third party data vendors assign solar companies to comparatively
generic Industry/Subindustry designations such as Renewable Energy/Renewable
Energy Equipment or Semiconductors/Solar.
In this manner queried results skew peer group analytics and valuation
unable to adequately distinguish specific business segment operations. Independent study suggests
relative value assessments within solar segment verticals are attainable based
on refined subindustry nomenclature assignments via applied indexation and capital
markets metrics derived from the variance of proportionate component member
market capitalization relative to portfolio weight per segment per
classification. Utilizing this
methodology, specific solar segment classification verticals (Integrated, Plants,
Modules and YieldCo) captured 50% of cross-referenced TAN US-listed Top 10 performers YTD (051515)
with ranged returns of 27.2% - 104.6% from data computations published during
the two previous sequential reporting periods (1Q15 and 4Q14).
Not lost in performance figures are the spread
differentials among asset class capitalizations and implied effects on
performance attribution. Consider JKF - iShares Morningstar
Large-Cap Value ETF, JKE - iShares Morningstar Large-Cap Growth ETF, JKH -
iShares Morningstar Mid-Cap Growth ETF and JKK - iShares Morningstar Small-Cap
Growth ETF:
Together with the causality determined by
regression analysis, supply and demand characteristics exhibited within the
Energy sector establish quantifiable relative value assessments based on
capital markets metrics and refined nomenclature:
Evident in the table above, the subset of
FRAK/TAN/FAN is relatively weakly correlated although significantly outperforms
component members of the one energy equation.
Interestingly, higher levels of correlation within the one energy
equation (absent UNG as marginal price arbiter) are more indicative of Beta
boosters than Alpha drivers. The statistical
relevance of Mid-Cap Growth (capitalization performance leader YTD 051515)
cannot be overstated given previously-sized Small-Cap Growth companies
reinforced market niche penetration, matured and developed into industry
leaders in the current mid- to late-cycle US economy. Finally, the ongoing Value versus Growth discussion
persists in two strongly correlated subsets:
1) XLE/FRAK/JKF (Large-Cap Value) representing a capital intensive
industry and volatile commodity price environment and 2) PBW/TAN/JKK (Small-Cap
Growth) representing scaled implementation of emerging technologies and
acceptance of broader public policy implications.
Beyond
abstraction, publicly sourced and policy delineated government
whitepapers serve in support to test the investment premise of a one energy
equation. A recent presidential decree
quelled the perceived ambiguity of climate change, associated statistical
vagaries and contentious debate. For
proposition, if Energy policy remains constant then the variability of capital
market performance among its component members is consistent with the demand
drivers per policy . . . albeit somewhat geocentric.
for additional articles and quantitative analytics, please visit <U/O> Research
No part of this article, related publications or web-based content may be reproduced in any form or referred to
in any other publication without express written permission of Universal Orbit
©2015 and David B. Kleinberg. Forward looking statements, estimates and certain
information contained herein are based upon proprietary and non-proprietary
research and other sources. Information contained herein has been obtained from
sources believed to be reliable but are not assured as to accuracy. Past
performance is not indicative of future results. There is neither
representation nor warranty as to the current accuracy of, nor liability for,
decisions based on such information. This content is distributed for informational purposes only and should not be considered as
investing advice or a recommendation of any particular security, strategy or
investment product. The author's opinions are subject to change without notice.
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