Clean energy versus oil

Host: Where is the energy market headed? And will we ever throw off the shackles of fossil fuel dependence?

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Host: From Thrivent Asset Management, welcome to episode 19 of Advisor’s Market360™. A podcast for you, the driven financial advisor.

Whether it’s the light in our bulbs, the gas in our tanks or the battery in the device you’re using to listen, energy is fundamental to our lives. That’s why the energy sector, and the oil companies that dominate it, have consistently drawn the interest of investors.

Scientists and engineers are working hard to better define the path towards a future in which we are all less reliant on oil with alternative energy like solar and wind gaining more traction in recent years. These developments have garnered the attention of investors seeking to make “green” investments. As you’ll hear later on, there are pros, cons, and a number of questions that come with the proposal of a decarbonized future. Are there energy solutions capable of loosening the oil industry’s powerful grip on the market? What’s worth paying attention to, and what’s just noise?

For this special report on the energy sector, we turned to John Groton, Jr., CFA, Director of Administration and Materials and Energy Research. Spoiler alert—the world still runs on oil.

Despite continuing strides in the alternative energy market, global dependence on fossil fuel is likely to persist for many years to come. Groton explains:

Groton: Regardless of what happens with EVs, you still have demand growth for pet-chem almost with certainty, out through 2050.

Host: For those not in the know, EVs is short for electric vehicles.

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Host: The price of oil has quadrupled since the start of the pandemic. West Texas Intermediate, a grade of crude oil used as a benchmark in oil pricing, went from an $18 per barrel average in April 2020 to about $75 this October. Over the past year, oil prices have essentially doubled from about $38 at the start of October 2020. Motorists have seen the effects of this spike at the pump, with the cost of gasoline up about $1 per gallon over the past year.

And as temperatures fall this winter, homeowners could also see a substantial rise in their heating bills, with the price of natural gas jumping about 180% over the past 12 months.

The rise in energy prices has coincided with the reopening of the economy, as global auto travel and industrial consumption have returned to pre-pandemic levels. While oil supply had exceeded demand even before the pandemic – spurring an extended slump in the oil market – supply and demand have recently returned to a more typical balance, driving up prices.

Inventories grew a lot in the spring and summer of 2020, but all those inventories have been completely absorbed in 2021. In fact, inventories in the developed markets are about 100 million barrels below normal. But Groton puts all this into context:

Groton: The price right now it feels like it's a high price just based on where we were last year. But the fact is, over the past ten years, oil has averaged about $66 per barrel compared to $70 today where we are. And over the past 20 years it's been about $64 a barrel. So, it feels like we've been on quite a role this year. But in a longer context, oil prices are fairly normal.

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Host: So, what’s keeping oil prices elevated? Although advances like electric cars and alternative energy technologies are slowly cutting into the demand for oil, a more disciplined approach by oil producers has helped correct the supply and demand imbalance and could keep oil prices at an elevated level well into the future.

OPEC, the Organization of Petroleum Exporting Countries, has shown a lot of discipline in keeping oil supply in line with demand.

Groton: They are adhering to 100% of the cuts that they have talked about. They've articulated a precise plan for bringing those barrels back to market matched with demand increases, not in front of demand increases. When we look at all of the various groups of producers, the supply side and supply demand equation for the intermediate term looks okay.

Host: Western oil companies are more concerned with enjoying the cash flow return for shareholders or reinvesting in renewables rather than “killing the golden goose” by raising oil production, which historically is how things worked. Groton added:

Groton: They were redirecting spending to renewables and away from oil and gas. And for them, it's a bit of a self-fulfilling way. You produce less oil. That leads to higher prices. That leads to better cash flow and more money to reinvest in renewables.

Host: The major oil producers, such as BP and Royal Dutch Shell, have become reluctant to take on long-term oil production projects, such as deep-water drilling, because these projects take five to ten years to develop. They then produce oil for 20 years and these companies do not know what 2040 is going to look like.

Historically, U.S. shale producers have stepped up drilling when oil prices rose to levels that made fracking profitable, but even that may be changing, according to Groton. He said that for most companies, management compensation metrics have changed from incentivizing production growth to incentivizing cash flow and return on capital. The number of wells being drilled this year is up versus last year because oil prices are up, but it's nowhere near the rig count of the past when oil prices have been in the $70-a-barrel range. 

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Host: Let’s turn now to alternative energy. The two most dominant technologies in the alternative energy market are solar, which provides about 3% of U.S. electricity generation, and wind, which provides about 8%. Hydrogen-based energy which, when using a renewable power input, is a carbon-free process of splitting water into hydrogen and oxygen molecules to produce fuel and heat, is also gaining traction.

Over time, the costs for solar and wind generation have dropped a lot through scale and engineering. But rising costs this year could drive up production costs. This is especially true for solar where the price for polysilicon modules, which make up solar panels, is increasing.

Groton: Additionally, solar and wind installations consume a lot of steel, a lot of aluminum and a lot of cement. All three of those commodities also have had dramatic price increases this year. That's not to say that those price declines don't continue over time, but the economics of this should be kept into account.

Host: Ambitious government goals for alternative energy generation may spur continued development, but Groton believes that the reality of market dynamics could short-circuit those ambitions. He noted that it's easy to set goals for 2040 and 2050, but what actually has to happen for those things to occur is very different.

The manufacturing process in the production of solar and wind generation applications can also be counterproductive in lowering emissions.

Groton: The actual production of aluminum and steel, especially are also very carbon intensive and also needs to be part of the equation for a lot of applications.

Host: Groton noted that aluminum production is responsible for more than 2% of global emissions and the carbon footprint for steel is even higher. That means that decarbonization via more electrification of transportation does not come cost-free—either in terms of the expenses required or the carbon footprint that goes along with those developments.

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Host: The growing number of electric and hybrid automobiles is slowly reducing oil demand, with automakers placing increasing emphasis on their development. Ford recently announced plans to invest more than $11 billion in new facilities to manufacture electric cars and batteries, with the goal of increasing the share of electric vehicles in its new vehicle fleet to 40% by 2030.

But it could be many years before electric cars make a significant dent in oil demand, according to Groton.

Groton: The issue, though, is the install base is so large, existing car and truck fleet is so big and so slow to turn over with about a twelve year average life per vehicle that it just takes time.

Host: One more complicating factor is the supply of cobalt used for lithium-ion batteries. According to Groton, about 80% of the world's cobalt is mined in the Democratic Republic of Congo and most of that is processed in China. And while the U.S. may not be as concerned about dependence on foreign oil, we still need to look outside our borders for other important materials.

Groton: We might start talking about our dependence on foreign countries for materials, and that will be an important factor in order to reach the types of EV supply and demand estimates that are out there.

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Host: So, how does the energy sector affect our overall investment strategies? Despite progress in reducing fossil fuels, the supply and demand dynamics of the energy market will continue to be a moving target. According to Groton there are a number of influences that go into the investment mosaic of the energy industry, making it very complex and difficult to predict in the short term. That’s why Groton and his team don’t get too moved by the near-term noise, but rather recognize that it’s an industry that’s driven by economics 101, supply and demand, and then making judgments about the best companies to invest in within that landscape.

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Host: Thanks for listening to this episode of Advisor’s Market360™. All episodes are available on Apple Podcasts, Spotify, and Google Podcasts. Learn more about us at thriventfunds.com and find other items of interest to you, the driven financial advisor. Bye for now.

(Disclaimers)

Speaker: All information and representations herein are as of October 12, 2021, unless otherwise noted.

Any indexes discussed are unmanaged and do not reflect the typical costs of investing. Investors cannot invest directly in an index.

Past performance is not necessarily indicative of future results.

Actual investment decisions made by Thrivent Asset Management, LLC will not necessarily reflect the views expressed. This information should not be considered investment advice or a recommendation of any particular security, strategy or product. Investment decisions should always be made based on an investor's specific financial needs, objectives, goals, time horizon, and risk tolerance.

Thrivent Asset Management, a division of Thrivent, offers financial professionals a variety of investment products to help meet their clients’ needs. Thrivent Distributors, LLC, is a member of FINRA and SIPC and a subsidiary of Thrivent, the marketing name for Thrivent Financial for Lutherans.