Ardevora’s Lang: Natural resource industries ‘trapped’

All is not as stable as it appears in the energy industry, warns Ardevora manager Jeremy Lang, who believes the sector is “a slowly unfolding trap”.


For the energy industry, “the trapped capital cycle looks set”, the manager of the Ardevora UK Income fund stated.

The reality is that “for most companies, it is getting harder to grow”, he said, a fact which is tempting more managers into risky behaviour and creating the ideal conditions for “trapped capital”.

By trapped capital, Lang is referring to a scenario in which there is “too much capacity, not enough desire to exit, most businesses locked into non-mean reverting low profitability, with investor anxiety ebbing and flowing around a slowly unfolding trap”.

The majority of managers are “either chasing growth too aggressively or resisting evidence of a more difficult environment too stubbornly”.

Though it can be difficult to tell whether the anxiety of the “seething mass of investors” in various stocks and sectors is misplaced, Lang thinks there are several red flags that indicate this is a problem for traditional oil and gas producers.

Other sectors like retail and media also look to be suffering from “trapped capital,” but in his view, energy is the most obviously at risk.

“Energy is the industry that vexes us the most at the moment,” he said.

“The industry experienced an unusually benign environment from 2000 to 2013. The oil price quintupled, making life easy for almost every company involved in energy production and switching management focus from survival and efficiency, to growth. The oil price collapse in 2009 proved to be short lived, emboldening managers further.”

The problem is these existing companies have continued along aggressive growth paths, while other new businesses with efficient, better ways of doing things have emerged, sucking up new capital along the way.

In the energy industry, this savvier competitor is US shale reserves, which have been cropping up at alarming rates in recent years.

“Huge strides have been made in transforming previously prohibitively expensive oil and gas reserves locked up in US shale formations into a low-cost source of new oil and gas,” Lang explained.

“Once uneconomic below $80 per barrel oil, now large areas of shale reserves make attractive returns at $40 per barrel. Capital has flooded in to take advantage.”

Weakened demand from China and “demand destroying technologies” like renewable energy are also shifting the previously benign environment, said Lang.

Although the oil price has somewhat recovered from the nasty shock it experienced in 2015, “no capital has really left the industry”, he notes “and now capital is coming back in as US shale producers, having cut costs further, begin to grow again”.

“The industry can offer opportunity, but most likely amongst the small number of carefully run disruptors or occasionally when investors worry about bankruptcies in the businesses that will survive, but not ultimately prosper.”