Given the rise of ESG investing, the race to become net zero and the weak performance of fossil fuel companies in the past decade, it’s little surprise that investing in energy companies has not been on the agenda of many investors in recent years.
Known as being a classic defensive sector, in bull markets investors tend to ignore utilities and focus on the more traditional growth areas. However, in conditions in which inflation has been surging, the rhetoric around investing in energy has very much changed in 2022.
Assisted by surging energy prices, the FTSE All Share Oil Gas and Coal and FTSE Energy sectors are the two best-performing UK FTSE sub-sectors year to date, returning 49.67% and 49.63%, respectively. To put this into context, over the same time period the FTSE All Share Technology sector fell 14.77% while the broader FTSE All Share Index is down 0.47%.
Given the effect that such energy prices have had on people’s day-to-day lives – with energy bills surging – and the perceived detrimental impact they are having on the environment, it may be natural for investors to be cautious. But is such a stance warranted and could it be affecting their portfolios going forward?
In this month’s head to head, Mark Hume, co-manager of the Blackrock Energy and Resources Income Trust, explains why energy prices are likely to remain elevated, while Barry Norris, manager of the VT Argonaut Absolute Return Fund, says he is investing in a fossil fuel future.
Mark Hume
Co-manager, Blackrock Energy and Resources Income Trust
Energy demand has long had a clear link with economic growth. Economic activity increases and demand for energy rises. During a recession, demand for energy falls. It is this simple equation that has weighed on energy markets over the past few months. The world economy is struggling, therefore demand for energy is likely to slide, right?
In reality, the picture is more nuanced. The global economy is weakening and that will put pressure on energy demand. However, this needs to be set against a longer-term upward trend in energy usage.
Demand now sits above pre-pandemic levels, having resumed its multi-decade trend in 2021. At the same time, European governments have been stockpiling energy resources – notably oil and gas – which is helping shore up demand.
Meanwhile, the real support for energy prices is coming from the supply side, which remains constrained, not just from the war in Ukraine but also because of longer-term considerations. Energy companies have been wary of capital expenditure, given the uncertain rewards of bringing on new fossil fuel supply at a time of energy transition. While governments have eased restrictions on new supply, it will take time to bring it on line.
Any hope of a short-term supply boost from alternative sources, such as Opec, appears unlikely. The consortium has agreed to a small cut in production. However, the impact of the cut to its targeted output is lessened by the fact Opec was already producing below its pre-existing quota.
Against this backdrop, we see prices remaining elevated owing to the supply/demand balance. But the energy mix will, almost certainly, change. In the short term, governments are looking for solutions to the lack of supply from Russia. The eurozone member states have committed to a 15% reduction in gas demand, for example.
Germany and France have agreed to an energy swap deal, which would see Germany provide France with electricity and France provide Germany with gas in the event of shortages. The EU is also planning a short-term boost for coal production.
In the longer term, governments are seeking greater energy independence, which will likely accelerate the move towards renewables. Europe’s €210bn (£181.8bn) package to reduce dependency on Russian fossil fuels will include a significant increase in solar and wind power investment, and the European
Commission is now targeting 45% of the energy mix from renewables by 2030.
The war in Ukraine has prompted a wider and more sober reappraisal of the realities of the energy transition by investors generally – and the role fossil fuels need to play in the short term.
It has exposed the complexities of how the world sources and uses energy. This is why we believe it is important for the Blackrock Energy and Resources Income Trust to have exposure to the energy sector and to be able to allocate flexibly between different segments.
Mining and energy companies lie at the heart of the global economy. Without them, countries cannot grow and develop. Energy companies power our cars, our homes and drive economic development.
The journey to net zero is expected to create remarkable opportunities, and the Blackrock Energy and Resources Income Trust is looking at companies that have the potential to reap the benefits from this transition. Demand remains intact and supply constrained, but the world’s energy mix will remain in flux. It is this uncertainty that requires a fully flexible approach to the energy transition.
Barry Norris
Manager, VT Argonaut Absolute Return Fund
Before fossil fuels and the industrial revolution, the average person in Britain was no better off than in the days of Julius Caesar. Energy was provided by what today we call ‘renewables’: wood, charcoal, straw, dried dung and weather-dependent rudimentary wind and water mills. Most work was done by humans, horses and oxen. Travel was by sail, horse or foot. It was called the ‘dark ages’ for a reason: there wasn’t a lot of cheap and reliable energy. It was a miserable existence.
Then in the time of Shakespeare, something remarkable happened, which changed the world forever: Britain started burning coal, saving its remaining forests. Because coal had a much higher energy density than wood, it meant that heat generation could be done on a more intense scale for manufacturing. In 1840, the steam engine was invented: coal’s reliable chemical energy could be converted into mechanical energy for factories, railways and steam ships.
Human and animal labour accounted for over 50% of Britain’s energy consumption in 1600, but only 7% by 1850.
By the 20th century, coal and British power had been superseded by oil. Crude oil is an incredibly flexible source of energy. Its different properties can be isolated by refining and used for a variety of different purposes: lubricants, asphalt, synthetic fibres, paints, coatings, detergents, pesticides, resins, adhesives.
Currently, fossil fuels represent over 80% of our primary energy consumption and are essential in the production of plastics, steel, cement, nitrogen fertiliser and silicon.
Today, we use 20 times more energy per capita than in 1650. The real costs of energy have fallen by 90% over the same period. This is the main cause of our living standards – defined by GDP per capita – rising by 30 times.
In terms of physical labour, our use of fossil fuels means the average person in the UK has the equivalent of 250 people working for them non-stop day and night without complaint. This improvement in living standards was achieved by replacing renewable wood and medieval windmills and waterwheels with fossil fuels.
Many people have understandably become alarmed by claims that the side effects of fossil fuels, namely their greenhouse gas emissions, are solely responsible for apparently unprecedented climate change, which we are told will make the world uninhabitable, and for which the only solution is the end of the fossil fuel industry.
During the past decade, there has been nearly $4trn (£3.4trn) of investment in wind and solar projects, yet fossil fuel consumption dropped from 82% of primary energy use to just 81%. The fundamental problem with wind and solar is the same as in medieval times: they are weather dependent so will always be unreliable and produce low bang-for-buck output.
You cannot run an electricity grid based on intermittent power or unrealistic hopes for battery storage: factories, schools and hospitals would only open when the weather permitted.
Only nuclear energy offers a genuinely scalable path for the progress of human civilisation, with immense energy density and greenhouse gas-free generation, but this is still strangely rejected by most environmentalists.
It is worth remembering that electricity is currently only 20% of our primary energy use so the path to net zero requires not just a renewable electricity grid, which is currently impossible, but also the electrification or hydrolysis of all energy use, which is just absurd.
If the cheap and reliable energy brought by fossil fuels cannot be adequately replaced by returning to those energy resources our ancestors gave up on as inferior, then it logically follows that we risk returning to pre-industrial standards of living, through rampant inflation, food and energy poverty, and increased geopolitical conflict. We do not believe this is a desirable outcome for society or our investors.
Therefore, we will continue to proudly invest in a fossil fuel future.
This article first appeared in the December edition of Portfolio Adviser Magazine
