KATHY DAVEY: Hydrocarbons and renewables both part of investment picture

The face of global energy supply is shifting as renewables attract increased attention and oil and gas continue to experience underinvestment. Yet we see value in investing in both sources of energy. 

It is hard to believe that nearly three years ago oil producers ran out of space to store the oversupply of oil left by pandemic shutdowns and were forced to pay buyers to take barrels they could not store. The spike in global energy prices makes this a distant memory. Energy prices have reached five times what they were at that point.   

The strong global economic rebound following the Covid-19 pandemic led to rapidly rising demand for energy, which was compounded by underinvestment in the production of oil and gas. These commodities make up almost 60% of primary energy consumption globally.

Underinvestment in the oil and gas sector has been ongoing for several years. However, 2020 saw a huge drop in global investment — 35% in dollar terms. No doubt this was a direct result of the uncertainty surrounding the Covid-19 pandemic and its implications for the industry.

To compound the situation, Russia’s invasion of Ukraine in February 2022 resulted in a further increase in energy prices, as Russia is a major exporter of energy fuels. Energy prices have dropped since the peak in the second half of 2022 but remain elevated. 

The war in Ukraine has highlighted that energy security is of paramount importance in a world in which geopolitical tensions are on the rise. However, we need to be cognisant that this has not been the sole factor driving energy cost inflation. The global community has not invested enough in renewable or clean energy sources to slow down our reliance or investment in hydrocarbons without risking an energy crisis in the process.  

Erodes power

High energy prices have a direct and indirect effect on inflation. We feel the direct effects in heating, cooling, cooking and mobility. Indirectly, the costs of goods and services increase if energy is an input into the final product. Energy costs are a relatively high proportion of consumer expenditure, making up just more than 7% of the US consumer price index basket. They have therefore contributed to the overall high levels of inflation globally. 

Inflation has a negative effect on global growth as it erodes household purchasing power, thereby reducing economic activity. The World Bank has reduced its global growth forecast from 3% to 1.7% in 2023. This lower prediction is a direct result of inflation, with tighter monetary policy. Rising energy costs have a profound effect on the global economy, which is why central banks worldwide are increasing interest rates to try reduce inflation.  

On the positive side, the crisis has encouraged the introduction of new policies by countries and regions such as the US and Europe, with the intention of speeding up investment in renewable energy. The goal is to reduce energy costs and encourage local production of renewables to improve energy security.  

On August 16 2022 US President Joe Biden signed the Inflation Reduction Act into law. This is the most significant commitment the US Congress has taken to promote clean energy to date, with planned investments also aimed at lowering energy costs for families and small businesses. The new policies announced will support energy efficiency too, which will play a large role in reducing overall household energy costs.  

Attracting investment

The act should go far in promoting the use of renewables in the US, the world’s second-largest energy consumer after China. It offers new tax credits and deductions to homeowners who introduce energy-efficient home upgrades such as heat pumps or better insulation. It also offsets the cost of residential clean energy sources such as solar panels and battery storage, and gives rebates for energy efficient retrofits and the electrification of home appliances. 

The new law has been successful in attracting global investment that might otherwise have gone to other countries. For instance, electric vehicle (EV) manufacturer Tesla had planned to produce batteries at its Berlin car plant in Germany, but has now prioritised US production. Volkswagen has also reported that it is considering the US as a location for its next cell factories. For Europe to remain competitive it needs to introduce similar incentives.   

Our expectation for 2023 is that energy prices will remain at somewhat higher levels. We believe the effect of a weaker global economic environment on oil demand will be negated by the reopening of China after severe Covid-19 lockdowns, growth in India, and a continued increase in global travel. However, we do not expect energy costs to be as inflationary as they were last year, which should offer some respite for households.  

For investors, we believe opportunities in energy lie in a two-pronged approach. Investing in hydrocarbons and renewable energies are not mutually exclusive. Underinvestment in the oil and gas sector is likely to keep oil prices at levels where producers generate decent cash flows, thereby offering attractive investment opportunities.

Growing investment in renewable energies makes this sector attractive too, though we find the future growth potential is often already priced into share prices. Better returns may be realised by looking at a broader range of companies that will benefit from the green energy transition, such as electrical companies.  

There is no doubt that the world needs to transition to low-carbon fuels, but as we have seen this needs to be done in a measured way to avoid future energy crises and further punitive energy costs. 

• Davey is investment manager at Ashburton Investments. Ashburton owns VW shares as part of the Ashburton Global Leaders Fund.