The energy sector in 2020: A year in review
In this extended Q&A, Newton energy analyst Laura Sheehan provides deep insight into how the energy sector is dealing with three key risks: US political uncertainty, the Covid-19 pandemic and sustainability.
Q: The US election could transform the US stance on energy usage. What can we say about Trump’s approach thus far? What steps will his administration take if he’s elected for another four years?
A: The Trump administration has looked to ease regulation across the energy space in its quest to support the ‘energy dominance’ narrative for which it has proudly claimed credit. This includes loosening drilling restrictions on Federal lands and parks, and support for pipeline infrastructure. The administration has also cut back regulations on health and safety standards alongside environmental ones, most notably in relation to fuel efficiency standards for cars.
However, it’s fair to say Trump’s policies haven’t always been effective. On the plus side, he did succeed in pressuring OPEC to restrict output at the height of the Covid-19 crisis. And he did use the Federal Strategic Petroleum Reserve (SPR) to buy oil at a point of minimal global demand.
Yet he also caused considerable pain back in 2018 when systematically tweeting the oil price lower. Likewise, the President struggled to build support for an industry-wide bail-out in the wake of Covid-19 lockdowns. Long-term, too, some of his policies have been the catalyst for rising resistance from lobbyist and environmental groups.
Therefore, in some senses, the administration’s record is mixed one. That said, Trump’s actions have made a different at the margin. They’ve helped support positive sentiment towards investment in the energy sector while giving company CEOs an excuse to ignore very pertinent questions on their environmental actions (such as flaring and methane leakage) and on the transition towards more sustainable forms of energy.
Q: What steps would a Joe Biden administration take with regard to US energy policy?
A: As a first step, Biden would likely unwind many Trump policies that opened up Federal lands and parks for drilling. This would affect the Gulf of Mexico and the Arctic in Alaska. The controversial Keystone XL pipeline would be stopped dead in its tracks, with increasing environmental scrutiny for any future pipelines. (NB: It’s worth noting that this this was happening anyway – witness the challenges with the Dakota Access Pipeline, for instance.)
A Biden presidency will likely to take a fairly pragmatic approach on a “frac ban” and focus on restricting new developments, rather than trying to shut down operating fields. But the administration would probably also promote some form of a carbon tax/pricing so as to cost-in the environmental impact from emissions.
Of course, many of these measures would have to be passed by Congress, where the Republicans control the senate, so there would be resistance. If that were the case, Biden has the rather dramatic option of declaring the climate crisis a national emergency, which gives him further powers.
On emissions, Biden will also look to regulate methane leaking or flaring – which could create a headache for companies which have relied on that mechanism to deal with surplus gas when producing oil.
On automotive policy, Biden would look to do the opposite of President Trump and improve emission efficiency standards. Overall, I would expect Biden to use whatever powers were available to him to push through greater environmental standards, focusing on reducing emissions and making polluters more accountable.
Q: How would a Biden administration act on climate change?
A: The expectation is that Biden would make a push to decarbonise US energy usage. What he’s said so far is that he’s looking to invest some US$2.0 trillion over four years to make the power sector carbon neutral by 2035. An additional US$400bn of funds is earmarked for new technologies such as batteries, electric vehicles, hydrogen etc.
This should be viewed as a positive, in my opinion, given the US has one of the highest rates of energy intensity of any nation and generates nearly 16 tonnes of CO2 annually per capita (over twice that of the EU average).
One additional goal would be to improve international relations, particularly on the climate crisis – something the Trump administration has not made a priority. Rhetoric aside, the visions of Biden and the EU are actually fairly well aligned, so I’d see this as an easy win for Biden.
Q: How would the market react to a win for either parties?
A: A Trump win is probably positive for the sector as concerns over Biden’s policy are already embedded in the price today. However, I don’t think even a Trump win would reverse the negativity in the space. Mainly this is because the investment community is already alive to transition risks and the push for sustainable investments and away from polluting companies. At the same time, there has been increased scrutiny over the business model of shale companies, and the potential for value destruction. This continues to be a headwind irrespective of the vote.
A Biden win is likely incrementally negative short term, and no doubt the uncertainty of how aggressive he plans to be with the energy sector is part of that. Medium term, it’s probably less negative than it appears since, without congressional approval, some of the Democrats’ policies won’t pass or could be diluted.
Alternatively, should oil demand rebound in 2021, a Biden win could raise the cost of production in the US. Given the US has been the engine of growth for the world more recently, this might put pressure on the supply system – which in turn would lift overall prices and help the global industry in the medium term as it recovers from the Covid-19 demand slump. Restrictions on flaring, for instance, could drive down production and generate a short-term uptick in the gas price. However, over the long term, such policies could contribute to oil demand peaking sooner.
One additional caveat is how Biden deals with Iranian sanctions. This isn’t clear at this stage and the return of c.1mb/d to the export market could have a significant impact on pricing.
Q: What might an unresolved election mean for the energy sector?
A: I believe it might be incrementally positive. At present, markets are pricing in the risk of a Biden win so any retreat from that could marginally benefit companies whose share price has suffered from the prospect of increased regulation.
Overall, though, given where we are on energy fundamentals, I don’t see this being a big positive and any uncertainty is a negative for markets in the short run. Investment levels are already restrained given the price environment, repressed demand and the size of current inventories. In reality, it’s economics not politics that’s the bigger driver of investment decisions right now.
Q: Which companies or sectors are the obvious beneficiaries of either a Trump or Biden win?
A: A Biden win would be positive for auto names with electric vehicle plans. Companies dealing with infrastructure and construction might also see a tail-wind given how much work needs to be done to lay the foundations for widespread electrification in the US. Similarly, metals and mining companies exposed to the renewables sector, electric vehicles and grid supply chains might do well.
Assuming Biden were to focus on energy efficiency, that should support technology companies within the semi-conductor and software solutions space (smart metering), alongside companies with exposure to building out energy efficiency standards overall. A lot of this spending does sit within the fixed income, so it creates more opportunities for project financing and green financing too.
The losers are no doubt companies with high fossil fuel consumption. A win for Biden sees their costs rise if an effective carbon tax comes into play. If they have export markets, their relative costs for production will be higher versus competitors not forced to pay carbon taxes.
Another potential loser could be the agricultural industry in the medium term and high carbon emitters more generally (industries such as steel and cement being the obvious candidates) given their high fossil fuel consumption.
There’s also a case to say the wider economy might suffer. Until recently, companies have been relatively unfettered in how they use energy to generate growth. Capping emissions puts pressure on substitutes like renewables to grow, which in the medium term can have its own limitations (think of the constraints around supply chains and permits, for instance).
Q: Turning to Covid-19, how has the energy sector fared in recent months? It’s been a tumultuous year…
A: It’s been a very difficult period for hydrocarbon energy, particularly so in Q1 when we first had the short-lived price war between Saudi and Russia which sent energy tanking right before the Covid-19 pandemic restrictions went global. From there, it got worse as there were genuine concerns that the market would run out of storage given a c.30% collapse in demand. Even in the financial crisis, demand only fell by a few percent. Never has the industry had to deal with such a collapse in demand, let alone at a time OPEC were actually increasing production!
The key lesson from this is when the industry is collectively in duress, it does rally well together as it’s in everyone’s interest to do so. As such, we did see supply rationalise itself very quickly, and while the fundamentals are still not good, they are stable: Prices closer to US$40/b are far less scary than US$30/b and below!
Overall, from my perspective, it’s been an interesting and challenging time. When the Covid crisis started in January, it already began to impact energy before other sectors as the solution to the crisis centred on restricting activity, which is what oil and gas are geared to. Clearly this escalated as time passed, but at the same time, it affected everyone personally, so it was a very unusual period where work and personal life converged. The energy sector is extremely dynamic, and it’s hard to believe that just at the start of the year we were dealing with a price hike over Iranian US tensions and threats of military action!
Q: What’s the lasting legacy of Covid-19?
A: In the longer term, I think it’s fair to say the Covid-19 crisis has accelerated the energy transition, with political agendas highly focused on green stimulus, but also alternative habits as people commute less and supply chains become more localised. Expectations on peak demand have come forward, and companies can no longer pretend it’s a non-issue in this decade.
Relative to how things were pre-Covid-19, I’d say investors probably now require a far higher rate of return to warrant investing in the energy sector, particularly for those companies not actively involved in the transition to renewable and more sustainable generation.
116839 EXP 5 Jan 2021