In September, we can feel the winds of change starting to blow after a long hot summer. The mornings start to get a little cooler, our little ones are back to school, and our minds wander to leaves changing, football starting up, and the beginning of fall. As investors, we are also forced to accept change, albeit sometimes less predictably than the seasons!
In 2021, Maple Capital Management exited many energy positions for clients, particularly for those not needing income. Those changes are outlined in a piece here on our website. Our thoughts were pretty simple: a transition away from the traditional sources of energy is coming and we would rather invest in that transition in a more direct way. What we did not, and could not, know at the time was that things would change in a dramatic fashion in 2022. A hot war in Europe has shifted the landscape dramatically for energy and geopolitics for the foreseeable future.
What’s new? Western bloc nations are now in a proxy war with Russia and as a result, sanctions are in place for roughly one quarter of the world’s oil and natural gas production. Add to that existing sanctions and roughly 40% and 55% of the world’s proven oil and natural gas reserves respectively are now under Western sanctions—as noted in the charts above and on the next page. This latest supply shock is too much for the energy market to bear and we expect that energy commodity volatility will continue until trade flows can adjust. We are under no illusion that Russia, as well as other sanctioned petrol states, will not find buyers for their energy oftentimes at a discount. However just as Iran and Venezuela experienced production declines following sanctions, we expect the same for Russia.
We also do not foresee any desire by OPEC members to fill any production losses as a result of sanctions on Russia as higher prices directly benefit these oil producers. This seismic shift in energy supply chains will take years to adjust as the EU builds sufficient liquified natural gas (LNG) terminals to replace gas supplies and Russia reworks pipelines to change the flow of oil and gas to Asia instead of Europe. Domestic energy producers should benefit from this changing dynamic as they are not constrained by OPEC production quotas.
What could alter these views? There have been some news headlines regarding possible sanction relief for Venezuela and Iran, but this has been going on for years. If this war does not end
quickly, as most thought it would early on, we expect further volatility and sustained higher prices for fossil fuels which will also make substitutes more economically attractive in the long term.
This leads to our long term view, which has not changed. We still expect natural gas and renewables to take an increased share of petroleum’s major end-market, which is transportation. Transportation represents roughly 70% of oil usage today! Internal combustion engines will probably be slowly replaced by electrical battery (EV) or hydrogen fuel cell (FCEV) power trains.
Nearly every major auto and/or truck manufacturer has committed to either all EV or FCEV production by 2035. We do not know which will grab the dominant market share, as it could depend on the type of vehicle and its purpose, i.e. passenger vehicles, delivery, bulk, etc. Either way — natural gas or renewables — we believe oil will be replaced as the consumable due to better economics and environmental concerns. The war in Ukraine and a shifting geopolitical landscape will just make the transition more volatile and may take more time with natural gas prices up ten-fold in some EU markets.
Maple Capital Management, Inc. (MCM) is an independent SEC Registered Investment Advisor with offices in Montpelier, Vermont and Atlanta, Georgia.
This commentary reflects the views of MCM and should not be considered to be investment or financial advice. MCM does not warranty these views and will not update this communication after the date of publication. Any mention of specific securities is done for illustrative purposes and the securities mentioned may or may not be held in client accounts. No assumption or assurance should be taken that securities mentioned will be safe or profitable investments. Past performances are not indicative of future results.
For further information, please contact Steven Killoran at 1-802-229-2838 or at [email protected]. For further information about Maple Capital, including a copy of our informational brochure, please visit our website at www.maplecapital.com.