Re-opening Theme – An Opportunity to Exit Client’s Exposure to Oil
Maple Capital used the prevalent re-opening theme in the equity market as an opportunity to eliminate our client’s exposure to the oil commodity in most portfolios. In our view, investors are not being properly compensated for assuming the rising risk of long-term volume declines and obsolescence in the primary consumable end-market. We anticipated a re-opening rebound in the energy sector and now that shares prices have moved near or passed pre-pandemic levels, we executed on that part of our strategy. We will be using the sources of those funds to reallocate to better return on client capital businesses that should benefit from the transition taking shape in the energy sector.
Price-taker Business Along with Cartel Risk
Generating consistent returns in the oil industry has always been fraught with more risk relative to other sectors. These are very capital-intensive and price-taker businesses that require scale and leverage to operate. Moreover, instead of a market pricing mechanism driven by supply-demand dynamics, prices are more often determined by OPEC (Organization of the Petroleum Exporting Countries). The power in this cartel consists of National Oil Companies (NOC’s), typically run by autocratic governments, whose main interest is to remain in power for perpetuity– that is what autocracies do. Controlling 80% of the world’s low- cost proven oil reserves gives pricing power to this cartel, not the firms available for public investment. In our view, the cartel through various strategies, has kept any major advancement in energy efficiency at bay. But we believe that is going to change.
Electrification Creates More Risk of Value Traps, not Value
Electrification is coming to petroleum’s major end-market (68% of transportation) via battery (EV) or hydrogen fuel cell (FCEV). Nearly every major auto and/or truck manufacturer has committed to either all EV or FCEV production. We have no idea which grabs dominant market share, as it could depend on use case, just to name one variable. But either way, natural gas or renewables, will replace oil as the consumable. This is simply the economics of much higher equivalent mpg. In addition, environmental concerns, institutional ownership pressure, and major firms committing (and requiring supply chains) to net-zero carbon dates, also seem to be tipping the scales. Big picture math says petroleum is set up for a steep decline in volumes. We see more risk and uncertainty, rather than value in oil over our long-term investment horizon.
Dividend, Fixed Income Strategies Still Have Exposure
Outside of our core equity allocation, we still have exposure to energy firms. We are comfortable deriving income for clients via firms in traditional energy, since lenders to the business are higher on the capital structure for claims on cash flows. However, this view is under constant vigilance and may also evolve, depending on the pace of transition. Traditional energy firms will want natural gas (oil is on the way out) to be used for the electric grid and the electrolyzers that separate hydrogen. Renewables are already taking steady market share in the grid. Furthermore, according to recent reputable industry sources, the cost of renewables to also power electrolyzers in the coming years will be cheaper than natural gas by 2030 in many locations. So natural gas could also lose market share to renewables in hydrogen production should it materialize.
As always, time will tell.
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. 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.