Why The Future Of Energy Is The Number One Question For Investors

The volatility in the oil price is about more than simple supply and demand.

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What’s the most difficult conundrum in investing right now?

We’re not short of challenges.
 
There are the big macro-economic questions:

  • When will interest rates rise?
  • Will the economy tank when they do? Will the stock markets?

 There are the political questions:

  • Will the UK vote to leave the European Union?
  • Will Donald Trump be the next President of the United States?
  • Can anything be done to halt the slide into terror in the Middle East?

And there are eternal questions about specific stocks, too:

  • When will Lloyds Banking Group (LSE: LLOY) escape the gravity well of fines and rising costs to become a big, boring – profitable – dividend payer?
  • Can Amazon conquer the world – and bring its valuation ratios down from the stratosphere?
  • Will anything make clothes from Marks and Spencer (LSE: MKS) fashionable? 

That last has been a staple of the business pages for as long as I’ve been reading them, but it’s not a question that can be asked indefinitely.
 
And the same thing is true of what I think is really the biggest and most difficult question about our economy, our future, our investment – even our planet.
 
That’s the question of energy.

Modern world, ancient fuel

Exactly how humanity will get past our dependence on fossil fuels was always going to be a challenge.
 
While an estimated 1.2 billion people still do not have access to electricity, modernity for the more fortunate rest was made possible by the exploitation of oil.
 
Cheap petrol gave us the automobile age and reshaped our cities. It helped power our homes and factories. It gave birth to plastics and it fuelled – literally – the green revolution that feeds a global population that has exploded to 7.4 billion.
 
Fossil fuels account for well over 80% of global energy consumption – and thoughtful people have long known this was problematic.
 
Why?
 
Well, the clue is in the name.
 
Fossil fuels.
 
While it’s not true we’re not making fossils any more, the planet is in no hurry. Fossil fuels are a renewable resource – provided you have a hundred million years to wait.
 
Oil, in particular, is scarce stuff, and we long ago extracted most of the obvious supplies.
 
This realisation – that we depend on oil, that we’ve used a huge proportion of what the planet has, and we’re fast burning through the rest – led to the theory of ‘Peak Oil’.
 
Debate about when Peak Oil – the moment of maximum extraction of petroleum products – will occur has raged for decades.
 
In 2008 the oil price hit a record $145 a barrel. Some said Peak Oil was making itself felt.
 
But then three long simmering confounding factors came to the boil.

Complication 1: unconventional drilling

In the resource sector it’s often said that the “cure for high prices is high prices” and this was true for oil over the past 10 years.
 
An oil price over $100 a barrel sparked a flurry of expensive exploration campaigns, in some of the globe’s most inhospitable climates.
 
Oil – if found – might prove expensive to extract. But the high oil price left a lot of spare margin on the table.
 
But high prices also led innovative companies to pioneer new ways to extract oil from fields that had previously been passed over, or considered depleted.
 
Hydraulic fracturing (fracking) and horizontal drilling sparked a new oil boom in North America. Output surged from fewer than 6 million barrels a day just a few years ago to hit some 9.7 million barrels a day by 2015.
 
Such techniques postpone Peak Oil by bringing more supply to the market.
 
But they also threaten the market share of existing producers.

Complication 2: alternative energy

Solar, wind and tidal power, nuclear fission and nuclear fusion, bio-fuels – a host of different technologies have been touted to succeed fossil fuels.
 
Some, such as nuclear fission and hydroelectricity, yielded great results immediately, but for whatever reason weren’t scalable to compete with fossil fuels.
 
Others – notably solar – held a lot of promise, but were inefficient.
 
However, as the years have ticked by, these alternatives have improved.
 
Solar power is now reaching cost parity with conventional fuels in much of the world. It will take an increasing share of new energy demand.
 
Already around half of all new power plants are based on alternative energies.
 
There are even signs of progress with nuclear fusion. That really would be a game changer.

Complication 3: global warming

Transitioning from dwindling supplies of oil – and more abundant but less convenient fuels such as coal – to such alternative energies always looked tricky, if even possible.
 
Everyone knew it would have to happen in stages.
 
Natural gas, for example, is seen as a bridge between today’s most commonly burned fossil fuels and a solar or fusion-powered future.
 
However, in the past 20 years it’s become clear we can’t wait to make the leap.
 
Man-made global warming is perhaps the biggest existential threat mankind currently faces – and curbing it means we must radically reduce our burning of fossil fuels, or at the least stop the resultant CO2 getting into the atmosphere.
 
The landmark COP21 deal reached by 195 nations last December pledged to cut greenhouse gas emissions to a level that limits further temperature rises.
 
It should spur huge investment into accelerating alternative energies.
 
However, by potentially capping how much fossil fuels we can ever burn, it could also lead to perverse outcomes, such as encouraging suppliers to dump their oil onto the market, rather than risk being left with vast reservoirs of so-called ‘stranded’ and economically worthless assets that cannot ever be used.

Picking winners

It’s the interaction of all these factors that make anticipating the trajectory of the energy sector so difficult, let alone investing in it.
 
Just consider the oil price crash of the past couple of years. It includes elements of everything I’ve discussed above – new drilling techniques, energy security fears in the US, and increased output from traditional suppliers such as Saudi Arabia who perhaps fear that the oil era is coming to an end, and hence want to sell all they can before solar technology or caps on burning fuels limits what they can shift.
 
How should we think about the Saudi’s plans to float their State-owned giant oil company Saudi Aramco, in this light? Are they calling the top of the market?
 
Would a seemingly ludicrously priced company like Tesla seem so dear if it were making 500,000 electric vehicles a year by 2018 – as we race to get away from fossil fuels?
 
Is the plethora of small-cap oil companies listed in London the opportunity of the decade because their shares have been hit for six – or value traps, because any oil they find will be swamped by new supply from majors desperate to pump while they can?
 
And what of the various alternative energy companies we’re offered via the world’s stock markets? Most have been rotten investments over the years. Has their time come – or do all the unknowns consign them to the ‘too hard’ pile?
 
To my mind, there’s no sector with as much relevance for every single person’s daily life and future as energy that is also changing so fast, that has the same potential for Doomsday, and that’s of the same importance to the financial markets.
 
Feeding perhaps 11 billion people by 2100 might be the other candidate – but agriculture is (currently) small fry in the markets, and energy plays into it, too.
 
Anyway, needless to say I have no firm predictions about how this will all be settled.
 
But as an active investor I know I’ll have to think about it every day for years to come.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Owain Bennallack owns shares of Lloyds Banking Group. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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