Investment Idea

The oil companies are still very interesting but perhaps hedge the general index

Mikael Syding
02/09/2022 | 5 min read

The price of WTI oil peaked at just over $130 in March. After a dip to $93, it rose to $124 in June, but has since fallen to as low as $86-87 a barrel in recent weeks.

The price of WTI oil peaked at just over $130 in March. After a dip to $93, it rose to $124 in June, but has since fallen to as low as $86-87 a barrel in recent weeks. The oil company ConocoPhillips (COP), which I often write about (and own shares in), reached its all-time high of $124 in June, which is about the same price as a barrel of oil at the same time. Although the price of oil (WTI) plummeted -28% from 124 to 89, COP has only lost 12% to $109.50 per share.

The resilience of COP's share price seems to be justified. The stock was extremely cheap at $124 and it still looks to be at today's price. There could be upside potential for oil prices this winter due to the Ukraine conflict. It is partly due to general inflation, and partly due to the fact that the lack of natural gas from Russia means that more oil needs to be burned to heat the Germans and their workshops. The reasoning is, of course, a bit simplified, because Germany has come a long way in the process of filling its gas reserves, and you can never know exactly how Russia will act. The more aggressive Putin is in cutting off gas supplies, the more Europe will adjust its energy policy until gas can no longer be used as a means of pressure.

Oil, gas and coal constitute the world's most important sources of energy. Overall, fossil fuels account for 84 percent of the world's energy generation. According to Brian Gitt (RealClear Energy) the share has only decreased by three percentage points from 87% in 20 years. So-called renewable energy sources have nibbled at the three percentage points. That's 3 percentage points by investing almost 3 trillion dollars in 15-20 years. The calculation shows how unimaginably difficult it is to change the world's energy profile and reduce greenhouse gas emissions. According to Gitt, in practice it is only the United States and the country's investment in natural gas instead of coal that has made any real difference regarding the world's carbon dioxide emissions. And besides natural gas, the only other reasonable source of energy is nuclear power.

Just extinguish the hope of sun, wind and water stored in batteries for balancing over daily cycles and seasons. The solutions require, on the one hand, enormous surfaces compared to nuclear power, 75-350 times as large surfaces per effect according to Gitt, and on the other such enormous amounts of batteries that a hundredth of that much would be difficult to fulfill. You may save some emissions during the energy generation itself, but you must first use several tens of times as much material and affect hundreds of times as much land area as for a nuclear power plant. In addition, thousands of times as much waste is created as from nuclear power. It may not be impossible given enough time and commitment, but history shows that it takes 1 trillion USD per percentage point increase in solar and wind power and requires 100 times as many resources in terms of materials and surface.

In a country like Germany, for example, Gitt's calculations show that a full 24 days of battery storage capacity is needed to balance energy consumption and energy production between the seasons if one is to rely on solar energy. It can be compared to the fact that today's battery technology is only rated for load balancing in 1-4 hours, in order to be energy and cost efficient. Building 350 times that capacity is not only financially and resource-wise impossible (where to get all the minerals and how much energy does it cost?), it's a hundredfold impossible. The battery technology is not made for that area of use.

If the energy produced is not free from environmental impact, neither are the electric cars. An investigation in China has shown that electric cars partly have a huge environmental debt from production compared to regular cars, and partly under certain circumstances do not even drive cleaner than traditional cars. The latter is due to the fact that electric cars are much heavier due to the batteries and are often charged mainly with energy from burning fossil fuels. Due to the initial environmental debt in the form of 6 times as much mineral consumption in the production of electric cars, the total environmental impact is therefore in many cases much more negative for electric cars than traditional ones.

The only reasonable solutions to the world's energy and environmental challenges could be a rapid expansion of natural gas and nuclear power. The EU has addressed this in 2022 and incorporated the energy law into its taxonomy of sustainable energy sources. It's a first step. But at the same time, China is building a new coal-fired power plant this week and Germany has chosen to import coal power from Poland to replace the energy lost when the country closes its last nuclear plants this year. Previous shutdowns of clean and efficient nuclear power plants were compensated with fossil fuels from supposed alliance partner Russia.

Yes, a series of very peculiar decisions in Germany have led to what could develop into a serious energy crisis this winter. Even though the gas stocks will soon be filled (at extreme costs) and they are working on expanding their infrastructure so that they can more easily receive natural gas from elsewhere (import of LNG from the world's largest gas exporter, the USA), then Germany's economy will back down noticeably this winter. There is no way the German people will agree to freeze through a winter so Germany will pay whatever it takes to get energy. This bodes well for the price of oil. Maybe it will just be a temporary price spike to $150-200/bbl (a barrel of crude oil), maybe it will be more of a relatively steady trend towards sustained $150 prices. In any case, the oil companies' share prices have not taken home such oil price levels.

Thanks to operational leverage, COP's share price should rise much more in percentage terms than the price of oil rises permanently. The same calculation applies to all oil companies to a greater or lesser extent. One reason why the COP did not fall more than 12% when the oil price fell 28% is that the market also did not raise the COP as much as the stock earned when the oil price rose. Now oil seems to be pricing in reduced demand due to an upcoming recession, but the market still understands that the new geopolitical order, both for OPEC and Russia, means permanently higher prices. Not least the utopian and idealistic investment with unreasonable hopes for a green transition at the same time as investments in fossil fuels were prematurely demonized by ESG activists is behind the imbalances in the oil market. Not least German politicians and their voters will have to eat it up in the coming years.

Unfortunately, southern Sweden has to suffer in a similar way, mainly because certain parties would rather buy Polish coal power than keeping fully functioning nuclear power, and at the same time put an end to the extraction of graphite for battery manufacturing and rare earth metals for wind turbines and electric car engines. Perhaps the failure could still lead to a change for the mining industry in Sweden when the EU's directive regarding a slightly changed balance between critical raw materials and environmental concerns is to be translated into Swedish laws.

It should be spring for low-multiple companies in important basic resources such as mines, oil and semiconductors, but the risk is of course that politicians refuse to admit their mistakes and instead double the subsidies for failed investments in "environmentally friendly" technology, without any thought of where the minerals and energy to bring about the change must come from. Now I also think that the bear market rally has been switched to the beginning of a second major step down for the entire stock market so you don't have to jump on the buy button for any company. On the contrary, one should probably try to hedge the downside for shares with mini futures on indexes and the like. But this winter, you should seriously look for the long-term bargains. First among stable low-multiple companies and after a while, as Powell's pivot approaches, even among some former high-flyers. Can you buy Evolution at SEK 700 per share by then? Perhaps. Unless you refrain for ethical reasons.


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