Investment Idea

A perfect storm for the energy sector

Mikael Syding
31/03/2022 | 7 min read

Do you have a strategy for your investments? Have you thought about what your investment philosophy really is, what you de facto have as a fundamental basis for how you invest your financial capital? Thinking in terms of priorities rather than absolute decisions can help.

Do you have a strategy for your investments? Have you thought about what your investment philosophy really is, what you de facto have as a fundamental basis for how you invest your financial capital? Thinking in terms of priorities rather than absolute decisions can help. Simply put, you have both capital ("money"), and a stream of income ("salary", "return") and expenses ("accommodation", "transport", "food & care", "entertainment"). You prioritize how much of the income you should spend today and how much should be invested. And somewhere you have a distant horizon where everything has to be consumed by you or others. Of what is invested, you prioritize between different asset classes, e.g. stocks or commodities, and various specific individual choices within the classes. Your task that you have assigned to yourself is to maximize your expected life experience, with a view to avoiding unacceptable outcomes on the downside.

How do you do it?

For example, if you only buy gold bars, you will have exactly these gold bars when you retire or when you want to consume the value of the bars. However, you do not know at all what the gold will have in relation to what you actually need in the future, ie food, accommodation, transport, care and entertainment. You know, however, that you cannot eat gold, nor using it for care or entertainment. So, if you are only going to have gold bars, you have a chance that gold in the future will play an important role as an anchor for the monetary system or that the gold's unique physical properties will eventually prove to be worth their weight in gold. Otherwise, you stand there hungry and frozen with a pile of yellow stones. It is such an "unacceptable downside" that must be avoided by investing in other alternatives.

It is not easy to invest, and it is not easier to invest on the basis of large overarching macro themes than to carry out micro-analysis of individual companies or entrepreneurs. Analysis of the type "everyone should live somewhere, so buy real estate companies" have no value if you do not know the price of the companies. The same, of course, applies to food, cars, online entertainment, etc. No, the task for an investor is to think out which relative prices give an increased probability of a well-executed “Lustiga Huset” staircase - that is, to jump back and forth between sufficiently good investments based on their currently relative value proposition. The question you want answered is whether it is better right now to have, for example, more gold (or oil, or real estate, etc.) and less equities or vice versa.

You do not always have to keep track of all relative prices at the same time to try to weight optimally between asset classes and individual shares, or other units of an asset class. For the most part, it is excellent to be weighted much like the world at large, ie just own some kind of average position - an index. Then you get the same return as all other investors, which is a little better than the economy as a whole, which in turn is clearly better than for the average person (because most do not have as much capital invested but balance their income and expenses in each individual time without opportunity for exposure to systematic creativity and creation via the stock market).

Sometimes, however, clear opportunities are created, large distortions in relative pricing between different companies, industries or asset classes. Of course, it is difficult to know for sure in advance how the future will develop. Investments are about probabilities. But with that said, a perfect storm in a positive sense seems to inflate in the energy and commodity segments of the economy relatively many other industries and classes. This is due to a combination of several different factors, not least inflation due to 1) pandemic-related logistics problems, 2) declining population growth and 3) money pressure. Rapidly rising prices make the economy less efficient due to difficult-to-understand relative price changes at the same time as real assets rise in price. Oil and other energy-related commodities are among the best indicators that are the actual winners of inflation. Energy, the ability to make things happen, has an indisputable value. Without energy, no activity. This means that the relative price of other goods and services falls relative to the price of energy until pricing balances the willingness to exchange for the most motivated marginal buyer of energy.

In recent years, environmental considerations have led to reduced investments in oil production. Of course, it is good in the long run to reduce the combustion of fossil fuels, but unfortunately it has gone a little too fast. Too late it has been realized that sun and wind are not as reliable as coal and oil. Sun and wind are not enough, especially at night, if you do not have sufficient energy storage solutions or controllable electricity and heat from nuclear power plants. The expansion of sun and wind is also quite slow, as you start from a low level and it costs a lot of energy to extract materials for the parks and to build them. And even when the energy parks are expanded, an enormous oversizing is required for the minimum production during dark and windless hours to be sufficient.

Unfortunately, other safe and controllable energy production is required, which in practice means oil, coal, natural gas and nuclear energy. Russia's war against Ukraine is largely based on Ukraine's enormous natural gas resources. If foreign companies such as Shell had been allowed to develop these deposits undisturbed, Russia's exports to Europe would probably fall significantly, especially if Europe and NATO do not like Putin's policies. In any case, the unit price of oil and gas would have fallen at the same time as a reduced Russian sales volume. It would be a disaster for the Russian economy, Putin's re-establishment of the Russian superpower and not least his ego.

Putin thus had to attack Ukraine. This in turn led to a slowed down flow of various forms of carbon-based energy sources and thus a lack of controllable energy. A panicked blow on the non-Russian gas and oil that was available thus pushed prices up to record levels. After that, it seems that Russian hydrocarbons were leaked via China and India, but the war and the price reaction have now focused on oil dependence once and for all. At the same time, there are no signs that investments in oil exploration will increase again, not as long as oil is classified as dirty - probably forever. This means that oil will be a constant scarce commodity, albeit in steadily declining volumes. In addition, the slightest disruption in Russia, the Middle East or US shale oil means that the price is rising. This means highly interesting investment opportunities for awake traders.

However, rising oil prices are expected to be accompanied by falling volumes for the oil companies themselves, so their profits are stagnating. Thanks to the fact that many investors are liquidating their ownership of companies linked to emissions and global warming, the oil companies are still relatively cheap, which means a high return for shareholders, even if the actual price development is moderate. Therefore, it is good to combine oil investments with uranium shares. It is the only other reasonable source of reliable and emission-free energy. Where the oil companies make up only a few percent of the market value of the stock exchange, the uranium companies are even an order of magnitude smaller. The stock market is worth tens of trillions of dollars, the oil sector a single trillion and the entire uranium sector is only counted in tens of trillions of dollars (billions). This means that regardless of whether you buy my view or not, the energy sector is undervalued relative to most other things on the stock exchange, as the basis for all economic production has become a scarce commodity and yet so far only valued at a few percent of all activity based on energy, then there is a value arbitrage between oil and uranium. The difference between oil and uranium, apart from the market capitalization that is counted in many tens of times difference, is that the oil is now while the uranium companies do not produce profits until in 5-7 years.

Fortunately, you do not have to choose. You have to make your strategic choice in favor of the energy sector over computer games, admin software, online casinos, retail chains, streaming services and more. And then you can tactically allocate any amount to today's energy, oil, and tomorrow's, in the form of uranium mines.

As a third leg in the energy game, there is a more distant future with solar and wind power as well as cars with electric motors and batteries. This requires unimaginably large amounts of raw materials and factories. And if anyone thought that Europe's dependence on Russia's oil was unpleasant, one can easily guess what they think about China controlling 90-100% of the key material for electric motors and wind turbines and one pole in the batteries, the anode (which consists of graphite). European authorities are therefore now fighting feverishly to develop their own mining industry, process industry and factories for batteries and materials for engines and turbines. But if the oil companies seemed small and dirty relative to the stock market, and the uranium companies even smaller and a little too radioactive, the environmental players in the critical raw materials segment for renewable energy production are even smaller, not to mention dependent on political decisions and a long start before any material arrives. out of the ground. The potential is of course all the greater in this third energy pillar, but the time for concrete production is even a little longer than for the uranium companies. 

An investor today must decide whether to do as everyone else, ie weight themselves as the stock market in general, as an index, as the economy, with the same proportions of housing, metals, energy elements, equity industries, etc., with risk and chance for significantly different outcomes than all other. Or if you want to take the opportunity and take advantage of the perfect storm that has arisen due to inflation, environmental policy and geopolitics. The storm is due to too fast and demonization of the oil industry, Russia's war against Ukraine, the metal dependence on China's command economy, and the US money printing press' war against a global cold. The storm means that the need for reliable energy, and a little later on renewable energy, leads to premium prices for oil, natural gas and uranium, but almost nothing of this is yet visible in stock market valuations. The latter is probably due to ignorance and a high price for time and security. The oil is on its way out and it is stamped as undesirable. The uranium mines are small and unfinished in several years' time. In addition, the size of the uranium stocks is unknown and the future demand is uncertain (despite the fact that about 50 reactors [ie an addition of about 10%] are currently being constructed). And finally, it can be repeated that battery anode producers and owners of deposits of rare earth metals such as Leading Edge Materials are currently many years away from actual production.

Yes, oil is the safest choice in today's energy arbitrage, but do not miss the transition to uranium and electrifying metals. The most important thing is the strategic relative positioning over the next five years, between historically extremely highly valued stock exchanges and relatively extremely low-valued energy-related companies. For the sake of clarity, this was already the case without regard to an increasingly skeptical view of Russia and China and a more robust domestic supply chain structure due to both pandemics and geopolitical considerations. It is a perfect storm and it is when you as a strategic and long-term investor have the opportunity to make a priority that leads to a very different outcome than the average, an outcome that thanks to the perfect storm has a very high expected value.

Karl-Mikael Syding


This information is in the sole responsibility of the guest author and does not necessarily represent the opinion of Bank Vontobel Europe AG or any other company of the Vontobel Group. The further development of the index or a company as well as its share price depends on a large number of company-, group- and sector-specific as well as economic factors. When forming his investment decision, each investor must take into account the risk of price losses. Please note that investing in these products will not generate ongoing income.

The products are not capital protected, in the worst case a total loss of the invested capital is possible. In the event of insolvency of the issuer and the guarantor, the investor bears the risk of a total loss of his investment. In any case, investors should note that past performance and / or analysts' opinions are no adequate indicator of future performance. The performance of the underlyings depends on a variety of economic, entrepreneurial and political factors that should be taken into account in the formation of a market expectation.