There are times when there are “fat pitch” opportunities available in the market, opportunities arising when the prevailing narrative in the market doesn’t match up to the likely practical outcomes in the real world. The market’s narrative can become beguiled by enticing but ultimately false promises, by misdirected thinking that is likely to be significantly different to the path of operations and these “real world” outcome. The wider this disjoint becomes, the “fatter”/greater the opportunity.
At present there are several such opportunities in global stock markets, but one of the biggest that we’d highlight is the current situation for energy. Energy share prices are suffering from crushing combination of two narratives: a terrible operating environment running into an ESG view of energy producers cast as inexcusable villains. This narrative looks misdirected, on both sides.
On the operating environment, there are good reasons to believe that the current operating environment headwinds are short term and will not be permanent. Fossil fuels provide about 80% of global energy needs and we do not have a scale, affordable and reliable alternative at present. It will take decades to solve the problems of finding the best new technologies, ironing out intermittency and reliability issues, and creating new infrastructure on a global scale.
The difficulties of 2020 were driven by weak energy prices due to a lockdown-induced demand shock. Lockdowns will end and the temporary dampening effect on demand will at least abate. At the same time, mentalities on the supply side have changed, and capex spend to maintain output has been savaged. Estimates of close a $1tn spent on upstream in 2014 halved after in the late teens, and was about $300bn in 2020, a third of the peak. This does not look sustainable when demand is off 5%, and that in a pandemic year. The outlook for strong players well positioned versus the rest of the industry is nowhere near as difficult as the market is assuming.
On the ESG side, climate change is a complex issue with no easy answers nor pain-free options. There certainly isn’t just one “right” answer: it will take many different approaches and angles, and it will involve a wide variety of players (including all of corporates, government, and consumers). There will be a transition in global energy provision over time, but evolving away from this 80% of our energy supply, with no clear solution even visible at present, will take decades.
In this context, we feel it is entirely responsible, indeed commendable, for companies to continue to provide a product that is essential to modern life, until this transition is complete. To deny this interim period where fossil fuels are needed is to be deluding oneself that the cost and reliability of energy is not core to modern society: heating houses, growing food and transporting it to the table, powering hospitals and ambulances, enabling clean water. If in doubt, check in with someone who has lived with a persistent or prolonged blackout recently. And it is easy to forget how much of an impact on quality of life inexpensive power can make, in the form of transport or heating or cooling or cooking, to anyone trying to live on a meagre income.
In this world, a company like Shell looks extraordinary. Shell is working to be part of the solution, and we feel it is one of the best at balancing all the issues involved. At the same time, even in the pandemic-induced distortion, its operations continue to generate robust returns. Providing the energy to power our society, playing a core role to finding the solutions of the future, at these valuations and this level of scepticism in the market, the opportunity is enormous.