The Energy Transition: "We aren't getting this one right"

Jamie Dimon made headlines during a visit to Capitol Hill last week. 

The topic of conversation centered around the energy dilemma; specifically how do we transition away from dirty fossil fuels to cleaner sources of energy.

He was asked by one elected official, "what do you think our nation's near term energy strategy should be in terms of traditional energy sources like oil and gas?"

In classic Jamie Dimon fashion, his response was quick and succinct, stating "we aren't getting this one right." 

He went on to add the world effectively needs 100 million barrels of oil and gas every day and this will be true for at least another 10 years. In order to meet that demand, we need proper investing in the oil and gas complex. And one negative externality of current high prices for oil and gas has been countries being forced to transition back to coal to meet their energy requirements.

In effect, he made the point that investing in oil and gas can be good for reducing CO2 emissions because it takes away the need to use coal during urgent situations, which is something we're living through now with Russia holding back energy supply to Europe.

This exchange can be found in the video below. 

In a more hostile Q&A later on, congresswoman Rashia Tlaib pressed bank CEOs to stop financing oil & gas companies entirely. 

Dimon, in no uncertain terms, made it clear he did not share her view:

"Absolutely not and that would be the road to Hell for America."

The exchange is below.

Opinions are rampant about the energy industry. Unfortunately, many opinions go a mile wide but only an inch deep. It's not uncommon for someone to say we need to move away from hydrocarbons which means we need to stop using oil and gas without thinking about the negative follow-on effects that may cause.

No sane person would say "I want to keep burning coal between now and kingdom come" but the obvious reality is we can't turn off oil and gas tomorrow and live on wind and solar. It would cause significant hardship across the world. 

Even Bill Gates, who I think it's fair to label as a climate activist of sorts, has admitted as much.

In an interview a few years back, he slammed the unreliability of wind and solar. In his own view, the economy simply couldn't function on these two energy sources alone. 

"Whenever we came up with this concept of clean energy I think it screwed up people's minds. All these financial guys are rating companies by CO2 output and ranking companies better if they omit less CO2. But how do you make steel? Where's the fertilizer, cement, plastic going to come from? Do planes fly through the sky because you put some number on a spreadsheet.  There is no substitute for oil and gas in how the industrial economy runs today."

The video of Gates interviews is below. 

Reality is, the transition to cleaner sources of energy will be a delicate and slow process. While oil and gas will likely make up a smaller piece of the energy pie twenty years from now ...  they'll still represent a substantial portion of the total energy supply.

The world will continue to need oil and gas for the foreseeable future to support a sustainable and affordable energy transition. 

The major oil companies that extract, produce, and refine our energy have been effectively "fat shamed" in recent years. Exxon Mobil put the below slide in their most recent earnings report which shows investment in production capacity has not come close to meeting the demand. 

By their estimates, energy companies are $50-100 billion behind in capital investments required to meet demand in the coming years.

One reason for the underinvestment is an uncertain regulatory environment. Why would an energy company make significant investments in oil and gas if the government is trying to diminish their usage?

The congresswoman above isn't the only one trying. California recently announced they were banning the sale of gas powered vehicles by 2035.

To that I say, good luck. 

The most logical course of action would be to acknowledge how critical oil and gas are to a functioning economy and encourage energy companies to continue investing to meet demand. This can be done in conjunction with energy companies reinvesting profits to push towards a renewable future in areas like solar, wind, and carbon capture projects. 

Maybe that's fairy tale vision but it's likely a better solution than rooting for their demise. 

There's an argument to be made, given the existing infrastructure and capital investment, that our current energy companies are in the strongest position to be the solution to de-carbonizing the world. 

Exxon Mobil's CEO Darren Woods alluded to this during their July earnings call: 

 "If over time, policymakers focus on what I think the real challenge with the energy transition is, which is dealing with emissions and the broader door opens for, say, carbon capture and storage or hydrogen and specifically blue hydrogen that that opens up the door for additional oil and gas and the receptiveness of oil and gas coming on the marketplace, which I think frankly, is important just given the costs associated with the transition. If you can find ways to use existing infrastructure and don't have to rewire your entire industrial processes and power generation systems, that's going to be a win for society as we bring down emissions."

Jeff Currie, head of commodities at Goldman Sachs, had an interesting conversation with Meb Faber on his podcast this week about ESG and the impact it's having on valuations. He mentioned:

"ESG is not economically sound. Look at free cash flow yields of where some of these companies are trading – some are 30%. Coal companies around 75-100% free cash flows yields. What does that mean? It means their easy candidates to be taken private, which means many of these companies will go private and fall out purview of ESG."

It's an interesting point. Sentiment on energy companies became so negative and valuations so depressed, that may have created the opportunity.

In 1980, energy companies made up nearly 30% of the S&P 500. In recent years, energy companies have fallen to a low single digit percentage of the S&P 500. 

This trend may reverse itself. The Russian conflict in Ukraine has shed light on the importance energy security, particularly in Europe given their reliance on Russian energy. There also may be a "come to Jesus" moment with the idea that energy companies may hold the strongest position to move us toward a renewable future.

The market seems to be opening up to the idea that energy companies will be more valuable in the future than they've been recently. Look at the performance of energy stocks versus the S&P 500 and Nasdaq (using $QQQ) since November 2020:

• Energy +163%

• S&P 500 +7%

• Nasdaq (-6%)

Maybe, just maybe, the commodity needed by society to keep the lights on is worth owning.