E2: Energy Evolution: ESG, Reserves & Volatility

Although energy envelops us daily, its profound impact on our lives, economy, and future often goes unnoticed. Join us as we discuss several energy-related factors impacting the world around us. 
 
 Tune in for our kick-off segment, "What's the Most Important Thing" where we offer our insights and perspective on the a relevant and timely topic on our minds. Be sure to subscribe to be notified of upcoming episodes. 
 
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Transcript

The Point Podcast Ep 2 Energy Evolution: ESG, Reserves & Volatility

SUMMARY KEYWORDS

oil prices, Strategic Petroleum Reserve, inflation impact, energy sector, ESG investments, clean energy, regulatory environment, global energy demand, oil production, energy transition, investment strategy, copper exposure, nuclear power, renewable energy, financial strategy

00:05

Welcome to The Point Podcast. We have informed, intelligent conversations about today's financial topics submitted by viewers like you. Let's go ahead and get started. Here are your hosts, Landis Wiley and Allen Wallace,

00:22

Well, welcome to The Point. My name is Landis Wiley, sitting here with Chief Investment Officer, Allen Wallace, thanks for taking some time out of your day to join us here on our podcast. If this is your first time tuning in, welcome, our format here is maybe a little different than what you're used to. Allen, I have no idea what we're going to talk about. We're going to find out in a couple minutes. We've got a hat hanging out back here. No kidding, behind the coffee mugs. We reach in and pick out a topic that's been submitted in, oftentimes by you, the viewers out there, and we just kind of feel our way through it. So it's always exciting, always interesting. The goal, hopefully, is to maybe demystify something in the world of finance for you, so you walk away from this maybe feeling a little more comfortable with things that you see on the news or talk about friends. So, before we get into the meat of today's discussion, we like to kick each episode off with a 60 second piece called, The Most Important Thing. And as the title suggests, really what it's about is something major happening that's influencing the world of finance, maybe impacting your pocketbook, or our pocketbook, or just changing the dynamic of finance. So Allen, without further ado, I'm kicking it over to you. What’s the most important thing?

01:33

Right now, the most important thing, I think, is oil. We've gone through this long period of declining oil prices over the last year or so, and a lot of that, I think, is attributable to distributions from the Strategic Petroleum Reserve. We've taken that down from about 727 million barrels all the way down to 350 million barrels, which is about 50% capacity. And it's a little confusing, because people think, well, we have 50% left, but the structure of the oil reserves is actually in salt caves in Louisiana and Texas. And the issue is you can't draw them down to zero, because they will implode. So, we really only have about 25% capacity left, which is something like 40 days of supply. So, we have to be really careful about that. And now the Energy Department is talking about starting to add back to it. When oil hits 79 we're closer to 90, so that's a moving target. It was at seven. Their buy point was 72 now it's up to 79 and what we're seeing is that inflation is starting to tick back up now that all that oil price reduction has sort of filtered through. Now they take the price of energy out of the headline number. But everything that you do in this country has, you know, has some sort of energy input to it, so it's relatively pervasive. But the first thing that you notice is the price of gas. So we had the price of gas drop a lot six months ago. It's starting to climb back up. And so I keep my eye on the price of oil, and as a derivative of that, watch the price of all the other goods and services that have some sort of tie into oil. 

03:07

Absolutely, and for most people out there, you know, oil tied to gas prices. Usually, the thing that we pay the close attention to. We feel it the most acutely. But as you, as you mentioned, it impacts everything in the economy. Impacts shipping, which eventually shows up in the price of things that are on the shelves in the store. 

03:20

Yeah, even a lot of the things we use that are plastic are made from petroleum products, right? So everything has a little energy component to it. So it'll be interesting to see if the fact that we've taken the SPR down as far as we can go, starts to increase the price of everything else. Directly, it is increasing the price of gasoline. So we're already seeing that happen,

03:42

right? So someone to close, watch closely, exactly. Yep, perfect. We'll be right back after a quick break. 

03:48

Today's episode is brought to you by Basepoint Wealth, a question for you to consider, is your present financial strategy working for you? Do you want another viewpoint? It may be time to talk to the experts at Basepoint Wealth. Call 319-826-1898, now for a complimentary financial consultation, take control of your financial future with Basepoint Wealth.

04:14

Welcome back to The Point again. Landis Wiley sitting here with Allen Wallace, thanks again for joining us. We're ready to get rolling with the meat and potatoes of today's episode. So again, for those tuning in for the first time, thanks for taking some time out of your busy day. The way this works, we've got a hat sitting over here. We're going to reach in, we're going to pick out a topic. We have no idea what it's going to be. Sometimes that can be fun, and sometimes it can be a little bit of a learning curve as we get through it. So, all the topics that are that are in the hat are ones that have been submitted in by people that either work at Basepoint or have come in from our viewers, like you. So, if you've got something out there that you're curious about, that maybe we don't talk about today, feel free to send in your ideas. And who knows, maybe, maybe one of these days, we'll pull your topic out. So without further ado, let's see what. We're see what we're doing here today. Allen, can't wait. All right, what do we got going? Oh, this is actually related to your most important thing. So, the energy landscape appears to be constantly changing. As of recent, ESG has been a popular investment class. The US has released a significant amount of oil from the strategic oil reserve, and the price of crude oil has been volatile in 2023. What are your thoughts on the energy sector? Okay, so most important thing that you just got done sharing with us was oil, right? So here we go. Let's talk about oil. 

05:39

There'll be at least one person that thinks we did that on purpose.

05:42

I’m sure there'll be a couple of them, but we promise that we did. So, there's a couple things in there. So there was a reference to ESG, right, which I think is something that's worth talking about. And then obviously the question around oil and kind of, what's going on with it? So let's start off with maybe just defining the landscape, what's going on so ESG, environment social governance, has been a hot button topic, to say the least, over the last, particularly last three to five years, but really going back maybe the last 10 or so, it's sort of been characterized or has evolved into a sense where the focus has mainly been on the environmental component of that. And where, you know, the belief, maybe, is that ESG is aligned heavily with folks that are concerned about climate change and reduction in fossil fuel use. So, oil obviously being a big component of that. And you know, we talk a lot, have a lot of conversation about the merits of slicing and dicing investment strategies by kind of any category, ESG being one, and kind of the challenges that can present any time that you're automatically disqualifying investment choices simply because they meet some criteria. So maybe let's just talk about that to start before we get too much into the specifics.

07:06

Sure, it reminds me of something that Buffett said, which is what the wise man does in the beginning the fool does in the end. And I don't mean that as an insult to anyone personally, but the first time I've read about ESG was in a book called The Money Game by Adam Smith, which I think was written in the late 70s, and actually, in that book, is the first time Buffett was introduced as a money manager, and he talks about this new tendency to try to let your morals dictate your investment strategy, and how the salesman were kind of pushing that on people. Well, you know, fast forward almost 50 years later, and ESG had reached its full maturity. And the thing about making a new asset class is that it's sort of a self fulfilling prophecy at the beginning, because the fact that there's more capital being drawn to that area causes the prices to go up. That doesn't necessarily make those better investments, though, and a matter of fact, it makes them worse investments. And then you also have the fact that there's this bandwagon effect where everyone's trying to get themselves on these ESG lists, which, by the way, include most of the oil companies. So, the environmental portion of it has become sort of back seat to the to the desire to control the way companies are run. And you've got a couple of big players in this market. You've got Vanguard, and you've got BlackRock, which own basically everything. And those companies are actually facing lawsuits now from shareholders who are saying that you used our money in order to push your political goals. And I think there's probably a little bit of truth to that. It's something that we've always kind of avoided. In our main portfolios, we have had a couple of clients that have said, Hey, I don't want this. I don't want this and the client is the boss so we have listened to them when they've said that, now their performance has been lower than our average performance, and that has to do with the fact that oil isn't going away in the next year or two. And I know there are people out there that think that's true, and we just don't have the infrastructure to shift over to a purely electronic economy, and the reason for that is because anything that you plug in goes to the power grid. And what is that power grid run by? It's not run by solar and wind. Of course, in Iowa, it is 30% wind, but across the entire country, it's mostly run by natural gas and coal, right, right? So, you're, you're getting rid of the oil in the combustion engine, but you're switching over to the coal burning power plant. We just don't have the infrastructure yet to run all that stuff off of what we consider clean energy.

09:34

And you've got the dynamic with just within the US of kind of, you know, you're shifting from this type of energy over to this type and what have you. But that's going on global too, right? I mean, oil and energy are global markets, so even if the US or Europe, where ESG or you know, the focus on reduction of fossil fuel reliance in general, has been popular over the last 10 to 20 years. Large swaths of the rest of the world are not moving in that same direction, right? In fact, there's, you know, there's plenty of data out there that suggests that places like China are consuming more coal today than what they did five or 10 years ago, and they're consuming more oil than they did five or 10 years ago in India. So, you know, whatever, whatever we may be reducing here that that demand isn't necessarily going away. It's just moving to a different part of the world, right? Which, you know, I guess, to kind of loop around then and talk specifically about the oil part of this. So, one of the dynamics has been interesting to me to watch, over the last five or 10 years, there's been so much focus on, you know, the reduced consumption of oil, and at the same time, the world is producing more oil than ever before. The US, even as recently as a few years ago, was producing, was the largest producer of oil. We were exporting considerable amounts of oil around the world, but yet we were consuming less. And at the same time, oil prices continued to go higher. Gas prices continue to go higher, and that doesn't seem to make a lot of sense on the surface, right? You'd say, well, if we're if we're consuming less and we're producing more, isn't supply demand supposed to say that prices go down. But if you step back, you realize that it's not just us that's in that market. 

11:14

It’s also more expensive to get out of the ground now, some of the places you know, the shale formations and things like that, are more cost prohibitive, and the price of oil needs to be higher in order to turn those sources on right. So that's part of the other thing is, we've already taken the low hanging fruit, and now when we when we find new reserves, they're deeper, they're harder to get to, and so they need a higher baseline price in order to justify taking them out of the ground,

11:40

Sure. And, you know, while it's nice when oil prices fall, you know, you can go back to 2020, and oil is trade for what, $0 a barrel,

11:50

negative for like, a minute, right? The North Dakota sour, or whatever it

11:53

is, right? Which is great. I mean, we love that. We love it when fuel prices go lower, but ultimately, that has impacts to production, right? You know, if companies are having to expend substantial sums of money to dig and find and locate and then ultimately drill and process this stuff, you have to have prices at a certain level. Otherwise, it's just not profitable, right? 

12:16

The other piece I want to touch on, though, is, is the amount of capital going into exploration. Right? There was a period of time in in the in the early 80s, where oil was one of the bigger components of the S&P 500. And over the last couple years, it's fallen down to, I think, under 2% less than 2% of the entire S&P 500 is in oil companies. And that tells you what this ESG monster has sort of created. We're something like 30% technology and communications, and we're like 2% oil well, which of those is going to dominate GDP and price levels and all those other things. If you see how much GDP and the rate of inflation were impacted by just some distributions from the Strategic Petroleum Reserve. I think that that's a much more important part of the economy. And to those who say, well I don't want my money invested in these things that I don't like, I would say, well, you should invest in those things and then change them to the things that you want, that you like, right? Make them be the companies that you want them to be. But the entire thing is sort of a little bit disingenuous. You know, Tesla is the largest manufacturer of electric vehicles, and they're not included in the ESG indexes because they don't like the politics of Elon Musk, right? And so, you have to be really careful about buying into one of these indexes when it's someone else's political design has created the index that you're purchasing. 

13:38

And on you know, maybe individual scale, the decision of one person to say, well, I don't want my investment dollars to go to Exxon Mobil, right? You know, I'd rather it go over here. I support this company over that one. For whatever reason you want to pick, not a big deal, but when you do it on a mass scale, which is what ESG kind of became, right? I mean, you had these large indexes, as you said, backed by some of the largest indexed, you know, money managers that are out there. It does have the ability to influence flows of capital, and it does have the ability to maybe withhold capital from companies that we need to have that capital to do things like continue to explore, to find energy, to keep energy affordable. You know, one of the, one of the maybe least appreciated facts about the United States, of why the US has been able to be such an economic powerhouse over the last 100 years is because, generally speaking, we've had among the cheapest energy anywhere in the world, right? So easy to build a manufacturing base when you're able to operate at relatively low cost of energy that it takes to power your plant and produce your goods and what have you. So maybe a little bite off your nose to spite your face. 

14:50

Well, we have to be really careful about the regulatory environment, off the off the top of your head, where you think the most expensive gas is? Probably California, right? And do you know why that is? I'm going to guess it has to do with regulation. Absolutely I mean, they only have two refineries over there that they use to process all of their gasoline. They've got specific formulas that have to be followed in order to sell gasoline in the state. They've got a winter mix and a summer mix that are significantly different in composition. So, when the summer is ending and you're going into the winter season, you've got supply issues, because if you didn't create quite enough summer mix, then you might have shortages, and there hasn't been a refinery built in this country for something like 50 years. So yeah, I mean, the regulatory structure is key to the pricing. They also don't have pipelines in California, most of the oil is transferred over truck, right, which runs on diesel, so you've got some compounding inefficiencies there that cause the highest gas prices in the world. And who do the politicians always want to blame when oil prices go up? Right? Yeah, that's the greedy oil companies, right? Well, there may be some of that going on, but you want to be careful to evaluate the entire situation and see if maybe some of that regulatory structure is what's causing your price mismatches.

16:04

So, from an overall, just viewpoint of the energy market in the US, I don't think anybody would dispute, you know, energy is critical to everything we do every day, right? I mean, we turn our lights on, you know, water comes out of our faucets. The whole world doesn't benefit from those modern amenities the way that, the way that we do here in the US. You know, our energy market does seem to be changing. Obviously, there's been a big push towards the green energy source over the last, you know, last few decades. I know there's been headlines here recently, particularly as inflation has ticked up. You know, federal deficits have ticked up. Concerns around the economics of some of these solar and wind projects, of whether or not they can even complete the ones that they've started because the governments are running out of the money to subsidize these things, you know? So what to somebody who says, Well, you know, what's happening with energy in the US? What's happening with energy in the US? It seems like a little bit of a mess right now. Yeah.

17:02

Well, you know, I was a good case because Mid-American energy provides most of the power in Iowa, and, you know, they're almost 30% wind power. And that's because we've got a we've got a lot of open, open land to put these turbines on. Texas is also high percentage wind power. They haven't had the same luck in California. So, the technology is not there yet. We have to be really careful about shutting off something that's working in the hopes that people are going to figure out how to use something that isn't working, and without government subsidies, most of these things are not economical. They're significantly more expensive than the current infrastructure that we have. So instead of drying up and killing off our existing infrastructure in the hopes that the new infrastructure is going to spring fully formed and operational, we should have a better transition. And I'm not against clean energy. I think that's a great idea. I think we should harness the power of the sun and use it to run our hair dryer. But the point is that we're just not quite ready for that yet. And if I were focusing on environmental things, I would focus more on pollution, on having more green space, on making sure that our water is clean, those are the environmental things that I would try to pursue, as opposed to just cutting off our energy sources. And you know, people like to be vocal about these moral, moral pursuits, but as soon as the power goes out, a lot of times, they change their mind. So, we need to be careful. We have an aging energy infrastructure. Our grid is a little bit tenuous at times. In Texas, a couple years ago, it shut down because they didn't winterize the windmills. I don't know if you remember this, and all of a sudden, the price of energy skyrocketed. You had some of that going on in Europe too. After Russia initially invaded Ukraine, you had price of energy going to the point where it was shutting down businesses, right? So, we have to be really careful about the potential disaster that could occur here with energy price spikes. 

18:59

In Germany's experiencing a lot of that even now. You can read stories all over the place about costs of energy in Germany today versus what they were before the Russia Ukraine war kicked off. And, you know, the shutdown of gas pipelines between Russia and Germany. You know, there's a lot of debate in Europe around that same time about countries that were shutting down nuclear power plants right, right with the goal of replacing them with wind and solar. And I know in some cases over there, they've reversed course, and now they're bringing nuclear back online

19:30

well, and even corporations in the United States are starting to look at running their own nuclear power plants. Microsoft is the person when the commission a study to see if they would be able to run their artificial intelligence infrastructure, on their own self contained nuclear reactors. So, the danger there, of course, is that, you know, there is a, there is a measurable risk of some sort of meltdown or some sort of contamination event. You end up with spent fuel. That is dangerous for 1000’s of years, they have to find, you know, find something to do with it. So, I think they're just like anything else, there are positives and there are negatives, and we need to weigh those and figure out whether the juice is worth the squeeze.

20:14

I think so, from an investor perspective, if you're looking at energy and you're saying, you know, how do I how do I take advantage of the current energy transition or energy market or challenges, or whatever, whatever term you want to use, you know, how should an investor approach just energy in general? Obviously, there's drawbacks to going the ESG route, right? 

20:35

That's not energy specific, right? I mean, that's, that's more of a marketing campaign than it is an investment strategy. And a lot of those companies in there are simply changing their corporate documents and having hiring quotas in order to make those well, at one point, you had something like

20:51

490 of the 505 companies in the S&P500 that were ESG, and as you pointed out earlier, Tesla wasn't one of them, right? So yeah, certainly a lot of marketing

21:00

there. Yeah. So we currently have energy exposure somewhere in the 4 to 5% range, is in energy securities, but we also have exposure to other things that will benefit from a change in our energy infrastructure, right? So, if you think back to the Gold Rush, it wasn't the prospectors who became rich, it was the person selling shovels. And so one of the areas that I would look to benefit from a change to our entire grid, or our entire infrastructure, is copper. Right? Copper is a industrial metal, and it drives a lot of the infrastructure that you need in order to build the grid, to run lines in your buildings. So I mean, we have some exposure to Freeport-McMoRan, which is one of the largest copper producers in the world. And I would avoid buying directly things like solar energy companies, because they are highly dependent on government subsidies. And if those subsidies dry up because of a change in political climate, you might find that your companies are no longer profitable.

22:06

Yeah, so definitely, maybe requires a little additional thought to what people want to put their money in, right? You know, we talk oftentimes it's not necessarily the headline data point or just the headline in general that you need to pay attention to, it's what's influencing that. Underneath the surface that kind of sounds like your message there, which is, you know, we can all, we can all support for, for various reasons, a transition in energy to whichever direction you think it ought to go. But fundamentally, there'll be companies then that provide good investment opportunity.

22:36

Yeah, I think you have to be careful what you wish for, right, right, perfect. 
 

22:41

So, I think this is kind of a good place to draw us to a close talking about energy, you know, influences a lot of the things day to day. Certainly can challenge a portfolio, but can also benefit from it, as long as you don't maybe get wrapped up in marketing. So, we again thank you for joining us on The Point here today. Again, if you've got a topic out there that you're seeing on the news or talking about the over the water cooler at work and you want to hear us banter on about it, feel free to visit our website, basepointwealth.com or send us an email info at basepointwealth.com Send us your thoughts, your questions, and who knows, we'll stick it in the hat here, and maybe we'll chat about your topic on a future episode. So, thanks again for joining us and take care.

23:26

Thank you for joining us for this episode of The Point Podcast, sponsored by Basepoint Wealth. As always, you can submit questions or topics you'd like to hear discussed to info at basepointwealth.com be sure to subscribe so you don't miss any future episodes. Basepoint Wealth LLC is a registered investment advisor. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to consult with a qualified financial advisor and or tax professional before implementing any strategy discussed herein, past performance is not indicative of future performance.