FidelityConnects: Powering up – Trends in U.S.

energy
Paul Gooden, Senior Equity Research Analyst (FIL)
April 19th, 2023

Where do we sit in the bigger energy picture at this point?

• When oil hit $120 last summer and gas prices were hitting all-time highs, we saw some people
make an analogy to the 1970s where we had two energy crises
o What we’re facing now is more complex
 In 1970s was just an oil crisis, today it’s gas and other factors as well
• One way to think in a framework is the energy trilemma:
o Affordable
o Sustainable
o Reliable
• At various points over last 20 years, we have focused on different points
o Pre-Paris climate deal, affordability
o Post-Paris climate deal, sustainability
o Post-Russia/Ukraine war, reliability
• It’s kind of like whack-a-mole, but you need to manage all 3
• The point is, by not managing all 3, you get unintended consequences
o Coal demand is at all time high when it’s the worst in terms of carbon intensity
o Coal is about 2x as bad as gas, oil is somewhere in the middle

What is the link between the Biden admin’s Inflation Reduction Act (IRA) with the OPEC cuts?

• Let’s start with the OPEC cuts

o OPEC has history of being reactive
o What they did in the start of April is proactive
• US shale is being disciplined for various reasons, including pressure from shareholders to
regressively grow
o This has created a floor on oil prices for now
• China dominates the supply chain of renewables
o The question is, how can you bring up renewables without effectively subsidizing China?
• With the domestic tax credits, the IRA is a game changer for US green energy
o The budget is $400 billion but it’s an uncapped program, some speculate it could be 2-3x
that
There’s been a lot of discussion about the energy transition, is it too fast or too slow? Is the transition
for real?

• The transition is in the first innings

• We have to deal with the real world
o It is not how we’d like it to be
o We have to absorb some truths: coal demand is at an all-time high
• The International Energy Agency’s “Stated Policy Scenario” that takes into account all
government initiatives:
o Forecasts that oil demand will peak in the 2030s
o With that, peak gas demand is likely in the 2040s
• We’re in the early stages, and it will take quite a long time
• Governments are keen to lower the cost of clean energy in general

Does there have to be more investment in oil if it isn’t going to peak until the next decade?

• On one hand, oil companies are careful: they don’t want to invest in stranded assets
o It can take 6-9 years until projects actually start production
o You don’t want to be entering a project only for consumption to start declining when
the project comes online
• So, oil and gas have been underinvesting
• Capex in 2023 will be about 70% down in real terms from 2014
• Some are speculating that peak oil and gas demand may be a bit further out
o In consequence, oil and gas companies are thinking maybe we need more capex
• If we want to transition:
o We need more capex in projects
o We need to focus on the demand side of things
o If you restrict supply, all you will do is bring up the price

Where do oil majors sit on a relative basis on the equity side?

• In 2021 and 22, US energy outperformed market by about 100%

o This followed an extended period of underperformance
• In 2023, given some of that back
o We had a warm winter globally, causing less demand for energy
o The OPEC cut has put a line on the things
• When I look at the overall sector, it’s trading on a 7-7.5x free cash-flow yield
o A lot of that is coming back as dividends for now
• What we’re trying to figure out is - what is the longevity of that?
o I.e., when is peak demand going to happen?
How do the European majors look compared to the US majors?

• European majors have taken a different route than the US majors

• EU majors have aggressively pivoted to clean energy, e.g. wind and solar
• US companies have pivoted more slowly
o You can see this in % of capex going to clean energy vs. oil and gas
• When you look at price to book, the US majors have moved upwards but Europeans downwards
o Oil and gas projects have had great returns, whereas clean energy projects have had
lower, more utility-type returns
• Things are picking up in US, partly from the IRA which provides strong incentives for clean
energy
o Pivoting in happening in areas mostly that are adjacent to their overall businesses:
 Green hydrogen
 Carbon Capture
 Biofuel

Should oil companies be these holistic energy companies, or just focus on pumping oil?

• If we want to invest in utilities or wind and solar as investors, we can do that ourselves
o We don’t need oil and gas companies to do that for us
• Companies should focus on core competencies, and project returns are important

When speaking to companies, what are some questions that you’re asking management?

• It depends on the company

• Upstream gas companies:
o Can’t control prices
o We focus on project execution - oil and gas projects notoriously go over budget and take
longer than anticipated
o And capex decisions - how much is going to capex, are you returning money in the form
of dividends or buybacks?
• Refiners:
o Are closer to the ultimate customer
o We can ask them about demand trends
• Clean energy companies:
o Talking about the IRA
 How much it will help them
 There’s still some fuzziness there
o Demand trends
 Clear there will be a lot of volume growth for companies
 But demand growth can be choppy
• E.g., supply constraints can cause problems
 • There have also been challenges In US energy connecting wind and solar
to the grid

What did you think when you saw the approval for the Willow project in Alaska? It seemed like a
polar opposite of what you would expect the Biden admin to approve a couple of years ago.

• Paul wasn’t surprised it was approved

• From an operator’s perspective, it’s a good (low cost to supply) project
• The decision to approve it shows that the operator had done a lot of work from an
environmental perspective, and got the local government to approve project
• It reflects the Realpolitik of the situation
o Yes, we want to transition - but it’s going to take a while
o This project won’t come on until end of this decade, peak oil demand will be beyond
that timeline
• Shale has been a phenomenal grower but its growth is slowing. It will be slowing
o Growth might plateau when this project comes online

Any thoughts on nuclear?

• No, not an area Paul focuses on

• It’s difficult to invest in from a public markets perspective
• Paul has heard it said that, “Commercial nuclear fusion is a decade away and always will be”
o It’s one thing to demonstrate it in a science lab vs. in a commercial venture
• Just last week, Germany turned off its last nuclear reactor
• France, on the other hand, uses a lot of nuclear has had good reliability
• Overall, it has a part to play
• In energy we need an ‘all of the above’ type approach
o Population is growing, energy demand is growing
o The transition will happen but will take a long time

Is China miles ahead on the green energy front?

• No, but it’s the green energy supply chain that China dominates
o Cover 80-90% of the global supply chain in wind, solar, etc.
o This reflect government subsidies, different ESG thresholds, and other factors
• It kind of becomes a problem:
o The US has a bunch of tariffs and non-tariff blocs restricting flows into the US
• It comes down to the IRA:
o On one hand, you want to massively grow green energy
o At the same time, don’t want to subsidize government-owned companies in China
• But, you are seeing companies respond to IRA tax credits to develop a home grown supply chain
in the US
Looking at the US energy picture, do you look at domestic usage or just exports?

• In terms of global energy demand, the US is the biggest driver

• Diesel demand softening a bit, gasoline demand is hanging in there quite well
• So yes, domestic usage is important to focus on

In terms of opportunities, looking within sectors, which ones provide real opportunities for people?

• There are two areas Paul would highlight:

o Oil field services, international ones in particular
 Again, the global capex picture - 70% below the 2014 peak in real terms
 Upstream companies are increasing capex
• E.g., Saudi Aramco announced a 1/3 increase in capex for 2023
o The second area is clean energy
 We’re still in the first innings of the transition
 Looking at global primary energy consumption, 83% is still from fossil fuels
• This is going to come down
 There’s A lot of growth ahead
 Still, we need to be disciplined, looking for companies with:
• Strong management
• Decent valuations
• High barriers to entry

You said you imagine OPEC wants to have handle on the price ceiling. Tell us about that, why don’t
they want the oil price too high?

• You don’t want to create demand destruction

o By growing the price so high that other technologies like clean energy can flourish
• Paul suspects, for OPEC, ~$80 is quite a good number for them
o No demand destruction, and they can make a lot of money

What would you say are the biggest changes in the energy market after the invasion of Ukraine?

• So, let’s divide it into oil and gas

• Oil:
o With oil, there have been various sanctions imposed from various parties on Russian
exports
o There’s a saying: “Molecules always find their way to market”
 That’s happening - Russian oil going to India to China
o But some people reducing their estimate of oil going to market post-Russia/Ukraine war
• Gas:
 o Is different - it’s a regional commodity, not fungible like Oil
 Very difficult to reroute gas to other parts of the world
o Removing Russian gas from Europe has taken it out of the global supply picture
o Europe is signing LNG deals with the US, Russia building pipelines to China

Does that change the dynamics of buying oil in USD?

• No, in terms of benchmarks, some people have talked about setting new benchmarks from WTI
crude
• But that’s a separate issue

Anything else for people to keep in mind?

• The key thing is: the energy transition will take a while
o We need to start from a position of recognizing where we are
 Which is: not a great spot, really
• We need an ‘all of the above’ type strategy and need to be pragmatic
• For example, gas has half the emissions of goal, does it have a role to play? Definitely.