By Jacob Mitchell, CIO and portfolio manager at Antipodes Partners
While Russia’s invasion of Ukraine has highlighted the fragility of the global energy system, the seeds of the current energy cycle were sown some years ago. Three factors stand out as having formed the energy cycle underway today – debt, decarbonisation and dividends.
The accumulation of significant balance sheet leverage through the last spending and acquisition cycle resulted in an industry that was by 2020 heavily burdened with debt.
For example, by the end of 2020 Exxon Mobil’s net debt to capital had risen to a 30-year high, putting its dividend at risk as the company balanced ways in which it could invest in future growth while urgently addressing its leverage issues. To both sustain its dividend and bring down leverage, the company cut capital expenditure to the bone. Across the industry a similar story played as capital expenditures declined by 60% from the peak in 2014.
Decarbonisation’s sweeping influence across capital markets over the past five years has added even more pressure to the energy sector. Many traditional upstream energy providers have pivoted capital budgets directly towards renewable energy activities at the behest of shareholders and policymakers, diverting capital away from the development of fossil reserves.
Dividends have become the other priority driving corporate behaviour. Capital returns have moved up the pecking order for most in the sector, with a recent pattern of fixed base dividends plus top-up dividends linked to quarterly free cashflow generation having become the norm.
Energy reset following Russian invasion
Russia’s invasion of Ukraine in late February has catalysed a further dramatic reset in global energy markets, adding to capital cycle dynamics already driving prices. Russia is the world’s third largest hydrocarbon producer, behind the US and Saudi Arabia, and provides one third of European gas and produces 11 million barrels of oil per day.
Europe, already struggling under the weight of the world’s highest energy prices, has now moved to eliminate its dependence on Russian gas, announcing the ‘RePowerEu’ plan within days of the invasion. By 2030, the programme seeks to eliminate the need for Russian gas.
In 2021, worldwide LNG trade totalled 480 billion cubic metres (bcm), according to the IEA. Europe’s accelerated move away from Russian gas, which will add an additional 90bcm to global demand, will likely sustain tight conditions for the foreseeable future. Against this backdrop the US stands out, as it has the cheapest natural gas prices in the world and an ambition to liberate its gas stores as additional LNG liquefaction capacity is built for export.
We also expect US domestic politics and policy to support an acceleration in US LNG exports to aid Europe’s move away from Russian gas. For these reasons, it has made sense for us to allocate more of our energy exposure to US natural gas plays as this cycle has evolved.
US leaders to prosper on LNG repricing
Our key holdings here include EQT Corp and Coterra Energy, where we see attractive starting valuations and a much bigger opportunity for US gas to be repriced as LNG export capacity is built-out – along with longevity of earnings power given the scale of each company’s resource base. We see upside to US natural gas prices as exports take an increasing share of US production, coupled with underinvestment in upstream development keeping supply tight.
In addition, we have established positions in providers critical in developing new, as well as modernising existing, energy transport infrastructure. Our holding Technip Energies, for instance, built the world’s very first LNG facility in the 1960s and continues to be among the foremost designers and builder of LNG systems today. Technip’s backlog of business at the end of 2021 stood at €16.4bn, growing by 30% for the year, which dwarfs its equity value of only €2bn.
Elsewhere, Siemens Energy designs and builds gas turbines used in power generation, but also the critical transmission and distribution components used to develop and modernise electrical grids – investment necessary to carry increased loads and link up newly developed wind and solar installations.
Siemens Energy also own two-thirds of Siemens Gamesa, the world’s largest offshore wind turbine company. While there are short term challenges associated with cost inflation, recent EU announcements have reminded us of the long-term commitment the region has to develop its wind resources. Specifically, the RePowerEU programme is accelerating the permitting process for new renewable projects.
