How Investors Can Benefit From Energy’s Coming Changes
JPM’s Michael Cembalest explores opportunities as renewables rise, but fossil fuels will too as the population grows.
Renewable energy is expanding amid concerns over climate change. That represents an opportunity for investors. At the same time, traditional oil and gas output is growing, too. So that also is an option, although those concerned about limiting carbon output likely would skip it.
The U.S. and the rest of the world are moving to decarbonize, but that does not mean that fossil fuel investments are goners, according to Michael Cembalest, chairman of market and investment strategy for J.P. Morgan Asset and Wealth Management, in a recent paper. An expanding global population means that demand for energy, in particular the traditional kind, is swelling too, he noted.
“The fossil fuel share of global energy use is falling at ~0.40% per year as the renewable transition progresses,” he wrote. Nonetheless, “global CO2 emissions have not declined since energy consumption keeps rising; what’s falling is the share of primary energy from fossil fuels, not their level.”
The world is moving toward the “electrification of everything,” he observed, such as home heating, now mainly done with fossil fuels. “The reason: if something can be electrified, it can eventually be decarbonized via wind, solar and energy storage,” he explained.
That said, he went on, “While this transition is underway, it will take time due to chemistry, physics, cost, human behavior and politics.” Coal usage is on the downswing, but natural gas (a carbon emitter, albeit less than coal) is gaining. A lot of gas will be employed to propel the electrification. Since 2018, gas usage has grown an average of 4% annually. As Cembalest put it, “current human prosperity is difficult to imagine without substantial contributions from natural gas.”
The top global renewable energy companies—NextEra Energy Inc. (U.S.), Vestas Wind Systems AS (Denmark) and Brookfield Renewable Partners L.P. (U.S.)—have shown good stock growth over the past five years, averaging around 11% annually. At the same time, the fossil fuel industry has seen comparable share increases: oil-and-gas giant Exxon Mobil Corp. for instance, is up 11.8% yearly over the same period.
Regardless, valuation multiples are below the market average (the S&P 500’s trailing price/earnings ratio is 24), with traditional fossil fuel providers behind renewables. Oil and gas prices were low for several years due to the pandemic, and now oil is recovering, although gas is lagging, amid ample supplies for both commodities. Exxon’s P/E is 14 and NextEra’s is 19.
Cembalest wrote that “energy sector valuation multiples remain low due to concerns about stranded asset risk, and the degree to which some institutional investors either cannot or will not invest in the sector.” Stranded asset risk refers to fears that oil and gas will be so out of favor that their worth will be destroyed—in Cembalest’s reckoning, an unlikely scenario. Meanwhile, numerous university endowments and public pension plans are divesting their holdings in oil and gas stocks.
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