Why investors shouldn't fall for the obvious green trade

WP has teamed up with Forstrong Global CEO and CIO Tyler Mordy for a weekly series highlighting and analysing seven macro super trends for 2021. In part one, he explained why a fiscal revolution is here, while, for Super Trend 2, he analysed the inflation landscape and its investment implications. In part three, Mordy delved into the low bond yields and the subsequent 'income famine' and, in explaining Super Trend 4, he examined the state of Big Tech. For Super Trend 5, he turned his lens on Europe, while for number 6, it’s the turn of oil.

Read some of the Joe Biden coverage on green initiatives and you could be forgiven for thinking it’s the only energy game in town. Surely we’re all driving EVs back to our solar-powered homes, buoyed by the proceeds of our net zero portfolio.

The reality, of course, is more nuanced. Populations are still largely reliant on fossil fuels. Oil prices have naturally risen off 2020’s negative floor and many green businesses are still jostling for leadership positions in their categories.

However, the super trend from oil to renewable energy was well under way before the global pandemic – and events of the past 12 months have simply accelerated this transition. To analyze this, Tyler Mordy, CEO and CIO of Forstrong Global, told WP that the important question is what has changed, and what hasn’t, as a result of COVID-19?

Let’s start with what will not change. Before the coronavirus hit, several headwinds were working against higher oil prices. First, vehicle efficiency improvements have been evident for years. The highest level of U.S. oil demand was recorded all the way back in 2005 at 20.5 million b/d. Despite the U.S. population growing by some 20 million between 2005-2019 and vehicle miles travelled increasing by 10%, oil consumption in 2019 was still below 2005.

The second point is the arrival of electric vehicles, which will radically lower oil consumption. Mordy believes that oil is still being priced off short-term cyclical trends and re-opening dynamics. However, he pointed out that “whether you agree with climate change or not is irrelevant - there is broad policy support for green initiatives right across the world.”

He said: “Countries like China and India are competing with Europe and the US for electric vehicle penetration. For automakers, the further optimization of the internal combustion engine is becoming increasingly expensive. By contrast, electric vehicles are set to become more profitable as regulatory targets for carbon emissions bite deeper and the cost of batteries continue to fall. These trends have deep roots and are unlikely to reverse course.”

Then you have the changes, which are led by behavioural shifts prompted by the pandemic. Millions of daily commutes have been eliminated by the global lockdown and global air travel, one of the fastest growing sources of demand over the past decade, has also collapsed. Meanwhile, face-to-face business meetings and conferences have been substituted with videoconferencing services.

“In many cases, businesses have already learned they can be more efficient while reducing travel costs,” Mordy added. “How much of this demand destruction is permanent? No one knows for sure at this point. However, it will surely be significant.”

In addition, many major oil companies believe we have actually peaked in terms of oil demand. With that in mind, it’s easy to sway too far to an image of abandoned streets and grounded planes.

Mordy said: “I'm certainly not in the camp that thinks  we will never return to any business travel and that cities are done. During a crisis, many investors can become irrational about the future and extrapolate current trends.”

The energy debate is lively, no doubt. Many believe the death of oil has arrived and the Green Revolution has begun but to understand the sector, investors must put time stamps on the path forward. Forstrong remains positive on oil in the short-term as the cyclical environment improves and restrictions are gradually lifted. However, the CEO urged investors not to lose sight of the longer-term trend.

For Canada, significant headwinds remain and Mordy insisted the onus is on the country’s business community and government to see if they can steadily pivot away from fossil fuels. He noted that “after the commodity boom of 2003 to 2012, the Canadian brand has taken a massive hit. There is much work to do to rebalance our economy and re-establish our global image as a place to that is easy to do business. Until then, our country will remain challenged as a destination for foreign capital.”

Meanwhile, the oil price collapse has redrawn the global map of power. Petrostates like Russia and Saudi Arabia - where the oil sector accounts for nearly 90% of its exports - will see diminishing influence. The U.S. will have to deal with the hangover of its shale oil spending boom, as the energy sector has been a key driver of its growth story over the past decade.

But there will be winners. These will be found in the oil importing regions of Asia and Europe, and will become more apparent as the positive impact on consumption, investment and liquidity materializes over time. The influx of green initiatives will compound the benefits to these regions from a macro viewpoint.

Yet, how should investors play all of this? Mordy explained: “From an investment standpoint and looking out three to five years and longer, oil is not a great place to be. But the problem is that investors have quickly priced in a nearly-utopian, green future.

“Alternative energy and electric vehicle companies have soared well above their underlying fundamentals and priced in even the most optimistic forecasts. That sets them up for future disappointments. What’s more, traditional energy companies themselves are strategically buying renewable assets. They'll be diversifying their mix from fossil fuels into renewables. So the way a green future plays out from an investment perspective, will be a lot messier than many think. As usual, investors need to look for other ways to capture the Super Trend of a structural move away from fossil fuels.”

Mordy offered an example: “If you look at the components that are necessary for the huge rollout of electric vehicles, copper and lithium are two commodities that will have a huge demand for many, many years to come.

“One investment that we've been making for clients is in Chile; the country is the world's top copper producer, the second largest lithium producer, and, despite strong recent performance, Chilean equities are still reasonably valued and do not fully reflect the terms of trade boost exporters have received from these rising commodity prices.”

The message: don’t throw your petrol-guzzling SUV on to the scrap heap just yet but don’t fall for the obvious trade in the coming green wave – there are other ways to play it.