Opportunities in Sustainable Farming Practices
PGIM IAS uses the example of alfalfa to show how farmland, can provide an answer to reducing greenhouse gas emissions.
What a year for the publicly listed energy sector! At the beginning of 2020, Saudi Aramco issued more shares to meet investor demand. But, soon thereafter, due to the pandemic and oil price war between OPEC and Russia, oil prices plummeted, and inventories reached storage capacity. Prices were briefly negative and oil & gas producers filed for bankruptcy with more than $50 billion in outstanding debt.1
Year to date (as of 11/30/2020), the energy sector has returned -25%, while the world equity market has returned 10%. There has also been wide dispersion in returns at the industry level (Figure 1). While renewable energy equipment returned 107%, exploration and production returned -37% – a difference of over 144 percentage points. Over a five-year period, renewable energy equipment and more defensive refining and marketing and integrated oil & gas industries outperformed the broad energy sector. Although renewable energy equipment represents only 3.5% of the energy sector, its long-term outperformance confirms a new trend in energy investing.
As the global economy transitions to non-carbon-based energy sources, investors will be evaluating the role and composition of energy equities in their portfolios. See our most recent webinar on "Investing in Energy" for the outlook and opportunities in energy.
To put this $5 trillion (public debt and equity) global sector in perspective, Figure 2 presents average one-year returns (on a rolling monthly basis) from February 1998 – October 2020. We then show the relative performance of different energy industries in different economic environments. Generally, in overheating (high inflation and growth) and stagflation (high inflation, low growth) environments, the various energy industries (and the sector overall) outperform. During muddled (mediocre inflation and growth) environments, dispersion across energy industries increases with refiners and marketing, pipelines and renewable energy equipment outperforming. In stagnation (low inflation and growth) environments, when energy might be expected to underperform the market, refiners and marketing outperforms both the sector and the market while integrated oil & gas and renewable energy equipment outperform the sector.
Recognizing the wide industry-level performance dispersion, an investor may wish to estimate the macroeconomic or market sensitivities of their energy holdings to check that they align with investment objectives such as inflation protection. We estimate one-year horizon RASA sensitivities to inflation (CPI) and economic activity (CFNAI – Chicago Fed National Activity Index). While the energy sector has a high inflation beta compared to the market, an investor may potentially improve inflation exposures by tilting energy sector holdings to exploration & production, equipment & services and renewable energy equipment.
For an ESG-conscious CIO in an energy transitioning world, the likely winners among oil producers will be those with high ESG scores that harness cheaper and cleaner fuels such as natural gas, renewables and biofuels.
It is important to note that there can be large differences in industry-level ESG ratings across index providers. And, these ratings can vary through time. Furthermore, ratings for two companies in the same industry and country can differ significantly. For example, a Russian company within the integrated oil & gas industry can have a high rating in the toxic emissions & waste category while another Russian company in the same industry can have a much lower rating.
The composition of the energy sector is rapidly changing. The renewable-energy equipment industry includes electrical equipment and semiconductor equipment companies. Even a company in this industry can have a low ESG rating by lagging in human capital development, labor management or corporate governance categories.
Coupled with wide industry level dispersion in risk and return, varying macroeconomic sensitivities and ESG ratings, a CIO may wish to consider an active approach to energy investing and perhaps a bespoke benchmark portfolio that better aligns with their specific investment objectives.
This material represents the view of the author as of 12/21/2020 and is for informational or educational purposes only.
1. Source: Haynes and Boone, LLP.