The energy sector consists of companies in oil and gas exploration (upstream), transport & storage (midstream) and product refining (downstream). Most majors are integrated oil and gas companies, involved in the entire value chain. The sector also includes thermal coal and uranium, which make up less than 1%.
A fall in the U.S. dollar is generally positive for the sector. However, a longer-term shift towards clean energy has been underway since 2004. We believe this trend will continue. Since 2004, renewable capacity investments in the U.S have been increasing at a CAGR of 18.5%. This is the second-largest growth globally, behind China (Figure 1). Despite deregulation of the energy sector during Trump’s term, renewable capacity investments continue to grow at a 2-year CAGR of 15.6%. This suggests an inexorable shift.
Oil production cuts of 6.1% in 2020E may ease oversupply but may be insufficient to offset a greater 8.5% fall in demand caused by Covid-19. As such, we believe oversupply will persist. Based on EIA projections, global oil demand as at end-2021 will still fall short of pre-Covid levels, by around 2.4%. Likewise, surplus production capacity could remain 36% higher than pre-Covid levels as at end-2021 (Figure 3). If this comes to pass, the glut will drag beyond 2021, capping oil prices.
Any virus resurgence may trigger another round of partial lockdowns and prolong travel restrictions. A second wave will cripple the economic recovery and cause U.S. 2020E GDP to fall by 8.5%, compared to the current fall of 7.3% (Figure 2). This would make a sustained recovery in the energy sector highly questionable.
U.S. Elections – Policy Overview
Biden and Trump take opposing stance on environmental policies and climate change.
Another Trump term will likely be positive for the energy sector. During his current term, monthly mining, quarrying and production of crude oil increased close to 45% to a record high at end-2019 (Figure 4). This was partly due to aggressive rollback of climate and environmental policies.
Biden is likely to reinstate the environmental policies which Trump rolled back if he wins. Reverting to pre-Trump production levels would mean a fall of 12.8% from current levels. With prices suppressed in the near term, a further fall in output would be negative for the energy sector.
Instead, Biden will likely accelerate renewable capacity investments in the U.S. and seek to close the country’s gap with China, which has been outpacing the U.S. in renewable capacity investments since 2012 (Figure 1). A US$2tr investment over four years alone would imply an 8.2% increase from current investment levels. We may also expect greater adoption of clean energy by companies as they align with the government policy.
Valuations / Relative Strength:
P/B for the energy sector stood at 0.99x as of end-3Q2020, below its 5-year historical average of 1.81x. Short term, the sector continues to lag the overall market. Only 8% of S&P 500 energy stocks are trading above their 50-day moving averages. This pales in comparison with 77.9% of the stocks in the S&P 500 which are trading above their 50-day moving averages.
We favour the clean-energy space with Biden’s US$2tr climate plan if he is elected. The secular shift towards clean energy will continue, we believe, regardless of who becomes president, though a Biden win could greatly hasten the pace. A Trump win may favour the sector and valuations seem attractive at current levels. However, we remain cautious due to prolonged oversupply and risks of virus resurgence.
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