After a hot first half of 2022, many commodity prices are down sharply and crude-oil prices are well off their highs.
Recession fears are driving down prices as investors expect demand for raw materials will fall.
That’s misguided and short-term thinking, as the energy transition will require a large increase in the mining of industrial metals such as copper and aluminum to power an electricity-based, carbon-free future.
Meanwhile, the world still needs to burn traditional fossil fuels during this transition.
Those are the opinions of Kevin Holt, chief investment officer for US value for Invesco who leads several mutual funds including the $9 billion Invesco Comstock ACSTX,
and Invesco Energy IENYX,
This transcript has been edited for length and clarity.
MarketWatch: Energy prices pulled back from their highs in the second half of this year, and commodities are falling. When it comes to traditional energy, what are people focusing on too much and what are they overlooking?
Holt: People are so fixated on short-term demand trends, and they’re not focused on the inherent structural changes that appear to have taken hold in energy. Historically this industry has been “growth at any cost.” They feed into the boom cycles and exacerbate the down cycles. It’s still a cyclical industry, but now they have a much better understanding of return on capital than they’ve had in the past, and are looking at things on a more normalized basis. For these guys to be good investments for the average investor, oil needs to average $75 [a barrel] over the cycle, because [energy producers have] implemented discipline into their models. Seventy-five dollars is now the old $55 because of this discipline. They can generate cash flow probably above $60, $65. To make cost of capital and a return on invested capital adequately, we think that number needs to be $75.
As energy company executives start to look at 2023 and put together their capital budgets… most of the bigger companies have said, “we will not grow more than 5% ever again.” I think most of them this year are probably growing 0% to 2%-3%. I think they’ll migrate to that zero to three [percent]just out of responsibility, because it is hard to predict what demand is going to be [as renewables penetration increases]. Demand growth has always been 1% globally for the last 20 years. The industry doesn’t need to grow more than 1% to 2%.
MarketWatch: The economy is slowing, according to many indicators including manufacturing. Are you in the recession camp?
Holt: If you define the recession as two negative quarters of GDP [gross domestic product], once we get Q2 numbers, we’ll probably be classified as recession because Q1 was negative. With that said, every recession is different. Corporate balance sheets are in much better shape than they’ve been historically, our banking system after 2008 is in a much, much better structural position in terms of capital levels in terms of the underwriting because of the federal government’s kept a better eye on stuff . There’s going to be pockets of weakness, I think, within alternative-asset managers, because that’s where a lot of leveraged loans are held now. But that’s going to be felt more in investment vehicles, as opposed to the overall US economy.
MarketWatch: Renewable energy was a darling for a long time, but for now is out of the headlines with the fossil-fuel resurgence following Russia’s invasion of Ukraine. What does the shift of attention away from this sector means for these companies and investors, and what’s your outlook?
Holt: Wind and solar are here to stay. I think most of us believe that the energy transition is a good thing. And then it’s just a question of just, how long does it take? What are the investments and where’s technology today, relative to where we needed to be to make this transition realistic?
With Russia and Ukraine, it’s highlighted what’s realistic on a shorter-term basis and who are we relying on globally. Europe is pretty reliant on Russia at this point. Then people look at the alternatives [and ask], can we do this faster? We really can’t. So we need to figure out a solution during this transition period of 20 to 30 or 40 years, probably not five years.
MarketWatch: So much of investment in renewables was focused on technology, while mining for the raw materials, such as metals, saw underinvestment. Were investors overly focused on sexy tech versus boring commodities?
Holt: I do think that, at least given where technology is today. It really comes down to what have we based our battery technology on? What are the raw materials that go into that? As you look out three to five years, if you believe that electric vehicles are going to continue to build traction, we’re going to be short a number of materials like copper. I don’t think people appreciate the value of some of these materials. In the short term, they’re getting thrown out with economic fears, but looking over a three- to five-year basis, it’s a very, very healthy scenario in terms of what demand looks like, relative to what supply looks like.
MarketWatch: Does the energy transition mean higher energy and commodity prices are here to stay?
Holt: At the margins, yes. Today you have a very low-cost infrastructure set up with oil and natural gas, maybe even nuclear; a lot of sunk costs built out over the last 100 years. To rebuild brand-new infrastructure is naturally going to cost a lot of money. There are going to be components, like copper, that we’ll need [to build it]. That is going to have inflationary tendencies within those commodities.
The energy transition will be good. It’ll be cleaner. But there is a cost.
MarketWatch: How are traditional energy companies looking at the energy transition?
Holt: Companies like Exxon Mobil XOM,
and Chevron CVX,
are being very selective in their opportunity set because they’re trying to make that cost to capital hurdle. I want to see small-cap new innovative companies trying to solve this issue. I don’t necessarily want my E&P [exploration and production] companies trying to solve this issue.
That said, we’re asking our E&P companies to [reach] zero scope one emissions, zero scope two emissions. We’re going to need oil for a long time, but we need you to be committed to be clean providers of this and be the best companies you can be. [Note: Scope one emissions are the direct greenhouse emissions controlled or owned by an organization and associated with fuel combustion; scope two emissions are indirect greenhouse gas emissions associated with buying electricity, steam, heat or cooling.]
From an ESG perspective, the questions we need to ask the companies that are consuming oil for resin or whatever else is, what is your solution? mr. Beverage Company, what are you doing to solve your plastic bottle use in terms of moving away from resin? mr. Mining Company, what are you doing to lower your emissions?
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