Source: Zhitong Finance
Goldman Sachs chief commodities analyst reiterated on Thursday that we are in the early stages of an energy supercycle. It said Wall Street’s rotation into natural resources has yet to begin, as share buybacks and the absence of sellers drive shares higher. For capital to flow into the energy sector from other sectors, institutional investors would need to see three years of strong returns.
Zhitong Finance APP has learned that as early as January this year, Jeff Currie, chief commodities analyst at Goldman Sachs, discussed with Grant Williams the “big trends” in the commodity market. At the time, Currie believed that commodity capital spending needed to accelerate to meet the needs of an emerging low-carbon energy system. To maintain a more than 200-year-old fossil fuel system while developing a new low-carbon energy system, Currie sees an additional $16 trillion in capital spending over the next decade. With energy companies largely inactive in 2022, Currie reiterated Thursday that we are in the early stages of an energy supercycle.
It will take time for capital to return to the energy sector
In Currie’s view, Wall Street’s rotation into natural resources has yet to begin, as share buybacks and the absence of sellers drive shares higher. Currie believes that for capital to flow into the energy sector from other sectors, institutional investors need to see three years of strong returns. It may seem inconceivable that Exxon Mobil’s stock is hitting a new all-time high, but it’s actually reasonable considering oil prices were negative two years ago.
Without institutional capital to push stock prices even higher, energy company boards and management teams face a dilemma: buy back stock or invest in new projects. Canadian Natural Resources laid out this dilemma at its first-quarter investor conference. The company has about 11 billion barrels of proven reserves, and even at its current valuation of over $77 billion ($91 billion including debt), the company’s “value” is only $7 per barrel of available resources ($8.27 including debt) /bucket).
With “exploration and development” costs nearly doubling, Natural Resources Canada’s board was effectively forced to buy back stock rather than invest in new projects. In this way, the board can increase resources per share at a cost of $7 to $8.27 per barrel by reducing the number of shares. If the company’s share price doubles again, the board will be faced with a more balanced capital allocation decision of buying back shares at $14 to $16.54 a barrel, or building new projects at a similar cost.
Currie believes the process of rebalancing stock market valuations and development costs will take another three years. After that, energy companies will start allocating funds to new projects rather than buying back stock. Once the process begins, the project will take another three to four years to develop. Further down the line, supply and demand will begin to rebalance and the cycle will come to an end. The overall process will take 10 to 12 years.
In the short term, companies focus more on immediate profits
Goldman’s bullish view above raises a key question. Unlike previous cycles, energy companies have been more muted in their response to energy policy over the next decade. Just Thursday, the European Parliament voted to ban the sale of gasoline-powered vehicles from 2035. Bitumen mines in Canada are expensive and long-lived. When policymakers announce new tax, carbon emissions and plumbing policies every week, will responsible management teams be able to allocate funds to development projects with expected cycles of 30 to 50 years?
In the short term, investors may benefit from commodity prices at all-time highs. Energy companies in the U.S., Canada and Europe are generally committed to accelerating the development of shareholder return frameworks under current conditions. Policies have so far proved ineffective in restraining prices, and a shift in policy could dampen the investment needed to balance markets. As Currie pointed out, this suggests that record second-quarter earnings may just be the beginning of an extended cycle.
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