Investment Management

Energy Challenges, Part I

Consumers across the United States – and the world – have been feeling the effects of inflation for several months. Prices are rising at the gas gump, at the grocery store, and even shopping online. In past blogs, we’ve discussed the overarching reasons for inflation[1]; and though this is a complex issue, you may not know that some of the inflation cost in each of these places starts in the energy industry.

The energy industry – encompassing fossil fuels and alternatives — is critical to global economic growth, the improvement of living standards for emerging economies, and national security because it enables the production, transportation, and utilization of goods and services. Let’s start with electricity. Electricity is commonly produced by coal or natural gas – so when the price of these resources increases, so does the cost of electricity. The cost of energy can also directly affect the cost of food. For example, rising natural gas prices have led to widespread production cutbacks in ammonia, an important input for nitrogen-based fertilizer. A decrease in the ammonia supply without a decrease in demand for fertilizer drives up the cost of fertilizer. Thus, increased natural gas prices are driving up the cost of crop production – and these increases are passed along to consumers via higher food prices. In addition, everything we purchase must be transported from its manufacturing site to the consumer – whether that consumer purchases the item from a brick-and-mortar store or online. Transportation occurs via commercial trucks, trains, ships, and airplanes — across land, sea, and air. Each one of these transportation methods requires fuel – so when diesel prices increase, so do shipping costs and the price of goods for the consumer.

Today’s inflationary environment brings the relationship between oil and consumer products into focus — and though this relationship has always existed, it was simply less noticeable in the past decade as the world grew with a cheap and abundant energy supply. During this period, the United States became a swing producer — increasing oil production at an average 8% a year. In addition, neither investors nor consumers paid attention to energy affordability and reliability — instead, energy policies in developed markets shifted from security to sustainability. As a result, money was diverted away from upstream oil and gas into renewable projects.

This poses difficulties for the traditional energy industry — upon which most of our electrical grid is reliant. The traditional energy industry requires capital to add production capacity, maintain proper reserves, and transition to more environmentally-friendly facilities and practices. Though much has already been invested in these efforts, more capital is needed. According to McKinsey Global Institute, to achieve Net Zero by 2050, investment in physical assets must reach about $275 trillion, or an average of $9.2 trillion per year. In addition, in 2021, global spending on the low-carbon energy transition totaled only $755B[2], far below what is required.

When oil prices broke out of the five-year range in 2021 and average national gasoline prices shot up above $3.50 per gallon, consumers and policy makers searched for answers. The truth is that demand for energy continues to grow while supply is experiencing challenges after years of underinvestment.

The examples above show how energy is intertwined into our daily lives – and foreshadow the complexity of shifting the infrastructure of the global economy away from complete reliance on traditional energy sources. We believe this provides a huge opportunity for investors to be part of the solution – and help prevent a structural upward shift in energy costs.

In this series, I will explain how we believe both fossil fuels and alternative energy sources will play an important role in fulfilling future energy needs. I’ll do this by addressing the opportunities and challenges for investing in each type of resource. In the meantime, if you are interested in learning more about private capital investment in energy, we encourage you to read this blog about our Decarbonization fund and/or reach out to your relationship manager.

[1] Balentine, Markets Anticipate a Cleansing for the Post-Pandemic Economy
[2] McKinsey & Company, The net-zero transition

 

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