We didn’t run out of stones in the Stone Age, bronze in the Bronze Age or iron in the Iron Age.
The same goes for wood, dung, coal, steam, oil and uranium. In fact, we never run out of anything. We always just move on.
Technology and the price mechanism are what determine this process. Technology determines the cost of finding and using different commodities to generate energy. And the price mechanism ensures we use the right mix of those resources.
If we’re running low on oil, as the peak oil theory suggests, its price will just rise and open opportunities for renewable energy to fill the void. After all, oil replaced steam power without any catastrophic event or shortage we still talk about now. It was a gradual process determined by economics.
If you can stay on top of technology trends and understand the price mechanism, you have the makings of a successful commodity investor.
On our sister publication Exponential Investor we cover extensively energy and commodities among other technology-related topics.
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For those who are already following the energy markets and just want some stock picks, click here to go directly to my energy stock picks for 2018.
You’ll know which companies’ technologies are set to become viable using which energy resources, and you’ll be able to position your portfolio to profit.
So what’s going on now and what does it hold in store for energy markets?
As you’ll discover below, technology is surging in the renewable energy sector. But the commercialisation of those technologies is built on the shaky foundations of political backing, not solid economics. And renewable energy suppliers have some deep flaws we need to confront before they’ll be a good bet.
In the more established fossil fuel world, technology is rejigging the economics of extraction in large, established companies’ favour. Nuclear power is set for a long delayed comeback in a forgotten form too.
There’s great news for investors. Energy commodities are incredibly underpriced relative to the wider stockmarket, making now a great time to invest in this sector. Let’s dig in…
Renewable energy revolutions
Environmentalism has thrust green energy on to centre stage. But renewable energy has made sense since windmills were still mills and hydropower ground grain at dams the size of your local pond. Environmental policies just messed with the price mechanism to push the transition to renewable energy sources along faster than it would have happened anyway.
It doesn’t matter whether you think that’s good or bad. It does mean that a bet on renewable energy in the medium term is a bet on political policy, not economic sense. You need to keep in mind that without political backing, companies like Tesla are toast.
Sales of electric cars fell 60.5% in Denmark when the country ended their tax break. Then there was the diesel fuel disaster in the UK. Having subsidised diesel cars for their lower environmental impact, the science was proven wrong and then the sales crashed.
But there’s an optimistic side too. Corn farmers in the US bet big on the whole ethanol subsidy story and made enormous profits. Wind energy farm companies have taken on enormous contracts. Tesla shares are a success story too.
Technology tends to run at a faster pace than the government can keep up with. And technology is racing along when it comes to alternative energy.
Spray-on solar power means we will soon be able to coat almost any surface to become a source of power. Geothermal energy could resurge thanks to new discoveries in Devon and Cornwall, ironically the birthplace of the steam engine too.
The biggest revolution has been in battery technology. The problem with electricity is distributing and storing it. Especially when you want to use it to travel with and if you want to use solar and wind to power a car battery.
But improvements in battery capacity mean that cars and other vehicles could soon be powered electrically in a viable way. Perhaps that’s already happened if you ask car companies about their latest models. But it’s not cost-efficient without government help yet.
The UK government is considering an electric charging lane on its motorways to help electric vehicles recharge while driving. You don’t have to plug in, just drive over the markers at a normal pace.
Renewable energy’s bizarre contradictions
Renewable energy has some difficult contradictions to overcome before the world can abandon fossil fuels.
Take for example the negative electricity prices which hit Germany in 2016 and are expected to again at the time of writing. A storm in Germany is set to cause overcapacity from wind farms and offshore wind parks. That can damage the power network if it isn’t used up. So the utility had to pay people to use power.
Then there’s the story of pump-back hydropower. Because electricity prices peak at certain times, it actually pays off to pump water up a hill into a dam during the off-peak time and then let it flow back down through a turbine during the peak. It’s a sort of battery that you use when the demand and price for electricity is high.
These sorts of schemes are innovative and impressive solutions to problems. But they’re problems created by the lack of matching up energy needs with energy production. We shouldn’t have the problem in the first place if we want to be efficient.
Batteries are the obvious solution to renewable energy’s timing problem. Batteries store and distribute energy. If we could make batteries effective, it could revolutionise the viability of renewable energy for the grid. And there’s certainly a lot to report there already.
Companies like Tesla and Panasonic made huge investments in battery technology that are paying off now. Commercialisation is hitting the market – no doubt you’ve seen and heard about home battery tech products already.
The return of thorium nuclear power
Nuclear power isn’t very popular these days. After Fukushima, many nations announced plans to abandon it. But there’s a different type of nuclear power to the one you know about.
Unfortunately, using thorium to power your reactors doesn’t have any weapons potential. That’s why researchers abandoned using the material back when nuclear weapons were still considered a good idea.
Using thorium also reduces waste and the risks of a meltdown are extremely low. Mining thorium has a mix of advantages and disadvantages. It’s rarely in any concentrated form, but there’s plenty of thorium ore in politically safe countries like Australia.
Hopefully thorium can make a comeback someday soon.
Fossil fuels are down, but not out
Despite all this, there’s no way fossil fuels will be knocked off their perch anytime soon. They’ll continue to generate the power we need to survive for a long list of reasons.
Without vast government subsidies for renewable and clean energy, they could not compete with fossil fuels. But can we continue to afford such subsidies given the state of government budgets around the world? We’ll see.
Our growing industries and innovations all use electricity. A high price of power leaves innovation hamstrung by making it too expensive. Turning to cheap power gives a country the edge. This creates an ironic situation where trying to be innovative when it comes to generating power actually hinders other innovation by raising the cost of power.
Fossil fuels can be cleaned up using technology too. We’ll see plenty of innovation in this area, especially if it’s given an inkling of the government support that renewable energy is.
The world’s population is still growing, and growing richer. Huge amounts of people around the world are set to begin consuming ever growing amounts of electricity. Trying to sell renewable energy to poverty stricken people is a no go, especially when you include the subsidies their government has to provide to make it economical.
The world still builds more coal power plants than it shuts. Investments in fossil fuels have plenty of time to run.
The geopolitical struggle for resources
Natural resources belong to “the people”, political leaders tell their faithful. By which they mean themselves via a shifty organisation called the government. Taxes, royalties, licences, approvals, tariffs, bribes, confiscation and plenty more go with being active in commodity and energy markets. Political risk is a total nightmare.
Africa’s political instability can be traced to the corruption and dodgy deals required to dig up valuable energy resources there. Russia’s control of gas flows means it holds enormous power over Ukraine and western Europe. People literally froze to death over one such dispute in 2009.
Oil is the mother of all geopolitical struggle causers. The Nazis’ decision to fight on two fronts was partially motivated by oil. The Royal Navy’s quest for dominance made Winston Churchill refit ships to run on oil instead of steam. Wars in the Middle East continue to wage over black gold ever since.
Even in developed and stable markets like Australia, the threat of policies like the Minerals Resources Rent Tax, or banning uranium mining and exports, can come out of nowhere. Then there’s Scotland’s independence bid, which oil is a major factor in.
In all commodity investment decisions, political risk must be high on your list of things to investigate.
Energy resources are undervalued
The following chart shows just how undervalued energy has become relative to the rest of the market.
It shows the value of a commodity index divided by the broader market. Specifically, the Goldman Sachs Commodity Index (GSCI) divided by the S&P 500. (The GSCI is mostly made up of energy commodities.) When it’s high, commodities are expensive compared to the stockmarket. When it’s low, commodities are cheap.
As you can see, it’s at the bottom of the range. The last time we were here, the ratio turned upwards on a long bull market.
Energy stock picks for 2018
If you want to bet on an energy boom, there is a selection of ways to do it. You might invest in an energy exchange-traded fund (ETF) that holds the actual resources. Or perhaps a basket of the world’s leading energy companies. You could pick the individual companies you like most and buy their shares. Some offer fascinating opportunities.
The energy sector might be beaten down right now, but it’s still an easy place to invest. Let’s take a look at each of these options.
ETFS Commodity Securities Limited ETFS Energy [LON:AIGE] tracks the Bloomberg Energy Total Return Subindex which holds four different energy commodity contracts – crude oil, heating oil, natural gas and unleaded gasoline. These are the commodities themselves, not companies. That means your investment will track commodity prices, not the performance of the companies producing them.
If you’d prefer to invest in the companies that explore and produce, check out iShares S&P 500 Energy Sector UCITS ETF USD [LON:IUES]. It follows the return of the S&P 500 Energy Index by investing in the world’s dominant energy companies.
But what about individual stock picks? Your obvious bet is Glencore PLC [LON:GLEN], one of the world’s largest energy companies. It’s very diversified in every way.
If you’re looking for something more exciting, Gazprom [LON:OGZD] certainly fits that bill. It’s one of the world’s largest energy companies, but mired in controversy. It supplies Europe with enormous amounts of gas from Russia via Ukraine. The reason I highlight it to you is that it’s extraordinarily cheap on price-to-value ratios. The share price could easily double or triple to match the valuation of its competitors. Thanks to the political risk, people are hesitant to buy it.
What about investing in renewable and clean energy? There’s a decent ETF for that world too. The iShares Global Clean Energy UCITS ETF [LON:INRG] tries to match the S&P Global Clean Energy Index. It holds the 30 largest and most liquid listed clean energy related companies from around the world. Solar, tech and utilities are all in the internationally diversified mix.
As for breakthrough technology in this area, I’ll leave that to the experts.
The greenest city in Europe
Just a few months ago I went to visit the award-winning greenest city in Europe. The honour had been bestowed on my birthplace, Essen in Germany. It adds to an impressive list of honours for the place nobody has heard of. It was the most bombed city in World War 2, and was once part of the largest industrial area in the world. This year, the last coal mine is set to close.
What makes the place so remarkable is that it went from the dirtiest, most industrial and coal-driven place to winning the greenest city in Europe award. My ancestors went from coal miners to passionate greenies over the course of just three generations.
The mountains you see on the horizon from the top of a former coal mine tower are actually the heaps of waste dug out of the ground by the countless mines in the area. They’re now covered in parks and trees as though they’d always been there. One has a religious statue on top visited by a Pope. The river which disappeared after being turned into a sewage system is being reborn too.
Change comes fast in the energy world. And it’s the same in financial markets. You need to keep up.