|  | | | | Energy Stocks and the Election |
| He’s a conservative, white, male baby boomer. She’s a liberal, multi-racial Gen Xer who communicates her gender identity through preferred pronouns (she/her).
He became President on promises to build a border wall with Mexico. She was a Vice-President who now denies that she was Border Czar and that we have ever had an illegal immigration crisis in the first place.
He formally recognized Jerusalem as the capital of Israel. She chose to meet with a sorority chapter instead of attending the Israeli Prime Minister’s official address to Congress.
Perhaps the only similarity between Donald Trump and Kamala Harris is that they both like to dance on stage. Trump wiggles his elbows to YMCA, while Harris can’t help but groove to the latest hip hop beat coming out of the speakers.
Come November, voters will need to choose between two wildly different candidates. Meanwhile, investors need to prepare for the potential consequences of an election that presents two starkly contrasting visions of America’s future.
Trump and Harris have vast disagreements on economic policy, and nowhere are these more extreme than in the energy space. While Trump consistently uses the phrase “drill, baby, drill” at his rallies, Harris is arguably more concerned about carbon emissions and climate change than even Biden.
There are limits to how much a President can shape any particular sector of the economy, but energy is relatively more sensitive to policy-making than other areas. And it seems clear that both candidates are motivated to influence the direction of the energy sector as much as they reasonably can.
In our view, a Trump victory would on balance be positive for traditional energy stocks along with many other companies that are linked to hydrocarbon production. But the situation is not necessarily as straightforward as it may seem.
High energy prices are usually good for energy stocks. Trump’s clearly stated goal is to reduce fossil fuel prices in order to spur growth and constrain inflation. While Harris may pay lip service to lower prices at the pump, decarbonization advocates generally want to see higher fossil fuel prices in order to discourage consumption (but not so high that it hurts them politically).
During the first Trump administration, energy stocks in fact performed quite poorly as energy prices were subdued. This raises the possibility that a similar pattern could repeat itself in a second administration. |
|  | Total Return of S&P Energy ETF vs. S&P 500 ETF during the first Trump administration |
| By contrast, since Biden took office, energy stocks have significantly outperformed the broader market. It is not an exaggeration to say returns have been exceptional, with the S&P Energy ETF producing an approximately 140% total return in less than four years. |
|  | Total Return of S&P Energy ETF vs. S&P 500 ETF during the Biden administration |
| Boosting domestic energy production is central to Trump’s economic vision. He puts especially heavy emphasis on energy prices in his explanation of the severe inflation that we have experienced under Biden. |
| | So inflation was caused by energy. And what [Biden] did is he started immediately cutting my energy. We had it down to a level—we had it down to, at some points, $1.50. That was a little bit artificial because we had pandemics…. But we had it down to $1.87. We had it very, very low and doing well and not in unusual times. - Donald Trump, interview with Bloomberg (7/16/2024) |
| | There has been cumulative inflation of approximately 20% since Biden came into office. Economists can debate the relative importance of the spike in energy prices to that outcome. Other contributing factors like excessive fiscal stimulus and overly accommodative monetary policy may have been just as relevant, if not more so.
Few informed observers would object to Trump’s claim, however, that the pandemic had a severely negative impact on energy demand.
Energy stocks performed especially poorly once Covid arrived in February 2020. Demand for oil in particular plunged. Spot oil prices even reached negative levels during the pandemic (as storage costs spiked with the oversupply). This naturally had a substantial impact on the earnings power of businesses linked to oil production.
Trump’s first administration came to an end shortly after a wave of global lockdowns depressed oil prices, while Biden took office as global economic activity recovered. The performance of energy stocks during both administrations needs to be interpreted in this context.
Whoever is President can certainly have an effect on oil prices through policy, but as we saw during the pandemic, there are generally much more significant macroeconomic, technological or geopolitical forces at work that drive the price of oil by influencing supply and demand.
What really moves oil prices?
At the risk of oversimplification, we can identify five major developments over the past 20 years that have had a substantial impact on oil prices. |
|  | (1) Housing Bubble (2005-2008). Propped up by easy credit and all kinds of fraudulent financial practices, the U.S. economy saw unsustainable construction activity and consumer spending. Thanks to elevated demand, retail gasoline prices exceeded $4 per gallon in summer 2008. Crude oil prices spiked to nearly $150/barrel.
(2) Global Financial Crisis (2008-2009). Once the credit bubble burst, demand for oil plunged as the world economy entered recession. Oil fell below $50. It would take several years for oil prices to move back towards $100 as new supply was curtailed and demand very gradually recovered.
(3) Shale glut (2014-2015). Widespread deployment of new horizontal fracking technologies led to a surplus of U.S. oil production, which prompted a strategic response by OPEC countries to increase supply themselves in an effort to snuff out U.S. competition. Oil prices once again collapsed through $50 per barrel, which set the stage for a period of sustained low oil prices after Trump was elected. During the Trump years, pro-energy policies and geopolitical stability kept oil prices relatively low despite higher demand from strong economic growth.
(4) Pandemic (2020). Oil demand plunged as the world went into lockdown. Crude oil prices briefly turned negative.
(5) Russia invades Ukraine (2022). Oil prices spiked as the U.S. imposed sanctions on Russian oil and natural gas, which disrupted energy markets worldwide. The actions taken against Russia also coincided with aggressive fiscal spending and accommodative monetary policy, which produced a more generalized inflation that lifted almost all commodity markets. |
| Nat gas: a somewhat different story
The other major fossil fuel that drives energy stock prices is natural gas. Nat gas differs from crude oil in many important respects. While oil is very much a global market, natural gas tends to be more domestically consumed.
Nat gas also has substantially different demand drivers. Whereas crude oil is refined and typically consumed as a transportation fuel, nat gas is generally used for electricity generation and heating. Natural gas prices have followed a somewhat similar pattern as oil prices over the past 20 years but are also impacted by unrelated factors, such as winter weather conditions.
There was a pronounced spike in natural gas prices in the immediate aftermath of the Ukraine conflict, as Russian gas supplies were turned off in Europe, creating a short squeeze for the small percentage of the global natural gas market represented by Liquefied Natural Gas (LNG). But since then, prices have returned to ranges we have seen more or less since around 2005, when the original fracking boom began. |
|  | Election impact on oil and gas prices
Energy stocks unsurprisingly perform well when prices are high, which drives up profits for producers of oil and gas. Other players throughout the energy complex also tend to perform well, as higher profits generally lead to more investment.
So to understand how the election might affect energy stocks, it is important to consider what kind of impact President Trump or President Harris would have on energy prices.
Trump has promised a looser regulatory environment around drilling in the United States, which could include opening up more federal land for exploration and production. This may lead to some job growth. But because oil is a global market and any expanded domestic oil production will take many years to develop and bring to market, from an oil price perspective, this aspect of Trump’s energy policy would likely be less meaningful.
What could be much more impactful to oil prices is how the next President manages diplomatic relations with other oil-producing countries and the overall signal to the fossil fuel industry with respect to its long-term future.
When it comes to diplomacy, this is largely a matter of speculation, but we would expect a second Trump administration to be more interested in a thawing of tensions with Russia and more focused on promoting greater OPEC production. By contrast, Harris has shown no appetite for a negotiated solution to the Ukraine conflict and would likely look to intensify U.S. commitments to fighting climate change. |
| | So, every day, all across our nation, we feel and see the impact of the climate crisis…. It is clear that the clock is not only ticking, it is banging. And we must act. - Kamala Harris (7/14/2023) |
| | A political and regulatory environment that is hostile to fossil fuels will inevitably lead to less investment in fossil fuel production. Less investment means less output, which means higher prices. Our view, therefore, is that oil prices could be lower under a Trump administration than a Harris administration.
Under a Trump administration, however, we would likely see the market embrace a long-term outlook for oil demand that is more optimistic. So even with potentially lower oil prices, stocks that are levered to long-term oil demand could benefit.
Natural gas, as noted earlier, is a different beast.
The decarbonization movement has a somewhat confused relationship with the natural gas industry. Natural gas is of course a fossil fuel, and burning gas contributes to greenhouse gas emissions. The overriding goal of Harris and her peers is to promote so-called zero-emission renewable energy (especially wind and solar).
Natural gas, however, is much better from a carbon emissions perspective than coal. The significant reduction in U.S. carbon emissions in recent decades is largely related to switching from coal to gas for electricity generation.
To the extent a Harris administration wants to continue to promote a rapid transition of the automobile fleet to electric vehicles (EVs), natural gas will have to play a critical role. Natural gas is currently the most important fuel source for the electric grid in the U.S. and accounts for more than 40% of all electrical generation. (Wind and solar are less than 15% combined and represent an intermittent source of power, which has to be backstopped by natural gas and nuclear generation even when wind and solar are deployed.)
With respect to electricity demand, a complicating factor for a potential Harris administration would be the already heavy demands on electric grids now coming from data centers. Whereas efficiency improvements have kept electricity demand stable over the last decade, AI-driven data center demand is expected to drive significant growth in U.S. electricity consumption, on top of EV adoption. Even if renewable energy output grows rapidly, this higher consumption cannot be accommodated without expansion of natural gas generation.
Nat gas: a win-win?
In recent statements, Trump has shown that he is not hostile to EVs per se but believes it should be up to consumers if they want to drive them. |
| | I’m constantly talking about electric vehicles but I don’t mean I’m against them. I’m totally for them…. I’ve driven them and they are incredible, but they’re not for everybody. - Donald Trump (7/20/2024) |
| | In a second Trump administration, we may see policies that on the margin favor gasoline-powered internal combustion vehicles, whereas a Harris administration would continue to promote EVs (and therefore demand for natural gas to support the electric grid). This fact alone might suggest natural gas is a loser in a Trump victory.
Any negative impact on nat gas prices from a policy shift away from EVs, however, is likely to be more than offset by Trump’s promotion of Liquefied Natural Gas (LNG) exports.
In January, noting that “climate change is the existential threat of our time,” the Biden administration temporarily paused further exports of LNG. Trump has stated a clear willingness to promote LNG exports and all the investments in pipelines and processing facilities required to grow America’s LNG export capacity.
Although Trump is certainly not interested in sparking domestic natural gas price increases, a significant escalation of LNG exports would create additional demand for natural gas that would compete with domestic consumption. (Think of what happened to natural gas prices in 2022 after LNG export demand surged.) All things being equal, Trump’s plans to promote LNG exports could lead to higher natural gas prices, as previously “trapped” production gains additional market access.
Mitigating the risk of higher natural gas prices from LNG exports, however, is the likelihood that a more permissive environment for both oil and gas drilling under Trump would lead to more natural gas production. Approximately 15% of all domestic natural gas production is now “associated,” which means gas is produced and captured as a by-product of drilling for oil. Some forecasts call for associated gas to grow as high as 30% of all U.S. natural gas production in the not so distant future.
Terminal values
A key concept in corporate valuation is “terminal value.” In any discounted cash flow analysis, the terminal value represents the final year of cash flow that is modeled out (typically something like 10 years forward). The analyst will generally apply a multiple to that year’s cash flow that reflects long-term prospects for growth and then discount it back. The most important decision in any corporate valuation exercise is usually that terminal multiple.
Notwithstanding the recent comeback in energy stocks, in recent years, in the face of the global decarbonization movement, investors have been less willing to apply high multiples to traditional energy companies due to the perception that these companies have a limited life span.
While the pandemic was the main reason energy stocks performed poorly during the Trump years, we also saw the dramatic rise of ESG investing in this time frame. Arguably the main objective of the ESG movement has been to make fossil fuel companies “unownable” for institutional investors. So even before anyone knew what Covid-19 was, we witnessed a rotation away from energy stocks while Trump was President and the application of more cautious valuation metrics.
The end of ESG?
The significant outperformance of energy stocks since the outbreak of war in Ukraine has done major damage to the ESG movement, which was largely sold on its merits as an investment strategy. The main premise of ESG is that fossil fuels are too risky, but over the past several years this narrative has been demolished.
With the war in Ukraine highlighting the extent to which the world still relies on fossil fuels and the importance of energy security, the ESG movement is in retreat. On this topic, we recommend a recently produced short film by the Financial Times called “Who Killed the ESG Party?” |
|  | ESG has been an important variable affecting the flow of capital into traditional energy stocks. The movement may indeed be in its last innings because of its own shortcomings, and a Trump Presidency would likely accelerate its demise. There are indications that the Securities and Exchange Commission (SEC) under Trump would intensify restrictions on ESG investment strategies, which many see as conflicting with the fiduciary obligations of asset managers.
If Harris is elected, we would on the other hand likely see a revival of support for ESG and other investment industry efforts that target carbon emissions. |
| Conclusions
With investment in new capacity discouraged and less diplomatic focus on the subject, oil prices might be higher if Harris wins the election instead of Trump. This could be helpful for the profitability of oil-producers and related businesses.
Natural gas prices are more of a mixed bag. Democrat promotion of EVs would tend to benefit natural gas over crude oil as a transportation fuel, while Republican promotion of LNG exports could create more foreign demand.
As important as oil and gas prices are, we believe the most important impact from the election will be the effect on market perceptions of the long-term political, regulatory and investment climate surrounding fossil fuels. Put simply, a Trump victory would represent a pivot back to traditional energy sources and would de-risk investments in businesses linked to the creation and distribution of fossil fuels.
Across our Model Portfolios, we have several energy sector holdings along with other businesses that are indirectly tied to the sector. In our July Monthly Portfolio Reviews, we will discuss how each of these securities might specifically be affected by potential policy shifts resulting from the election. |
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