Understanding the American Energy Matrix
Knowing the strategic importance of this sector for its economy, the Americans have, over the years, seeking new sources of energy generation that allow the machine working at full steam.
Shares of total US energy consumption by major sources in selected years (1776-2017)
Diversification of their sources of energy is a strategic issue and the major sources are outlined in the table below. The oil and coal (fossil fuels) still account for 51% of energy generation, but the natural gas and renewable options have gained space in recent years.
US energy consumption by energy source, 2017
We can summarize the energy destination by saying that there are 5 main sectors of primary energy consumers and their participation in total primary energy consumption in 2017 were: (i) electricity consumed 38.1% of energy generated; (ii) transportation with 28.8%; (iii) Industrial with 22.4%; (iv) Residential with 6.2%; (v) commercial with 4.5%. The usage patterns of energy by generating source varies greatly. For example, the oil provides about 92% of the energy used for transport, but only 1% of the energy used to generate electricity; 91% of the energy generated by coal is destined for the electricity sector.
Self-sufficient in energy? Not. In 2017, the amount of energy produced in the United States was equal to approximately 87.5 quadrillion Btu, and this amounted to approximately 89.6% of the energy consumption of the USA. The remainder can be explained by net imports of crude oil.
For many, this factor explains why so much interest in geopolitical issues worldwide, in particular, those linked to oil, i.e., the fact that even today they are not self-sufficient in energy production and need to import not to stop the “motor”.
The graph below shows the main fuels used for power generation in the USA. Note: the sum of sources reaches 87%, the remainder being explained in good part by imported oil.
US primary energy production by major sources, 2017 (quadrillion British thermal units)
It’s necessary to renew... The oil is still the main source and they need to import part of its consumption. But leaving the controversy and conspiracy theories aside, the USA has increasingly invested in renewable sources of energy and not by chance the consumption of biofuels and other renewable energy sources (excepts dams) more than doubled from 2000 to 2016. The EIA (US Energy Information Administration) estimates that oil and coal tend to lose strength at the expense of renewable energy sources growth, in particular the natural gas and other energy sources (wind and solar), see chart below.
Energy consumption in the United States 1776 – 2040 (quadrillion BTU)
Investing in the sector
If the machine has to be always connected and that power is required, then, is this a good sector to invest? Before answering this difficult question, let's understand some basic points of the sector.
In fact, when we talk about the energy sector, we can divide it into 2 segments with different characteristics that end up being reflected in performances and volatility of these stocks. We have: Energy and Utilities.
Are the companies that are related to the energy production and supply; involved in the exploration and development of reserves of oil or gas, drilling and refining of crude oil and gas.
Upstream represent companies that extract and refine the oil, while Downstream represent the business side of the industry as gas stations (petrol and heating oil).
As common characteristics to these companies, we can mention:
Sector largely influenced by the global balance of supply and demand for energy, and it is implicit oil and gas as large-scale energy sources. Therefore, the sector tends to perform well when the price of oil rises and tends to go wrong when this is reduced.
Highly influenced by global economic cycles.
Sector presents high barriers to entry given the infrastructure level needed for its operation.
Energy Transmission and Distribution
Are the companies that provide the infrastructure (cables, poles, wires, energy distributors, etc), so that the generated energy reaches those who demand it.
As common characteristics to these companies, we can mention:
Sector works with high leverage (debt) given the need for substantial investments.
Companies have a more stable cash generation profile given the low price/income elasticity with the demand and by its ability to pass the costs fluctuations for consumers. In other words, the cycles affect less these companies, because they have a kind of "captive" demand resulting from providing a good or service of first necessity.
Companies highly exposed to interest cycles that directly influence their numbers by means of leverage. For the investor their shares are often seen as "bond proxies".
Sector presents high barriers to entry given the high level of investments for its operation.
About their performance:
Bullish view in power generation:
Bet on long-term cycles of the world economy. Economic growth pulls up the energy demand.
A proven ability of large companies in the sector to adapt to different scenarios.
Bet on innovations and technological developments that raise profits in the industry.
Bear view in power generation: >
High risk and uncertainty coupled to the results of the companies.
Failures of implementation in production may lead to heavy losses.
Elevation of the production costs compresses margins.
Bullish view in transmission and distribution:
Stability and predictability of cash flows and profits;
Strong payment of dividends;
Low but stable/almost constant;
Bear view in transmission and distribution:
Sector strongly regulated by government;
Interest rate elevation reduces the attractiveness and can raise the financial costs with debt;
Natural disasters tend to elevate the need for investments and erode the capacity of payment of dividends.
In terms of aggregate sectoral performance, the graph below gives us an overview of the last 13 years in the energy and utilities sector, in comparison with the S&P 500. Both sectors were clearly "backwards" at the expense of the growing technology sector, in particular after the fall in oil prices in 2015/16 that affected in full the companies in the Energy sector. It was also observed that the utilities sector presents a less volatile behavior as well.
Performance comparison between S&P 500 index (red line), DJ Utilities (green line) and the S&P 500 energy (black line)
Who are the major agents?
Added the sectors of Energy and Utilities (generation and transmission, distribution), they represent 8.2% of the S&P 500. Here is a caveat that in Utilities we can also find companies of Water Utilities Services and Chemicals, that are beyond the scope of this post. Then we can say that the energy “pure” companies tend to be a bit less representative.
S&P 500 sector division
Looking only energy companies we can pick the 10 largest companies in the sector, being 3 considered in Utilities side (more related to energy transmission and distribution, or mixed) - NextEra Energy, Inc., Duke Energy Corporation and Dominion Energy, Inc.; and other 7 more related to the segment of power generation in particular the Oil&Gas: Exxon Mobil Corporation; Chevron Corporation; Schlumberger Limited; ConocoPhillips; EOG Resources, Inc.; Occidental Petroleum Corporation; Phillips 66. Altogether these 10 companies attain a market value of ~US$1 trillion; assets of $1.1 trillion, revenues around US$ 612 billion.
The latest results show a certain difficulty with oil prices (looking for 12 months ago) with profits of "only" $41 billion. The table below summarizes its key figures:
The 10 largest energy companies negotiated in the US stock market
ExxonMobil Corporation is the largest oil and gas company in the world with market value that reaches R$ 1.3 trillion, or 5x the market value of Petrobras for example. The company has more than 500 thousand barrels per day of crude oil capacity and has more than 71 thousand employees operating globally. The company has 3 business segments: Upstream, Downstream and Chemicals.
(i) In the upstream business, the company explores and produces crude oil and natural gas.
(ii) In the Downstream business, the company manufactures and sells petroleum products such as gasoline, jet fuel, heating oil, diesel and propane.
(iii) In Chemicals, the company manufactures and sells petrochemical products of commodities, including olefins, aromatics, polyethylene and polypropylene plastic, and a wide variety of specialty products.
Exxon recent results show its dependence on oil with declining revenues and profits in recent years due to the fall of crude oil in the international market.
Something in line with the earlier discussion, i.e., the fact that the companies suffer a strong influence of their main product price quotation. The chart below shows Exxon stocks (blue line) compared to the price of petroleum (black line). You can see that, although it is not perfect, there is a strong correlation between the two.
Stock performance comparison between XOM (blue line) and the OIL (black line)
Due to the "recent" high of petroleum price (last 2 years, reaching US$62/barrel), the company's results had a strong inflection and begin to show improvement. However, the difficulties faced in its main sector meant that the company would reduce the investment in exploration. Next to this, the company "seized" the low interest rates to renew their debts at lower costs.
Hence, in recent years Exxon considerably increased their dividends and stock repurchase programs and the current dividend yield of 4.2% is much greater than 5 years ago, 2.4%.
NextEra Energy, Inc. operates as an investment holding company with interests in the generation and distribution of electricity, having been founded in 1984 in Juno Beach, Florida. When all the company counts with 45.9 GW of energy generation capacity (a little more than Eletrobras which has 42 GW) and ~15 thousand employees (Eletrobras has 25 thousand). Its energy generation capacity is essentially in gas and nuclear as shown in the chart below:
Generation profile of NextEra Energy Inc.
The company divides its operations in the following business segments: FPL (Florida Power & Light Company), NEER (NextEra Energy Resources) and Corporate & Other.
(I) The FPL segment accounted for 35% of the profits of the company in 2017 and primarily involves the generation, transmission, distribution and sale of electricity in Florida.
(II) The NEER segment accounted for 55% of the profits of the company in 2017. It is responsible for the production of electricity from clean and renewable sources, including wind and solar energy.
(III) The Corporate and other segment accounted for 10% of the profits of the company in 2017 represents other commercial activities that are reported separately.
NextEra can be understood as a renewable energy company (mostly natural gas) which responds by relevant portion of its result, but that also counts with the security and stability of a solid power distribution operation in Florida.
For the future, with the reduction of solar and wind power production costs, the company plans to expand its generation capacity from these sources and hopes to be able to deliver a good growth of profits to its shareholders.
"Always be wary of future promises and analyze the past of the company".
The “value investing style” phrase lies in NextEra Energy analysis. Looking to the past, the company actually managed to deliver good returns and profit growth to its shareholders in recent years with profits growing on average 8%, dividends at 8.9% and the total return to shareholders highly outperforming the S&P or even the industry average.
Selected numbers from NextEra Energy Inc – adjusted earnings per share, dividends per share and total shareholder return
We could follow here talking about the most diverse companies in the sector... but the simpler way for the investor to expose to the sector in diversified manner is through the ETF's.
Let's look at the ETF's energy sector options.
We have a list of 41 ETF's with assets of approximately ~US$38 billion invested, being ~US$28 billion invested in Energy and ~US$10 billion in Utilities. Despite the large number of options, the 10 largest ETF's focus ~93% of the total market value. Below the list of the 10 largest ETF's in the industry:
The 10 largest ETF’s from the energy sector
The largest of them, Energy Select SPDR Sector Fund (XLE), provides exposure to 32 companies in the energy sector, including many of the largest oil producers in the world, being Exxon and Chevron the highest positions of the fund. It offers the advantage of being the largest ETF in the industry and possess greater liquidity of the market.
For those who prefer to invest in smaller companies, the Small Caps, there is Invesco S&P SmallCap Utilities ETF (PSCU) which diversifies investments in 16 companies with lower market capitalization and showed appreciation of almost 100% in the last 5 years.
For those who bet on the development of clean energy, there are 2 options: First Trust NASDAQ Clean Edge Green Energy Index Fund (QCLN) and First Trust NASDAQ Clean Edge Smart Grid Infrastructure Index Fund (GRID). Both diversify investments in approximately 40 companies with operations not only in the US, but in other regions; medium and small businesses. These ETF's invest in companies that are involved in a variety of different activities related to various subsectors of green energy such as biofuels, solar energy and advanced batteries; gauges and devices that generate energy efficiency, power storage and management, software used by the infrastructure sector of intelligent networks, among others.
A world of options. It is important to note that the ETF's offer to the investor different options than the simple bets in the sector. It is possible to invest in those who bet contrary to industry - case of "Inverse Equity ETF's" - or even seek more aggressive returns through an exposure that replicate 2x, 3x or more the performance of the basis assets - case of "Leverage Equity ETF's". You can also invest in ETF's oriented to the payment of dividends or even if you bet on a specific segment as nuclear energy.
On ETFdb.com website, it is possible to do searches and filters for the type of ETF that most suits you.
Finally, but no less important, despite the text being dedicated to investment in U.S. energy companies, investors do not need to be restricted to these. Through the ADRs traded on the American market, the investor can access other markets such as Chile, France, Italy, and still rely on the security of an US Dollar investment. Below a list with some companies in the sector of energy generation and also in the Utilities segment.