In this week's episode of Industry Focus: Energy, host Sarah Priestley talks with Motley Fool Canada Premium analyst Taylor Muckerman about a flurry of news in the sector this week. General Electric's (NYSE:GE) stock has tanked lately, but the company is straightening itself out for the long term -- and this week's disclosure about new, more transparent accounting standards is just one of many concrete steps in that direction.
Hyundai is shaking up the electric vehicle game with their new Kona Electric crossover SUV, which could have massive market potential. The International Energy Agency forecasts that the U.S. will dominate the oil industry for the next five years. Tune in to find out more.
A full transcript follows the video.
This video was recorded on March 8, 2018.
Sarah Priestley: Welcome to Industry Focus, the show that dives into a different sector of the stock market every day. Today, we're talking Energy and Industrials. It's Thursday, the 8th of March, and we're going to be discussing all kinds of things in the news and energy and industrials. I'm your host, Sarah Priestley, and joining me in the studio is the marvelous Motley Fool Canada Premium analyst -- did you like that introduction?
Taylor Muckerman: Yeah, marvelously premium. [laughs]
Priestley: So, are you into March Madness? Because it's taking over my household.
Muckerman: It actually caught up with me. I had really no idea. I saw some of the ACC tournament on TV upstairs yesterday in The Fool cafe. I have to get my game back.
Priestley: Yeah, we work in a nice place that allows us to play the games. My husband, who is super, super into it, he's a UNC Tarheels fan, does not have the pleasure. I think he has to surreptitiously look on his phone.
Muckerman: Yeah. At least during March Madness, a lot of the networks have the boss button, where you can click it and it'll switch windows really quick for you.
Priestley: [laughs] So, first thing I wanted to touch on was, we got a great listener question from Brendan around the likelihood of Baker-Schultz carbon tax. If you don't know what that is, you are not alone. [laughs] I'll go into it.
Muckerman: Yeah, I'm very much in that boat.
Priestley: The Baker-Schultz carbon tax was devised by the Climate Leadership Council and released in February 2017. It was created by a group of Republicans headed by Reagan's Secretary of State, George Shultz and George W. Bush's Secretary of State, James Baker. It's called "The Conservative Case for Carbon Dividends," and you can read it online. The proposal aims to tax CO2 emissions from the use of fossil fuels at a rate of $40 per ton.
A crucial aspect of this proposal is that it would return the revenues from this in dividends to Americans -- every American, child, adult. I'm paraphrasing the report, but it says these dividends would be distributed on an equal monthly basis via dividend checks or as contributions to an individual's retirement account. They give an example in which a family of four would receive $2,000 in carbon dividends payments the first year, and that would grow over time as the carbon tax rate increases. This is direct quote. They say, "This would create a positive feedback loop. The more the climate is protected, the greater the individual dividend payments to all Americans." So, that's the premise of this.
That was a very, very high-level overview. If you want to learn more about it, just google Baker-Schultz carbon tax, or shoot me an email and I can send it to you, firstname.lastname@example.org. I find it really hard to say Baker-Schultz without saying Baker Hughes.
Muckerman: Yeah, I'm so used to that. We might talk about that later in the show.
Priestley: So, Brendan's question was, how likely is it to come into effect? Well, it seems very unlikely for the next few years. I talked to Eugene Mulero, who was on the show last week. He's the Capitol Hill reporter for Transport Topics. He said the proposal has barely reached discussion level so far, which is unsurprising because it's pretty new. It was only released last year. So, it's not part of the President's tax overhaul. Although there's an outside chance it could be brought into the reform debate, it doesn't look likely at the minute. But, it takes a long time to communicate these things and educate people on what it would actually mean before these things even get put forward.
However, it does have some ground level support with what you might term the next generation of politicians. Which is terrifying. [laughs]
Muckerman: Yeah, but that seems like it's probably a pretty small subset of overall politicians on Capitol Hill.
Priestley: Yeah. So, Brendan, in answer to your question, and thank you very much for sending it in, it seems quite unlikely in the next few years, but it's certainly something to keep an eye on. Thank you, as always, to people writing into the show. We always appreciate hearing from listeners.
Taylor, after that boring soliloquy ... [laughs]
Muckerman: No, I was excited, I was pretty interested. Like I said, I didn't know too much about it. I think it's probably going to take a change in the administration, or at least a rollover on Capitol Hill before anything dramatic happens in terms of environmental protection.
Priestley: Yeah, it's a very interesting proposal. I think it's more academic at this point. And I always love reading stuff like that. But, yes.
Another interesting report, the International Energy Agency, IEA, has forecast that the U.S. will dominate the oil industry for the next five years, and it will become the world's largest oil exporter. That's quite the turnaround from being the world's largest importer at one point.
Muckerman: Yeah. Much to OPEC's demise.
Priestley: It anticipates the states will be able to export five million barrels a day around the world by 2023. We currently export two million barrels a day. This probably didn't come as much of a surprise to you, did it, Taylor?
Muckerman: No. This has been under way for a few years now. It's the reason why prices of oil collapsed down in the $30 range and are now oscillating in the $50-$60 range over the last few months. That's pretty astounding. The first time we've produced over 10 million barrels per day in over 40 years, looking at 11 million barrels per day next year. And as you alluded to, 17 million barrels per day by 2023. So, overtaking Saudi Arabia, Russia, and really putting the screws to OPEC and those countries that have said that they're going to continue to cut production for at least the rest of the year.
But, if they do decide to bring production back online, what's that going to do to prices? You can imagine that the U.S. producers are still going to want to keep the pedal to the metal, as they have. Although, when you think about out a few more years as spending on capital expenditures really fell off the same cliff that oil prices did in the last few years, people are expecting some kind of a shortfall in the next five years because these long-tail projects do take multiple years to bring online. We're talking big, unconventional oil fields and offshore oil that's lost everyone's attention. So, shale has very steep decline curves. You're looking at needing to replace, I think they say, roughly about 3 million barrels per day of oil each year are lost, so, you have to replace that. And if spending hasn't been following suit, maybe OPEC will finally have some salvation if that oil supply isn't there. Maybe holding back will be the smart play in the long run.
Priestley: Absolutely. You've obviously mentioned this, historically low investment, those rates in the report. OPEC Secretary General Mohammed Barkindo also mirrored these concerns. Investments have fallen by 25% in both 2015 and 2016, haven't seen 2017 figures yet.
Muckerman: I'm sure a little bit came back, but yeah, for the most part, still down.
Priestley: And you've mentioned this, it matches up with the period where we had oil over $100 a barrel in 2015. And they fell to below $30 at one point in 2016. It is a concern, like you said. This isn't something that you can just switch on. It's a lot of infrastructure that you have to build, testing, permitting. It'll be interesting to see how that plays out.
Muckerman: Yeah. And like you mentioned, we were at one point a very large importer. We're down to just four million barrels per day of importation. We were at 12.5 million barrels per day in 2005, so cut that in a third in just 13 years, which is pretty impressive. It's kind of ironic that, when you're talking about our exports, with all this tariff talk going on, that China is actually the largest importer of U.S. oil. Kind of interesting to see that dynamic play out.
Priestley: Over the next five years, demand is supposed to increase by 7%. Half of that is meant to come from China. And obviously some of that is the burgeoning middle class, so you have a lot of people wanting plastics and chemicals to make the stuff that you want when you're in the middle class. Then, some of that is also, they brought a lot of refining capability online. Is that right? So, they're importing a lot more crude?
Muckerman: Yeah. So, they can obviously distill that and make the fuels and the petrochemicals, fractionate all of that out into the ability to make, like you said, plastics and pretty much everything you touch on a daily basis, outside of anything that says organic on it. [laughs] Even though, I guess it's technically organic, because it came out of ground. But, yeah, very interesting. And, the LNG export trade that we're getting into in the United States with additional facilities expected to come online this year and over the next several years, in addition to the Cheniere Energy Sabine Pass that's already been exporting LNG for some time now.
Priestley: And you've already mentioned what has sparked all of this, which is shale. For anybody listening who doesn't know what shale, can you explain the difference between that and conventional extraction?
Muckerman: Very briefly, we can go into that. Conventional oil is, you find these huge basins that are in the ground and you basically just have to tap it, and the oil is naturally pressurized. Because it's a large basin, you don't need to open up any fissures, it's just basically a pool of oil down there. Shale is oil that's more or less trapped in layers of rock and shale and sediment over time. You're drilling down through all these layers. And in total, there's a lot of oil down there. But it's not as easy to access as just basically sticking a straw in the ground.
So, they'll drill down and basically send a canister down -- it's much more technical than this -- but, they send a canister down into the ground filled with proppants, and they'll basically light the fuse, explode it, which sends fissure through the shale. Then, they flood it with water, different chemicals, and sand to A, add pressure, and the sand will then keep the fissures open, allowing basically a maze-like structure for oil to flow out of the singular hole being the well. So, they're able to do that, drilling down several miles and horizontally several miles.
And that's all increased over time, therefore giving us access to more oil and natural gas that was once thought to be unattainable. Even still, we're leaving more than 50% of that in the ground. The pipe dream there, no pun intended, is to be able to extract more of that. They're slowly doing that over time, but because of the nature of it, the decline curve is so much steeper than conventional oil. The initial spurt is insane, but you lose a lot of that daily production over the first few months and certainly the first year. It's a much faster replacement cycle with shale vs. the conventional oil that you're seeing offshore and that you're seeing in the Middle East.
Priestley: Absolutely. And that's definitely a consideration, like you were talking about. These don't have the life cycle that we're used to. This really revolutionized the industry, and what furthered that was the ongoing efficiency. That lower cost per barrel, or lower price per barrel, has led to people really concentrating on lowering the cost per barrel. And that enforced discipline on the industry.
Muckerman: Yeah, it did. Originally, it was just a huge land grab. Everyone went out and spent a ton of money. They tried to do it secretly, acquiring land rights at the courts without trying to draw a bunch of attention, but quickly people caught on to the best basins. You've seen energy companies and high production numbers leapfrog from basin to basin to basin. Marcellus and Utica in West Virginia, Pennsylvania and Ohio, still very prolific for natural gas. That really hasn't changed. At one point, you were hearing a lot about the Bakken up in North Dakota with Continental Resources and Harold Hamm. Then, everyone was all in on the Eagle Ford. Now everyone's all in on the Permian. You're extracting the low-hanging fruit. And once that starts to run dry, you start to worry about low oil prices preventing people from making money on this.
But, like you mentioned, efficiencies. You have pad drilling. Basically, instead of having to deconstruct a drilling rig every time you want to drill a new well, which takes time and money, they have what they call pad drilling, which is basically putting a rig on, basically, if you imagine a bulldozer with tractor wheels and the track, is I guess what they call it, you can move these drilling rigs around without having to deconstruct it and then rebuild it. So, you're drilling these wells much faster within a certain parameter of land, and it's making it easier and cheaper. Multi-stage fracking, which is basically just extending that line out underground, and using multiple canisters, drawing the line wire backwards, fracking further out, then fracking closer and closer and closer so that you continue to hit more and more pockets oil. Definitely more efficient. We've talked about people drilling for under $30 a barrel, break even cost. That's the best drillers in the U.S., doing that.
Priestley: Yes. Hopefully that background was helpful to anybody who's been reading any transcripts of conference calls and kind of doesn't understand what any of that stuff means. It was very helpful for me.
Muckerman: And they use seismic data, they can directionally drill with a joystick directly at where they need to be. It's very, very precise these days. But, EOG's former CEO came out recently saying that he's a little nervous that these projections for shale are a little outlandish because of the declines in shale and because he thinks the prime acreage is all but taken. Some people say he's busy talking his own book, because obviously if that's the case, oil prices are likely to rise, and he is the CEO of a small company that has prime acreage in the Permian now. So, only time will tell if that's correct or not, but the pace we're on right now certainly doesn't hint that that's the case.
Priestley: Absolutely. Coming up, we're going to be talking about the stock that everybody seems to love to hate right now, which is GE, and news of Hyundai's new electric contender. I believe that the British say Hyundai differently to how it's said here.
Muckerman: Yeah. I've heard it both ways. I didn't know it was a regional thing. I just think it's people like, "How the heck do you pronounce that name?" [laughs]
Priestley: We need to get some company spokesman to come and set us both right. Just to recap the tragedy that has been GE recently --
Muckerman: That's a good word for it.
Priestley: -- the stock has fallen 50% since last June. It's now trading at its lowest levels for seven years. And it seems like the bad news just doesn't stop coming. Most recently, they filed a full disclosure which recognizes the impact of their new accounting standards. For background on this, there was an SEC investigation. It's been known for many years that they do not have the most transparent accounting. If you look at their free cash flow, for instance, under Bornstein, their former CFO, it's not done the same way as any other industrial company.
They've implemented these new accounting standards or revenue recognition rules to try and become more transparent, more accessible for investors. They've recognized this. They also recognized the effects of tax reform. They're revising back to 2016, which, under the new rules, results in a non-cash charge of retained earnings at $4.2 billion. They also lowered earnings per share for both 2016 and 2017 by $0.13 and $0.16 respectively. Now, the issue here is that this was misrepresented by a lot of the financial journalists and even some analysts, that it was a correction of a misstatement.
Muckerman: Yeah, that's not the case.
Priestley: No, that's absolutely not the case. The company is trying to become more and more transparent. I, as a shareholder, really appreciate that.
Muckerman: Yeah. It's tough, with a company this big.
Priestley: It is, yes.
Muckerman: So diverse. Maybe not the size, but the diversity is definitely a hurdle to get over.
Priestley: Yeah, absolutely. And GE Capital is really the devil on their back right now.
Muckerman: Yeah, it's that thorn in your boot you just can't get out.
Priestley: Yeah. And they have Power, which is underperforming, but Aviation and Healthcare are doing really well. So, it's kind of this mixed bag, and they're trying to parse it all out for people. Then, to top it all off, their CFO Jamie Miller said of earnings estimates, I think you should expect it's at the low end of guidance. Wall Street did not like that.
Muckerman: No. Bad news continues. But, if you think about the way that they report things, maybe they're trying to address that moving forward with a new board member that they're bringing on, Leslie Seidman, a former chairman of the Financial Accounting Standards Board. So, maybe there will be a little more oversight into how they're going to represent their numbers moving forward. And a couple of other new board members that I think are going to bring a lot of diversity and experience to the board. And, they're shrinking it from 18 to 12, which is still a pretty big board.
Priestley: It is a big board. I personally really like the shakeup. I think the one thing that this whole ordeal for GE shareholders has revealed is the mismanagement, essentially, of the company. It's easy for people to say that as commentators, but I would say objectively, there's been mismanagement. So, I like the fresh faces on the board. From my perspective, this is almost over-transparency. However, if you're going to air your dirty laundry, you might as well get it all done in a six-month period.
Muckerman: Spring cleaning, yeah, for sure.
Priestley: I'm praying that it's over.
Muckerman: One other one, Thomas Horton, former chairman and CEO of American Airlines. So, some good insight into one of the largest sector customers, the airline industry. So, that and the former CEO of Danaher, which is a competitor of GE in several lineups.
Priestley: Yeah, very smart moves. Fourth quarter earnings weaker than expected, as we mentioned, due to the Power unit. They didn't revise those estimates before they released earnings, which I think a lot of analysts were perturbed by. The reason that they gave was that they thought the strength of Aviation and Healthcare would offset. That's kind of the ongoing story. Siemens also released earnings, and they performed slightly better. They were showing a bit of more strengthening in pricing, services taking a bit of an uptick, which is something that we haven't seen in that segment before. It's oversubscribed, for want of a better word. So, possibly, there's light at the end of the tunnel there.
Muckerman: And speaking of Siemens, I just saw an announcement today that GE is going to be getting into the battery storage game for solar and wind. So, maybe that'll help out a little bit.
Priestley: I feel that's very sensible. Some stuff to watch out for if you're interested in this stock -- we've had asset sales promised by the CEO, the new CEO, John Flannery. Improvement in operating performance with regard to cost cutting measures. And we're starting to see that somewhat already. Cutting the board. Presumably, the new people will not be cheap, but, cutting boards, cutting exec-level. There's been a lot of layoffs. Obviously awful for the people impacted, but in the next two years or so you're going to start to see that have an effect on the bottom line.
Muckerman: And the ever-growing storm cloud of the pension shortfall is narrowing from 67% funded to 71% funded now, and they say that rising interest rates will only help to close that gap.
Priestley: Yeah, absolutely. I wish I could remember this, I saw something somewhere and it was saying a 0.1% rise in interest rates would almost pay off for that.
Muckerman: Yeah, they're supremely levered to even the most micro increase in interest rates, for sure.
Priestley: So, one good thing to look out for with rising interest rates. They're also looking for a margin recovery. We just discussed GE Power. A lot of that will come from the Services side, which is the high-margin aspect of the business. They almost give away the turbines, having worked in that industry. They also want a trouble-free resolution of the SEC investigation. The revisions that they've made and the new board members suggests to me that that should be within sight.
Muckerman: I agree.
Priestley: So, yeah, we're hoping. We're hoping this is it. Who knows. The next thing I wanted to talk to you about is Hyundai's new SUV. The Korean auto manufacturer has created what our senior auto specialist John Rosevear describes as a potentially world-beating new product, an all-electric small SUV with nearly 300 miles of range. They're calling it the Kona Electric crossover SUV. It's clear this could provide some real competition to the current frontrunner, General Motors' Chevy Bolt. The Bolt is currently America's best-selling electric vehicle. It's sold more than all of Tesla's (NASDAQ:TSLA) models, I believe. The big point of interest essentially is the range available. We don't know if that's going to be a long-range version and then there'll be a shorter-range version. But, 300 miles is very good.
Muckerman: Yeah, for sure.
Priestley: What I wanted to get your opinion on is, as somebody else who follows the industry, Elon Musk trumpeted from the beginning that this was all part of his plan. He wanted to encourage traditional automakers to take electric seriously. I guess this is an indication that that's happening. What do you make of this?
Muckerman: It certainly is. And they went straight at Elon with a couple of Billboards that they've placed around, I don't know exactly where, but I assume it's more in Elon Musk's neighborhood, with the lineup of the Hyundai cars, and it just says, "Your turn, Elon." Interesting, because he's already the first mover in this category for the most part, in terms of broad scale electric vehicle sales. He was the first to make the move. Maybe it should have said, "Your second turn," or, "Your third turn, Elon."
But, it's geared toward the mass market, which, maybe the Model 3 is for Tesla. But still, it's not really stepping on his toes in terms of their SUV, because the Model Y is definitely geared more toward the luxury market, and more of a status symbol than anything else. But, great to see more cars coming out with this electric capability. Yeah, 300 miles is impressive. Getting ahead of a lot of other companies for Hyundai. Definitely good to see. I don't necessarily think this is a shot over Tesla's bow, just because I think they're tracking different markets.
Priestley: Absolutely. The one thing that I do think it's interesting is, it's not a zero-sum game, because the more people who want to buy electric vehicles, the more people are going to be incentivized to establish the infrastructure necessary for electric vehicles. Right now, that's probably the biggest prohibitor for anything long-range.
So, it's all very interesting. We're not sure if it's going to be available in the U.S. I presume that some model or some version will be available in the U.S. But, absolutely, it's an indication that the master plan is taking effect. It's interesting that electric is being chosen when you had all of these alternative energy sources touted when all of this was going off. You had fusion technology, hydrogen fuel cells --
Muckerman: Compressed natural gas, liquefied natural gas.
Priestley: Exactly. And electrics seem to be the choice du jour.
Muckerman: It sure does. And they're not just attacking people buying new cars. Their addressable market is everyone who has a car. As your car gets older and you retire it, or maybe you want a new one, it makes sense to at least consider electric vehicles. The competition there is so much smaller than all petrochemical vehicles that I don't think new entrance is really as big of a threat to even other players in this market as some people make it out to be. You're addressing a smaller pool of competitors. There's thousands of petrol cars vs. a handful of electric vehicles. I think there's a much bigger opportunity there than people are giving everyone credit for, not just Tesla.
Priestley: This plays into our previous discussion about GE's latest investment. I think a lot of people don't understand that an electric vehicle has a huge battery on it. This is kind of a huge cell made of lots of conventional batteries, essentially. So, any investment that you're seeing right now in that area is already sold up, it's already been bought up. But, it's sensible.
Muckerman: And, if you know anything about batteries, they die. There's going to be a replacement cycle on that, as well, not just the car itself. Tesla, far ahead of the game with their Gigafactory, in terms of lithium battery production.
Priestley: Thank you so much for being on the show --
Priestley: -- and talking about all these different things with me. We hope the listeners enjoyed it. That's it from us today, but if you would like to get in touch, please feel free to email us at email@example.com, or tweet us on Twitter @MFIndustryFocus. As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear. Thank you to Steve for mixing the show today. For Taylor, I'm Sarah Priestley. Thanks for listening and Fool on!
Sarah Priestley owns shares of General Electric. Taylor Muckerman owns shares of General Electric and Tesla. The Motley Fool owns shares of and recommends Tesla. The Motley Fool is short shares of General Electric. The Motley Fool has a disclosure policy.