In this episode of Industry Focus: Energy, host Nick Sciple is joined by Motley Fool contributor Jason Hall to break down what happened with the blackouts in Texas and potential impacts the situation could have across the energy and industrial sectors.
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This video was recorded on February 18, 2021.
Nick Sciple: Welcome to Industry Focus. I'm Nick Sciple. Texas is dominating the energy world this week with a generational winter storm leaving millions without power. Motley Fool contributor Jason Hall joins me to break down what's going on with these Texas blackouts and its broader implications. Jason, welcome back on the podcast.
Jason Hall: Hey, Nick. Good to be on. I have a brother in Texas. He's in San Antonio, so he's pretty far south but he's been in Texas on and off since '89. This is tough.
Sciple: Yeah. I can imagine. So, yes, snow in Texas in general, crazy. Snow to the extent that it's shutting it down the power grid is wild. I think this continues this past year. You want to look back at March of last year, it was really when this whole pandemic stuff started. We've had a crazy hurricane season. We went into the Greek alphabet. Now we have this, a blackout in Texas. It's really been a crazy year. What is going on in Texas right now? Fundamentally, what is happening?
Hall: Everything's frozen. I think that's really about it. I think that's the biggest issue. They get cold weather in Texas, especially the further North you move, but it's such a sustained period of below-freezing, single-digit even, whether that so much of the infrastructure is just frozen. It's impacted their ability to get gas through the pipelines to the gas plants. I think one thing that's leading the headlines is these frozen wind turbines. A lot of fingers are getting pointed at wind and renewables as being the cause of this. That's a little inaccurate. We'll talk about it. But it's definitely those 100-year event scale kind of things.
Sciple: Right. This is the type of thing where certainly there was some wind production impacted, frozen by these temperatures, but that alone wasn't what did it. There's lots of these factors all coinciding at once, pipelines frozen shut, even had a nuclear plant with some freezing of water involved in its facility.
Hall: It was a frozen sensor that shutdown that facility, yeah.
Sciple: Yes. All these things frozen, try to think one thing that's remarkable is you can't winterize these facilities to be prepared for these types of events. Texas had a similar blackout in the past, not a multi-day blackout as we've seen this past week, but in 2011, phase-rolling blackouts due to a winter freeze. The Federal regulators actually advised the Texas grid operators to winterize its grid to prevent further problems. Those steps weren't necessarily taken and now we are where we're at today. When you think about that, if you're someone in Texas and you said, "Hey, we didn't winterize," what explanation do we have for those folks?
Hall: A couple of things. There's always disaster planning, and I think it's ERCOT, right?
Sciple: Electric Reliability Council of Texas. I'm sure lots of people know what that means today. I did not know what that organization was before this week.
Hall: Elon Musk went so far as to call them out in a tweet saying they're not living up to the R in the name, which is the reliability. Of course, Musk relocated his residency to Texas and there's plans for the company involving the state. It's tough because you have disaster planning but Nick, you and I, we're talking offline about, philosophically, where do you draw the line between the capital investments that you want to spend and the costs for planning for something that most people will never experience in their lifetime, just like this crazy confluence of things that have happened? One of the things that a professor who covers energy and also looks at environmental aspects, meteorological, pointed out that one of the things that was happening is ERCOT allowed some of these power producers to bring facilities down for maintenance to prepare for the summer peak when they had some line of sights and forecast that were close enough to be relatively predicted that there could be risk to the grid of some outages. If you go through it, it seems like there were just systemic things, like lots of little things, almost death by a million paper cuts, so to speak. Do you think that's a good way to think about this?
Sciple: Yeah. I think so. Part of it is there were advisories for if you're a grid operator, you should winterize, but these weren't mandatory. Then we layer on if you're a grid operator, do I want to make this investment in winterization when this is an event that may not happen, at least at this scale in decades or ever? If you're someone who is a customer of that grid operator, do I want to pay higher effective rates because of that investment to ensure against something that is unlikely to happen? It's very easy to look back with a 2020 hindsight and say, "Yeah, of course, they should have winterized." When you're making that decision, obviously, you don't have the full scale of how the probabilities are going to fall out. That said, we have had these probabilities fall out this way. We have had a historic blackout in Texas. Lots of people are upset. How do you think this changes the regulatory environment for utilities going forward? Again, you're in California. There were some impacts from utility under-investment there as well.
Hall: Yeah. I'm glad you brought that up, Nick. I live in Southern California and it dominated the news the past two or three summers. The rolling blackouts throughout the state, the wildfires, PG&E went through bankruptcy because they were found liable for a tremendous amount of billions and billions of dollars in damage from fires because their transmission lines were not properly maintained. I want to be careful here and think about this from a couple of perspectives. Thinking about as a yield utility investor, utility companies that are publicly traded, they're public companies that we own shares in, they have two mandates. They have a mandate to provide power at a regulated cost, and they have a mandate to return to investors. These are dividend investments that return a portion of those cash flows to investors. So there's significant attention because to a certain extent, there's almost fighting. Really, it's a conflict of interest, and that's where the regulators are supposed to come in, is to make sure that these businesses are meeting their obligations to their customers and then whatever is left over can go to the owners.
The question becomes, as an investor, do I need to reevaluate the way I'm thinking about the extremes of weather, because you have climate and then you have weather. Climate changes are happening and a lot of people, the connotation we hear, is global warming. If global warming is a real thing, what the heck is happening in Texas? It's actually part and parcel. There are more extreme weather events. Think about the hurricane season we talked about, how much longer it's become, how many more large storms we're getting. I think investors just need to be a little more cautious about what's the worst case scenario you want to think about if you're investing in any utility that's in an affected area because at the end of the day, these are supposed to be safe, stable investments that can generate some meaningful rate of return and generate income, right?
Sciple: Yeah, certainly. You had some of these utilities that were forced to buy power on the spot market at prevailing prices which were heavily inflated and then deliver power to customers at those lower regulated rates. Some of those utilities caught in those positions. Another thing to think about, Jason, that I've thought about is you talked about utilities being regulated. There are certain requirements around the investments they need to make and those sorts of things. There are some shifts coming out of this when you look at what's happened with PG&E and the goings on in Texas, then ups the requirements of capital that these companies have to put in to ensure against these types of events.
There is a story you could tell that future returns for holders of those utilities could go down. Just capital requirements go up, capital that's available to go to shareholders goes down. We'll have to see what happens but I think there's going to be some wide-ranging implications. I think it's important to note that the power is starting to come back in Texas this morning. I think they were down to about half a million people without power. Another one of these issues we talked about earlier, Jason, looking out longer term, is the role of renewable. Renewables have been very politicized in this conversation. Many people are quick to come out and say renewables are responsible for this. Do you think this impacts the appetite for folks to want to have renewables as part of their grid in a meaningful way going forward?
Hall: I don't expect it will. I think it's important to remember that whenever there's any sort of natural disaster or large-scale event like this, there's always immediate political posturing. It always happens. It's because this is just part of our political commentary, and politicians are going to look for ways to position themselves to leverage this event in some sort of way. We saw that happen very quickly in Texas, particularly with a number of folks coming out and blaming wind turbines as being the cause of this problem, blaming federal subsidies that have shifted the amount of renewables in Texas and maybe push natural gas out. Frankly, it's a little bit inaccurate, because if you look at ERCOT's planning, the expectation for when, particularly this is the big one, because it's winter and solar really wasn't expected to be a major source. But wind was expected to be a very, very small portion of power production. Again, at the end of the day, this is like an entire infrastructure thing that took a hit.
Here's my expectation, and I think it's really important as an investor to try to step back and be as objective as you can. Wherever you fall on government subsidies for renewables, stance on any of the political stuff, this is where you really have to go check in and think about it. I think what we might see is, we're going to see continued political posturing. That's going to drive a lot of the headlines, but I don't think it's going to change any of the incentives, I don't think it's going to change any of the regulations. Texas still has two things very much in its favor: a lot of sun [laughs] for a lot of the year, and a lot of wind for a lot of the year. You get up into the panhandle on the western side of the state, and it falls in what they call the Saudi Arabian wind, which is that Midwestern corridor of the United States that has some of the most consistent, predictable wind output in the world. Here's the other part too, as much as subsidies have played a role and will continue to play a role, the levelized cost of production has continued to fall because the technology just continues to get better and better and better every year. I would say this, I think if investors were looking for maybe one kind of, "Hey, here's a good place to look," because I think it's something that more utilities are going to look at as well, is you start thinking about the independent power producers. You think about Brookfield Renewable, ticker BEPC, you think about Atlantica Sustainable Infrastructure, ticker AY. They focus on renewables. There are some others that are independent power producers, NextEra Energy Partners, NEP, they also have some gas production.
I think what we're going to see potentially, is more and more utilities, they're going to operate the infrastructure, and they're going to connect to the right payers, and they're going to rely more and more on independent power producers to provide them with power, because they're going to need it. They're going to need to have that flex. Plus, it means less capital investments for them to make, which means lower risk, less liabilities on the balance sheet.
Sciple: Yes. I agree with you as far as the role of renewable going forward. We'll have to see what happens from a regulatory point of view, what changes are made for these companies to see what happens to utilities. There are some other impacts outside the utility space directly that I think are worth talking about as well. One of those is just in construction. One of the stats I pulled, so Austin Water put out a statement so this is the water utility for Austin Texas to its customers saying they had many thousands of residential pipe bursts, many dozens of water main breaks. First thing I think about is just, we've got to replace all that. If there has been many thousands of residential pipe bursts, that means many thousands of homes and apartments that have significant damage need to be torn out, replaced, or what have you. How should we be thinking about the read through in this construction demand, demand for lumber, those sorts of things?
Hall: Again, I think this is one that's mostly going to be an on-the-ground localized thing. But I can tell you this, if I'm a homebuilder operating in Texas and that's a key market, like LGI Homes, ticker LGIH, is a big win. I think Green Brick also has some operations in Texas. Again, these are smaller operators. Their labor costs just went up 10%-20% or maybe more for a substantial part of at least the spring season because there's just a whole lot of renovation work that's going to need to be done. You think about the burst pipes inside houses, other damage, then you start talking about -- again, this is what's easy to forget. By the way, we are still in the midst of a global pandemic. Think about all of those unoccupied commercial spaces that nobody thought about, and the power went out, and the heating went out, and all the pipes froze in those buildings. The implications could be pretty enormous in terms of construction costs, and the implications I think are pretty noteworthy. Again, homebuilders, I think as an investor, those are the companies I think are going to bear some of the implications of maybe headwinds for that. If I'm [...] or Lowes, I'm rubbing my hands together right now because these companies, it's going to be a benefit for them, but it's temporary. There's nothing durable that's coming out of this that I think is really creating an opportunistic, "Hey I should invest X here because it's something that's durable." I don't think that's the case.
Sciple: Yeah. I think certainly if you're someone who's going out to buy a home today, or wants to build a new home today, your construction is going to be significantly more expensive. It's going to increase some of those costs in a time where there really has been just significantly historic amounts of demand for housing. You layer on top the already elevated cost for construction materials because of what I said earlier I believe about when we went into the Greek alphabet in hurricanes. This is already in an environment where there is elevated demand for some of these materials. I think you can expect to see some of these commodity prices go up. Along those same lines, oil prices are moving up in a significant way. We've seen U.S. oil output down four million barrels per day, largest ever decline. U.S. down 40% overall. How should we be thinking about this impact in the oil and gas market? Lots of wells frozen and maybe might not be producing soon.
Hall: Yeah. A couple of things on the commodity side. Lumbers are already at all-time high prices, so the homebuilders are going to continue to take a beating there and additional labor costs, and then you start looking at oil. Here's the good thing: in terms of the implications broadly, there's a lot of oil in a lot of places around the world that can be brought online to soak up, they can help meet the global demand, because global demand is actually on the rise as the vaccines are starting to be rolled out. Some areas are able to start opening up economically. Who are some of the big ones in Texas right now? Oxy [Occidental Petroleum Corporation], they've had some force majeure. Who else has had some?
Sciple: Yeah, Chevron has had one as well, Plains All American Pipeline because of issues with their power supply. Lots of folks being impacted.
Hall: Was it like four million barrels a day I think this knock back? That's like 40% of U.S. oil output that's offline.
Sciple: That's 4% of global consumption. Remember, normalized obviously, demand down somewhat because of the pandemic. You have some read through impacts on oil and gas. Again, this is another one of these things that I think is going to be a bit of an air bubble. One interesting thing, you had Texas ban natural gas exports from the state through February 21st. I think it was structured as a first right of refusal for Texas. That's a constitutional interstate commerce loophole there. But you have states circling the wagons around their energy supplies with this Texas, I think so. Impacts there probably won't be incredibly long lasting, but in the near-term, there are some folks turning on supplies that are doing quite well. I saw one stat with spot prices for natural gas in Oklahoma up to over $1,000 per million British thermal units, it was a huge, massive amount.
Hall: Again, context, $3 is a good price [laughs], $1,000 is not a good price.
Sciple: Yeah. One of the things that we were talking about before the show, Jason, and this isn't like an absolute answer because we're talking about inflation and macro stuff that is maybe a little mushy. But you're going to see a lot of people come out and say, listen, Lumber prices, all-time highs, oil and gas shooting up to crazy highs. I'm sure copper, other types of construction materials are going to be up, and they're going to point it out and say, "Listen, guys, inflation is going through the roof. We've been calling for inflation for years. The Fed overshot on their interest rates. We need to watch out for inflation." What's your response to those thoughts on those types of sentiments?
Hall: Yeah. I think it's going to be reflected in the inflation numbers to some extent for probably a quarter, but again, this is Texas, Texas is one of the largest states. Texas drives, economically, costs a lot. But again, I don't think this is going to be meaningful or durable. I don't think this is the kind of thing that you think about as true inflation, because again, it's just a blip on the radar. Think about hurricane season in Florida for example, that's another thing I think we don't fully know yet how disastrous it's going to be in terms of cost. How much is it really going to affect lumber costs? How much is it going to affect some of those other materials in a meaningful way, because there's going to be a big volume of sales of those products in Texas that's going to drive it? I think the bigger impact is definitely going to be oil and gas. We're going to see maybe somewhat of a sustained increased cost, but the flipside of that is, as much as Texas is really important for oil and gas, there's a lot of gas coming out of Wyoming. Wyoming has some pretty extreme weather. They're built to deal with winter. You still got the Dakotas that produce a lot of gas, a lot of oil, and you mentioned Saudi Arabia for oil, Russia as well. They can lever up. They can meet that demand relatively quickly. I don't think the implications are necessarily as big as we thought. Again, I don't see any durable upside for anybody as, OK, let's go invest in Continental Resources or something like that. I just don't see somebody that's not Texas-based as being a big sustained winner from this.
Sciple: Absolutely. Just to maybe underlie those natural gas prices, very localized because of the dislocation in the market, this huge spike in demand. You're not going to be able to realize those on a global basis and to the extent, you're not going to be able to realize it for any extended period because people are smart and they like to make money and they're going to compete that away and get the supplies onto to meet demand. We've talked a lot about, there are going to be some impacts over the next six months in maybe construction materials, oil and gas as this air pocket plays out. We'll see what happens on a regulatory basis. The story is dominating the news this week. When we come back, Jason, six months from now and we're talking on this podcast, what aspects of this story do you think are going to still be relevant, we'll still be paying attention to six months from now?
Hall: If there's anything, maybe the regulatory implications. I think that's one thing to consider for utilities. There could be additional costs, additional burdens put on utility companies in multiple areas, because it's possible that we see other states say, we have to act. We have to act while there's political will to make sure this doesn't happen here. I think there are some potential implications there. As an investor, they were focused on utilities, looking at them as safe investments with that higher floor. I think I would want to reevaluate where those companies are operating and if they have higher regulatory risks, then maybe I was factoring in that could affect the income they generate for me. I think that's one thing I would consider. But I think most of the impacts, sadly, they're going to be the human toll in the areas that are affected, the people that are affected, the people that are fighting their insurance company to get enough money to fix the pipes that have burst and ruined their entire home. The insurers, we talked about that, you think about companies like Berkshire Hathaway, they have these massive reinsurance operations. You think about the property casualty insurers that operate in Texas, I would reevaluate those companies and make sure that I own ones that have strong balance sheets, that have good reinsurance in place to protect them. I think those are investor implications. But I think in general, six months from now, sadly, it's just going to be the people of Texas that are still trying to recover.
Sciple: The big takeaway for me is things that have never happened before, happen all the time. Lots of things we've seen in the past year as an example. You're going to see lots of things like this as an investor. Be prepared for them, don't be surprised, and we'll talk about them as they happen. Jason, thank you for joining me on the podcast, as always.
Hall: This was great. I'm glad we could pivot to talk about something timely like this. To our listeners in Texas, anybody that's affected by this, we're thinking about you guys. Like I said, I have a brother in San Antonio. Luckily, they're far enough south. They haven't been really harmed, but they've had a few inches of snow and still have some cold weather. So, we're thinking about you guys and just wish everybody to be safe and careful out there.
Sciple: All the best wishes from all of us at The Fool. As always, people on the program may own companies discussed on the show and The Motley Fool may have formal recommendations for or against the stocks discussed, so don't buy or sell anything based solely on what you hear. Thanks to Tim Sparks for mixing the show, for Jason Hall. I'm Nick Sciple. Thanks for listening and Fool on!