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Energy Edition: 2021 Review & 2022 Preview

By Matthew DiLallo – Updated Dec 24, 2021 at 5:05PM

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Motley Fool contributors Jason Hall and Matt DiLallo join the show to break down the defining energy themes of 2021 and share their predictions for 2022.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

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This video was recorded on Dec. 16 2021.

Nick Sciple: Welcome Industry Focus. I'm Nick Sciple with 2021 coming to an end. Jason Hall and Matt DiLallo are here with me to take a look at the year that was in energy and share their predictions for 2022. Jason and Matt, thanks for joining me.

Matt DiLallo: Thanks for having me.

Nick Sciple: Great to be here with you. This time December every year, we tend to do a year end review episode, take a look at what's happening in energy and look ahead to what is going to happen here in next year. I've asked both of you to bring three stories that defined energy for you in 2021 and then one prediction for 2022. Without further ado, let's get to it. Jason, let's lead off with you. What's your first story for you that defined 2021 in energy?

Jason Hall: One thing that I think just really interesting that's happened, and I think a lot of people are just overlooking at is you're going to see the oil and gas industry be more involved in renewable fuels. The one that I wanted to highlight for that is Phillips 66. Phillips 66 has got a refinery in the UK that's been producing a small amount of renewable diesel, biodiesel for a while, but it's converting a pretty significant, one of its refineries located in Northern California, its rodeo facility, to be 100 percent to be renewable diesel. It's going to be producing hundreds of millions of gallons of diesel per day from things like soybeans, used cooking oil, lots of waste products like that. I think we're just going to see more companies focus on traditional oil and gas companies. They're going to be producing renewable fuels.

Nick Sciple: Absolutely. If folks want to hear more about that, we did an episode back in February with David Gardner. One of the companies we talked about there is Darling Ingredients, which is a market leader in processing things like used cooking oil, etc. Also, very heavily involved in renewable diesel, they're 50 percent partner in Diamond Green Diesel with Valero Energy. They were one of the earlier movers into this renewable diesel space. To your point, Jason, we've seen lots and lots of other companies start to come in, whether it's Phillips 66 with their project, there's been a number of private equity projects as well. Part of that is government starting to incentivize some of these fuels. There appears to be a clear path to profitability with a little bit of government support and clearly a trend that I think is going to continue playing out over the next several years.

Jason Hall: Phillips 66 has a history of finding ways to make money using feedstocks, and having better access with just really high-quality refineries. I think they're going to be a leader in this.

Nick Sciple: Matt, what have you got for your first story here?

Matt DiLallo: Mine is playing on the same theme of energy companies going renewable, but this is the midstream industry. Your pipeline companies and processing companies, there's a lot of big names like Kinder Morgan, Energy Transfer, Williams, they've all launched what they're calling new energy ventures groups this year to get into this space. They're doing a lot of different things a lot of them, like they'll buy solar power or wind power to self-power their pipeline operations to reduce emissions. But they're also looking at ways that they can leverage their base business of storing and transporting liquid fuels and taking that into alternatives, like Jason mentioned, renewable diesel. Well, this is a bread and butter business for some of these companies was just regular diesel. 

Now they are using those same facilities, investing the capital that needs to reinvest and to bring them up to the type of standards for these things and then using that to grow in the future. Kinder Morgan, for example, they are really getting into renewable natural gas. They bought a company called Kinder Rex Energy, which is building I think it's three renewable natural gas facilities. What they're taking is gas from landfills, all that methane that landfills are producing, they're taking that and putting it into pipelines. It's much lower carbon emissions. It's a fairly good business for them because it fits right into their existing pipelines. They don't have to do anything with that. 

Then they are looking at other things like carbon capture and storage, hydrogen. They want to get into this future of energy, and we're seeing the same thing with Williams. They're doing very similar things. They have a lot of land in Wyoming, they want to put a big wind farm out there and see if they could use that to generate hydrogen with that. Energy Transfer, another big midstream company. They're looking at very similar things, self-powering and how they can get into processing, storing, exporting these types of alternative fuels. There's a big trend that's really paying to the forefront this year.

Nick Sciple: Taking these pipes and then transporting a new form of liquid. Matt, how early on would you say that these companies are on the process of getting involved in this renewables space, still relatively immaterial to the overall business, but growing?

Matt DiLallo: Yeah, definitely immaterial. For example, Kinder Morgan is spending about $1.2 billion this upcoming year to expand their natural gas pipeline business and some oil. They're probably going to spend maybe 200 million of that on these smaller projects. Some of them are only $50 million projects. They want to build a renewable diesel hub out in California, little project right now, but it has big implications.

Nick Sciple: Snowball rolling down hill. As we see proof-of-concept in Kinder Morgan, you say, hey, look at this project we've done in renewable diesel. Hey, other company we can go run the similar playbook for you. Clearly, a story we're going to continue to see playing out over the next couple of years. Jason, what's your second topic for us?

Jason Hall: I would boggle the mind a little bit when you start peeling back the layers and look at carbon capture and hydrogen. A company that I'm looking at through the lens of is Chart Industries. I was going through a recent presentation the company did back in November, highlighting a big manufacturing, their main manufacturing facility. One of the slides they have shows their acquisitions and strategic investments that they've made starting back in 2018. You look at 2018, 2019 and it was an expansion to the facility. They acquired a cryogenics company. They bought VRV, which is an Italian company. They did as the same cryogenics mainly for natural gas and industrial gas. They bought Air-X-Changers from Harsco, which was tied to liquefied natural gas. 

They divested part of their business that didn't really fit. That year was all liquefied natural gas, that was clear the thing. Then you flip the calendar to 2020 and 2021, and I counted a dozen deals that they did where they either made acquisitions or there were strategic investments taking on maybe a minority stake or master supply agreements. Every single one of them, they were three, were tied to either carbon capture or hydrogen, every single one. The thing we've been talking about with Chart for most of the past six or eight years has been liquefied natural gas is the need to get more natural gas around the world. 

They make the equipment to get that gas from places where its produced like North America to places like Asia and Europe where they need it. But there's been so much focus on carbon capture and liquefied natural gas just over the past two years if you look at their acquisitions. Here's the thing, this has caught me of guard too. They did that presentation in November. Since they released that presentation, they've made three more announcements of acquisitions or joint ventures. They are really hitting the gas pedal focusing on carbon capture and on hydrogen. They're calling those two combined $30 billion market opportunities by 2030. That's 10 times larger than they are right now. To me, that's really compelling.

Nick Sciple: Again, next-generation fuels. I've been involved in liquefied natural gas, now getting involved in carbon capture and storage. Again, an example of some of these energy-related businesses. Now starting to transition at somewhat into these industries of the future at least in the energy space. Matt, what's your second story?

Matt DiLallo: This marks along the same theme and just looking more broadly at overall big oil. Last year, we saw a lot of the European big oil companies, BP, TotalEnergies, they really started to get into renewable energy. Offshore wind is a big thing that they're looking at, and that was how Europeans are playing this energy transition. This year, the US big oil companies gave investors their blueprint of the way they are tackling the energy transition and it's completely different. They're going into the industries Jason talked about. Carbon capture storage is the big thing that Exxon is looking at. Chevron is another one, carbon capture and storage and they're both pumping a lot of money into this, a lot more money. Exxon, for example, plans to spend $15 billion over the next six years on carbon capture and storage and hydrogen. 

That's up from 10 billion that they initially planned to spend, and then Chevron just recently tripled their low-carbon investment. For that, that means renewable fuels, which we've touched on earlier, carbon capture and storage and hydrogen. They're going to spend about $10 billion through 2028. Now, those sound big numbers and they are, but compared to what Exxon and Chevron spend overall, I think Chevron is around $15 billion a year in their oil and gas. These aren't material, but the whole idea is they want to produce what is close to net zero oil as possible. With carbon capture and storage, the idea is all the carbon emissions as they're producing oil and then burning oil, if they can capture that in store that, offsetting that emissions, and then oil becomes a viable commercial fuel as we're trying to combat climate change. That's the direction they're going. It's completely different from Europe. I think it's a high-risk bet, but they really are pumping a lot of money into it.

Nick Sciple: Matt, what do you make of? Do you think these results would've happened but for the activist pressure those companies faced earlier this year, or to what extent do you think this is being driven by just the investor environment?

Matt DiLallo: I think it's a totally investor environment. I think Exxon and Chevron would rather just invest in oil because that's where they can get the returns. They know that business. This is really trying to be part of the solution. I personally question whether carbon capture and storage and low carbon oil is going to be a viable alternative.

Jason Hall: Me too.

Matt DiLallo: If green hydrogen becomes that solution, which we have a lot of big names like NextEra Energy and Brookfield are investing in that. If that becomes the big thing, then they've really wasted a lot of money.

Nick Sciple: That's the question, we'll see how it plays out. There's one argument on the side of activist that says, "If you don't transition, then you're not going to have a business here 10 years down the line." and there's the other bucket of folks that says, "Hey, you got to make money to have a business." Maybe these things won't make money, that's why they play the games, that's why we have to monitor these companies and see what the actual future looks like. But that's a big question facing the industry today, that still we don't have all the answers to. Jason, your third story.

Jason Hall: I was thinking I would just take a look at what's happened in offshore oil, I guess you'd really say what hasn't happened. But I think looking at the bigger picture is actually more useful. Baker Hughes, the largest oil and gas services companies in the world releases a monthly rig count and it produces a global rig count. I just thought it would be really interesting to talk about the numbers here. In 2021, so far, this is through November. There have been an average of 1,343 rigs, active operating rigs, globally. That's actually lower than it was last year, it was 1,352 in 2020. It surprised me that it was a little bit lower. Now, there's some upside here. The past couple of months, October, November, it was over 1,500, so we're seeing it go up. 

But let's go back to 2019, 2018, 2017, all of the preceding years. The rig counts consistently we're over 2,000 every year. In 2019, were actually above 2,200 which was probably too many because the reality is that they knew heading into the end of the year, the projections where that oil demand would actually fall in 2020, mainly because China and COVID. Even back then at the end of 2020, it was like there's this virus in China and it's probably going to affect their oil demand. The last time we saw rig counts this low was in 2016, and they were around 1,600. For those who don't remember, oil prices hit like below $30 a barrel early that year coming out of the 2014-2015, the peak. Then oil was over $100 a barrel. Just thinking about broadly two years of rig counts being this low, I think it's going to support one of Matt's predictions that he's going to make a little bit later.

Nick Sciple: Yeah, we really are seeing spending on oil and gas exploration at a cyclical low, it looks like so. A number I came across the other day, Evercore ISI put out productions. US oil producers are on pace to spend the lowest amount of capital on exploration and production since 2004. Clearly, not as strong environment to be investing incremental dollars on oil and gas, which over the long term is arguably constructive to the oil and gas price as long as demand remains intact, maybe we'll talk about that a little bit later. Matt, your story mentions a little bit about how much capital is getting allocated toward exploration and production. You want to talk about your third story?

Matt DiLallo: Yeah. Usually, when we have higher prices, which we had this year. Oil companies in the US, the Shell companies that can really produce oil quickly, they'll ramp up their drilling programs and pump as much oil as they can. This year, that didn't happen. Instead of pumping all this money into their CapEx program, they are returning that to shareholders. It's a good thing for shareholders. Whether that's a good thing for the market, we'll see. But it's just been an amazing, the amount of money that they have decided to return to shareholders. A lot of them decided we're going to keep production level with last year's level and anything regenerate above and beyond what we need to keep production steady, we are returning that to shareholders. They're doing that is pretty interesting, a lot of them, they'll pay like their typical dividend. 

But then in addition to that, they're paying variable dividends and they're paying out a significant portion of cash flow net. I'm going to run through a couple of names. Devon Energy, their variable dividend is 50 percent of their excess cash after capital expense and their base dividend. That variable dividend has gone up every quarter because oil prices have gone up. Devon is just making more money as they integrate, they made a big deal earlier this year. That's really just been pumping a ton of the cash flow into their business, they're also repurchasing some shares. Pioneer Natural Resource is a big Permian driller, they're paying up to 75 percent of their excess cash each quarter and dividends and they're also repurchasing shares. Now, they see their dividend which couldn't yield around 9-11 percent could actually double next year if oil prices continue to rise. They get all these merger synergies, they made a couple of big deals. 

We're talking about huge, huge dividends coming from these companies. ConocoPhillips, big oil company in the United States. Their planning on returning seven billion dollars in cash investors in this coming year. It includes a base dividend, $3.5 billion of share repurchases. Then a billion dollar variable dividend, they're calling available return of cash. 

They're actually staggering theirs. Devon and Pioneer, they're paying their base dividend in court in variable dividend together. ConocoPhillips is offsetting a different quarter, so gives investors a little bit more cash flow. Then EOG Resources, they've always been like a huge growth company. Anytime oil prices went up, they were just ramping up production. They're not doing that, they've increased their dividend twice this year. Ten percent the first time, 82 percent the next time. They pay two special dividends, really, really big special dividends, and then they've set a $5 billion share repurchase program. You have some of the biggest growth companies in the oil industry not growing, they're all returning cash to investors.

Nick Sciple: Really, a huge shift in how capital is being allocated. If you think about it, when all this money was being invested in production, the beneficiaries are the folks who were getting low prices at the pump. More and more oils out in the market, the lower the prices go. Now as we see, oil and gas companies being more restrained, more and more value is actually being captured by the shareholders in oil and gas businesses, we'll see how long that lasts. But there's an argument to be made that this is probably the best time in a long time to be a shareholder in some of these companies, given the amount of money that's being pushed into production and also the amount of cash you're getting back as a shareholder.

Matt DiLallo: Yeah, I agree. Even the ones that are growing, when we do need production, they can actually add some incremental production. It'll be interesting to see oil prices hit $100, is that what's going to break the camel back and then they go to that, "Drill baby, drill." But right now, it's all about giving money to shareholders.

Jason Hall: Well, the key is it's not what these companies are going to do in that regard. It's all the other independents that are not following this similar strategy.

Nick Sciple: Right, they're private equity folks, etc. Well, Matt, you mentioned $100 oil, so maybe let's stick with you for our 2022 predictions, what do you have for us?

Matt DiLallo: I think based on what Jason was saying and then based on what I was saying, I think oil prices are going be higher over the next year, I think they could even hit $100 a barrel if we have a supply shock, we've had those almost every year. There's been something that happens, somebody will bomb Saudi Arabia in the oil production or there'll be fires in Canada, something seems to happen that shocks the oil market, I think we'll see that this year and it could send oil to $100. You add that with booster shots being widely available, new drugs to combat COVID. I think we're going to be a lot more travel going on, International travel should rebound, It just all sets up for high alarm for instance.

Nick Sciple: Demand is going up and supply is not following suit based on what you said as far as the amount of cash being allocated to production. That's a combination that makes for higher oil prices.

Jason Hall: It's not even close. That's the thing. It's not even just the investments that weren't made last year or in 2021 or 2020. We're talking about investments that weren't made five years ago. This isn't just a COVID story, this is a story that's been playing out over the past 6-7 years really.

Matt DiLallo: That's for these variable dividends. They could be really substantial next year. If you have $100 oil, you're talking some big time dividends.

Nick Sciple: Jason, what is your prediction for 2022?

Jason Hall: Honestly, this is a bit of a softball for me. The renewable industries, you think about utility scale projects like solar and wind. It's a pretty cyclical space for the way that the investments are made, the capital is allocated out from one year to the next, they change a lot even though the big long tail trend is growth. We're in a bit of a weak spot in the cycle right now and a lot of the projections are that next year will be relatively flat. But I think we're going to see some growth. I think the cycle is going to turn next year. I think that's going to be good for one company, in particular, TPI Composites, ticker TPIC. This is a bit of an easy guess prediction here. The company almost went bankrupt this year. I don't think that's much of a stretch to say that. It was far closer to being bankrupt the management, whatever admit. But here's the bottom line. 

When you have to go to Oaktree Capital, which is the lender of last resort, and pay an 11 percent interest rate to get your hands on 400 million plus in capital and you tell investors that you were out of compliance with some of your lending agreements, you are in trouble. But the core business is really important. Wind turbine industry is big and it's global. As one manufacturer, you can't manufacturer turbines in every market you participate in because it's too expensive. You don't have enough scale to get the volume to do it cost effectively. You can't manufacture from somewhere else from 5,000 miles because they're so giant and the model doesn't work. That puts TPI Composites in a really good position, is like the vendor of choice for third-party manufacturing for all of the wind turbine companies out there. I think it's going to be a good year and I think the stock is going to go up pretty substantially, assuming the management learned its lesson and they don't screw it up.

Nick Sciple: Well, I don't think there's a lot of data out there about the growth of wind energy. Offshore is one particular area where there seems to be a lot of excitement.

Jason Hall: Very much, and the technology has gotten a lot better. There has been billions of dollars that have been putting into making those offshore turbines even bigger and more powerful, and that's important because that's a place where you can pretty much predict that there's going to be wind a lot of the time, you just have to maximize how much power you get out of every bit of wind that you get offshore.

Nick Sciple: We've got a couple of minutes extra, so I'll jump in with one prediction. I will contribute to the team here. I think 2022 is going to be the year that nuclear energy goes from heel to face in the global energy market. For the longest time, nuclear has been something that's been on the decline, something we don't want to build incremental nuclear capacity, but I think the rubber is starting to hit the road when it comes to energy prices such that attitudes are shifting. One example is in Europe. We just had the Netherlands coalition government basically announce that they're going to build their next-generation energy strategy around nuclear. 

You've got France and Germany battling back and forth around whether nuclear will be classified as clean energy in the EU, you've also got some very public battles of which Elon Musk has gotten involved around the Diablo Canyon nuclear plant in California with folks debating back and forth. I think given the prices that we're seeing in natural gas and they are insane in Europe. Just the constraints to really shift to renewables like wind and solar, given the intermittency and the stress it puts on the grid as you get more and more intermittent energy sources, I think we're reaching the point where folks are going to have to come to Jesus a little bit with nuclear energy. Nuclear makes up 20 percent of the energy mix in the US, it's much larger in other countries, we need baseload power that can be produced in a carbon-free environment. I think we've just reached the point where given the way the cycle is turning in fossil fuels, we're going to have some hard decisions to make on nuclear. I think 2022 is the year where sentiment turns.

Jason Hall: No, I think you're spot on. I think the bottom line is that the biggest thing here is political will, and the further we get away from Fukushima Daiichi, the terrible disaster that happened in Japan. It fades from the public consciousness and the perception of the risk and the danger, and the math about the safety of nuclear starts to become more of the reality of the way people think about it in terms of safety and the real harm of climate change in carbon and spewing carbon into the atmosphere becomes more apparent. I think that's what's going to change. Is the cowardice that we've seen from politicians around the world is going to be able to go away because there's an economic story that makes sense and more people are going to feel safe about it.

Nick Sciple: Yeah, it's still a very difficult space to invest in right now and a lot of pure-plays.

Jason Hall: Just invest in Brookfield Asset Management. You want to invest in nuclear just buy Brookfield because they've got a big investment there that's going to be worth a lot more money over the next five years.

Nick Sciple: They took Westinghouse out of bankruptcy and I believe in 2019, and they service basically all the nuclear plants in North America or at least a meaningful chunk. They are one potential beneficiary. But hopefully as things normalize, as maybe sentiment shift, there may be some more opportunities to invest in this space. I don't know, that's something we will continue to pay attention to and hopefully talk about in the future. But until then, I want to thank Jason and Matt for joining me today and I will see you all next time.

Jason Hall: Thanks, this was fun.

Matt DiLallo: Thanks for having me.

Nick Sciple: 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 and Matt DiLallo. I'm Nick Sciple. Thanks for listening and Fool on!

Jason Hall owns Chart Industries, Phillips 66, and TPI Composites. Matthew DiLallo owns Brookfield Asset Management, ConocoPhillips, Energy Transfer LP, Kinder Morgan, and Phillips 66. Nick Sciple owns Devon Energy. The Motley Fool owns and recommends Brookfield Asset Management, Chart Industries, Kinder Morgan, and TPI Composites. The Motley Fool recommends Brookfield Asset Management Inc. CL.A LV. The Motley Fool has a disclosure policy.

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