Cathie Wood has built a big reputation and a big investment fund called ARK based on investing in innovative companies. Her main fund ARKK was up 150% in 2020. She contends that the accelerating simultaneous development of AI, high speed internet, cloud computing, robotics, DNA sequencing and block chain will disrupt many more businesses that look like good investments today. Wood believes that 35 to 40% of the stocks in the S&P 500 will turn out to be value traps.
We believe the same can be said for many companies in the S&P that are in fossil fuel businesses or that rely heavily on fossil fuels to make or use their products. They look good now as the economy restarts but in five years will be in decline. The transition to a clean energy economy will be the most important investment theme of the next decade. We have mostly written about innovative clean energy companies that are involved with solar, wind, battery storage, efficiency, hydrogen, electrification and the grid. These companies have already outperformed over the past few years, and many are up in price by ~10% the last week alone. However, we have not written so much about who the losers will be.
The companies at the top of the list are the oil and gas companies (exploration, production, refining and pipelines), airline companies, traditional auto companies, utilities, heavy industry, petrochemicals, and mining. Their core problem is the need to make a near term 50% cut in global fossil fuel consumption. Crude consumption has to be cut from the current 100 million barrels a day to 50. The Paris goal was to get 50% done by 2030 to stay within the 1.5 to 2.0 C temperature rise. While it will take longer to make the cuts, it’s still going to happen. As we delay, global warming and its impacts only intensify, making the inevitable transition more costly and disruptive than necessary.
Here is what happens to a couple of companies if we use the most optimal tool to cut emissions, a price on carbon: If Exxon has to pay a $100 a ton price on just the emissions from its operations (not from the oil and gas products it sells) the cost would be $11 billion annually. Its recent average operating profit is $10 billion. If Delta Airlines paid $100 on the 40 million tons its jets produce, that would cost $4 billion a year versus its average profit of around $3 billion. The utility Duke Energy makes around $6 billion a year, but its 80 million tons of emissions would cost it $8 billion a year.
In the absence of a US carbon tax or other policy provisions over the past four years, the institutional shareholders that own the bulk of the shares of these companies have been demanding they come up with a plan to get to net zero by 2050 with 50% cuts by 2030. Otherwise, the companies are on a path of inevitable decline. Now it looks like we will have further impetus in the form of $550 billion in federal incentives to speed the path away from fossil fuels to clean energy. This will supercharge the fortunes of the clean energy companies and further degrade the value of companies dependent on fossil fuels to generate earnings.