Written by Nick Ackerman, co-produced by Stanford Chemist
Environmental, Social and Governance (ESG) investing has been becoming an emerging theme to investing for several years. In the CEF world, we are starting to see this taking hold as well with another fund sponsor jumping into the ring with an investment policy change. Agree with it or not, the fact is that it is going to continue gaining momentum. In investing, we have ways to take part as well. This can lead to better returns for us as investors over the long term. Oil isn’t going anywhere soon, but is certainly going to decline at some point. Several sources say that this could happen in the next decade.
There are several places to invest in the CEF world to take advantage of this now, too. The three funds that are available are all trading at significant discounts, too. They pay attractive distributions on top of gaining exposure to this trend. With that being said, there are some ETFs that might be of interest as well. Though for an income investor, they might not be the income-generating investments one would hope for.
At the forefront, and the area that seems to be the most puissant in investing is the push into renewable energy. This is pushing many companies to find alternative sources of energy or renewable sources. Sometimes this is by social influence/choice, other times it is by law.
Investing in oil/pipeline companies has been a struggle for several years now. First, it was the price collapse in 2014/15. This was due to the U.S. and Canada creating a glut. These countries began pumping out tons of oil after years of developing fracking and oil sands processes. Then, most recently, we saw the price of crude collapse again. This time it went into negative pricing due to Saudi Arabia and Russia not coming to an agreement on production cuts. This was since rectified with cuts put into place, though it took its toll. Of course, this was in addition to the recession we are already in due to a certain pandemic going on.
This is all the while that the oil companies are contending with companies that are jumping on the ESG train and going to alternative energy sources. Energy isn’t dead, it’s evolving. It is evolving to come from different sources, not just burning fossil fuels. Yes, they still have a long way to go to become more cost effective. However, this puts a permanent ceiling on just how profitable things like oil and coal can become to fuel human needs and wants. The basic idea is a teeter-totter; should the price of crude start to become elevated, the alternatives become more attractive and rise. The vice versa is true as well, when oil is dirt cheap (or negative), then alternatives become less economical.
I have been an oil bull for several years, giving plenty of excuses on why this could be a great place to invest. However, it always seems like it is an excuse for this area of the market. No, I don’t believe oil is going to disappear overnight (discussed more below), but my opinion has changed. I guess after five years, that is enough time to realize to invest in the energy space – you must be very selective. The good news here is that plenty of companies are changing and evolving along with the times.
Alternative energy can come in the form; solar and wind seem to be the most popular or thought of. However, there is geothermal, biomass and hydro energy as well.
Before jumping into several ideas that investors can jump into for investing in these changing times, I wanted to take a look at the outlook for oil itself. I’m determined that oil isn’t going to disappear overnight, not even in several decades.
Consider this, according to the EIA, transportation accounted for 28% of the U.S. energy use in 2019. They listed that petroleum was the main source of energy for transportation (as should be expected at this time). The exact number is 91% of the transportation slice being attributed to petroleum products (i.e. petroleum products are products made from crude oil).
They mention that “electricity provided less than 1% of the total transportation sector.”
Now, think about companies like Tesla (TSLA) and Nikola (NKLA) – they are certainly hoping to change this. At the moment, NKLA is more of a concept than reality; however, TSLA is a real game-changer that is selling plenty of electric vehicles (EV) today. As they have become more and more popular, the other big three are following suit with their own line of EVs. For example, Ford’s (F) F150, the best-selling vehicle in the U.S. since 1981, is coming out with an electric model. If you don’t think that will make a splash into the reality of an EV future, then I’m not sure what will convince you.
These automakers aren’t going to want to buy TSLA’s regulatory credits forever. Which is exactly where the law steps in to push these companies into a greener future. This was a big thing in TSLA’s latest earnings that had many bears jumping on the company. It sold a record $428 million in the most recent quarter.
Of course, that is just one segment of the market – 28% of the energy needs of the U.S. Don’t be fooled though, the other sectors are changing as well. All this means the demand for oil is going to continue to be pressured though. It is hard to say exactly, after spending hours researching, where peak demand will fall. Every single place I looked seemed to have something different. However, the best material I found was from McKinsey. They provide a very in-depth PDF file. I spent more time than I wanted to reading through it. There is plenty of great information, and I would encourage others who are interested to read through it as well.
Essentially, they are showing exactly my kind of interpretation of what is happening. That sometime in the next decade we will hit peak demand, this demand will then persist for probably decades upon decades. It seems and most logically appears there will always be some type of demand as long as humans are around. However, if a company does not adapt, they will be vying for a smaller and smaller market.
Where To Invest
With all of that being said, where can we put some money to take part in this inevitable future? I’m glad you asked, we just recently had another CEF, the Kayne Anderson Midstream Energy Fund (NYSE:KMF), announce that its board approved a policy change. KMF is now going to be the Kayne Anderson NextGen Energy & Infrastructure, Inc. It cites that “it provides KMF’s additional flexibility to capitalize on key trends and development within the energy and infrastructure sector.”
Its new policy will be that it “plans to invest at least 80% of the Fund’s total assets in securities of energy companies and infrastructure companies. Further, KMF plans to invest a majority of its assets in securities of next-generation companies facilitating the energy transition.” It expects that it will be a mix of “renewable infrastructure companies, utilities, and natural gas-focused midstream companies.”
If this sounds familiar, it is because the Cushing NextGen Infrastructure Income Fund (SZC) just went through this same thing earlier this year. Formerly, it was known as the Cushing Renaissance Fund. While it still does have positions in the energy space, it has really branched out as of its latest Fact Sheet. It even threw in Microsoft (MSFT) into its top ten mix!
Tortoise Essential Assets Income Term Fund (TEAF) is also invested in this area of ESG. Though this fund launched with this specific purpose and wasn’t a converted fund.
It is interesting that all three of these funds have an oil tilt to them though. With SZC and KMF being energy/MLP specific funds previously. Even TEAF is carrying some “old energy” in its portfolio. It isn’t too much of a surprise as Tortoise has a background in the energy space. TEAF also isn’t just specifically in the energy space either – branching out into social infrastructure and sustainable infrastructure as well. That sets it apart from the others.
Another interesting thing to observe about these funds is that they are all carrying significant discounts.
That large spike in SZC is from a reverse split that distorts the chart. Even before the March panic selling, these funds were at some significant discounts. Now, they seem to be absurdly so. It is understandable why as the energy space has been absolutely decimated. This is essentially why SZC and KMF are converting to the “next generation” era anyway. With SZC and KMF, it could also be because investors don’t realize they haven’t changed. For SZC, it is a very small fund, so probably not a lot of interest in the first place.
For TEAF, it is also quite interesting as it didn’t take the sell-off well either, but it does have the term structure. Its term comes up after 12 years, which puts it in 2031. Still quite a significant way out, but something to keep a close eye on. Especially if it can turn around its fortunes. All three companies are still down significantly for the year – even TEAF that wasn’t a pure-play energy fund heading into this year.
(Thank you again SZC reverse split for messing with the data.)
As we can see, TEAF did perform the best on a YTD basis. SZC didn’t make its investment change until just April of this year. That means it took it on the chin with the rest of the energy funds.
Outside of the CEF space, there are several ETFs that one can choose from too to participate in the trend. Of course, you aren’t going to get the dividend focus that you get with a CEF. Though they are rolling more and more out as ESG has become quite a trendy area.
There is the iShares MSCI Global Impact ETF (SDG). SDG gives “exposure to global stocks aiming to advance themes related to the United Nation’s Sustainable Development Goals, such as education or climate change.”
This ETF even pays a bit of a dividend semi-annually. Though that is unlikely to be enticing to an investor that has an investment strategy that is solely income based.
(Source – Seeking Alpha)
Another BlackRock fund – the iShares ESG MSCI USA ETF (ESGU). It gives an investor “exposure to large and mid-cap U.S. stocks with a favorable environment, social and governance practices.”
Since the U.S. is home to the largest selection of quarterly dividend payers anywhere, it also has a quarterly dividend on this fund.
(Source – Seeking Alpha)
Another idea for an ETF in the ESG space is SPDR’s S&P 500 Fossil Fuel Reserves Free ETF (SPYX). The fund “seeks to provide investment results that, before fees and expenses, correspond generally to the total return performance of the S&P 500 Fossil Fuel Free Index.” This is essentially the S&P 500 index that “eliminates fossil fuel reserves from their portfolio.”
Again here, we see quarterly dividends as it is just the S&P 500 ex-fossil fuels.
(Source – Seeking Alpha)
Energy isn’t dead; it is evolving to a greener future. Oil will survive for plenty of time longer in our lives; however, the demand for oil will eventually begin to wane. This will happen through regulations and/or social pressures to do so. This isn’t a new trend; it is one we have been dealing with for several years now. It is just becoming more and more popular. As investors, we need to take a good long look and see where we can position ourselves for the future.
I do believe that it is fine to hold onto pure-play energy positions at this time, just that they will eventually have to adapt or get left by the wayside. Fortunately, many companies are making necessary changes. This is a good thing for investing as well. There is a reason why NextEra Energy, Inc. (NEE) can trade at a forward P/E of 30.72, while Duke Energy Corporation (DUK) plays catch up and trades at a forward P/E of 16.74. Both are large and important utility companies, except NEE is the “largest generator of renewable energy from the wind and sun and a world leader in battery storage.” This is while DUK is still working on making strides into that area.
Overall, there are some interesting developments going on in the investing world. Two CEFs that were energy-related switched their investment policies to include more renewable energy investments. TEAF, which launched just last year, is also evidence that the growing ESG trend is gaining momentum. Even the ETFs are all relatively newer, launching only just a few years ago. We need to shift our portfolios for the future, taking some steps now might mean better returns for us over the long run!
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Disclosure: I am/we are long KMF, SZC, MSFT, NEE, F, NKLA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: This article was originally published to members of the CEF/ETF Income Laboratory on August 4th, 2020.