Who's Boring Now: Utilities vs Oil

were you there? Or the World Stone Skimming Championship. Okay, those last two sound pretty cool. Today we'll be talking with Nat Bullard about a piece he wrote with Liam Denning for Bloomberg Opinion called energy stocks are now duller than utilities. It opens with quote, utilities are, by design a bit of a snooze. We feel no excitement of the miracle of instantaneous light, television and coffee grinding, expecting those things simply to happen when we want them to,

which virtually all the time they do. Reading this, I thought for sure there would be a Dull Men's Club, appreciation society, or electrical things that worked as expected. I checked, there's not listening back to this interview. I kept pressing that, trying to get him to say energy or oil stocks are duller than utilities because utilities are doing all kinds of cool, new exciting things leading to really exciting growth stories.

But no, he held his ground, wouldn't go there. Turns out it seems utilities are just the less dull of the two. So maybe we have a candidate for the Dolmen's Club. I don't know. The interview itself is actually quite interesting, so stay with us. We'll also discuss a piece called big Energy Companies see Cole's Last Stand that he wrote with David Fickling, also for Bloomberg Opinion. We'll talk about the future of coal and where and why it still make makes sense or not and we mentioned

it last time. But Not is global head of executive Insights for BANF. He wears many hats for beanof one of which is writing a weekly op ed called spark Lines, published do Bloomberg Opinion. You can find them on terminal under Ni Bullard or on Bloomberg dot Com under spark Lines. In either location you can sign up for a weekly distribution. And as always, BENIF does not provide investment or strategy advice and you can hear the full disclaimer at the

end of the show. Him Mark Taylor here with Dana Perkins, and you're listening to switch On the benf podcast. NAT. Welcome back to Switched On. Thanks for having me, folks, it's going to be back. So this first one we're going to talk about today actually has the word dull in the title that it actually was one of your best read pieces and I actually really got quite interested in it. Tell me why it was one of your

best red pieces. What happened there? So what I wrote about, and I'll give you the exact title is energy stocks are now dumber than utilities. Wah wah wah. I know that from many of you out there in radio man,

that doesn't sound that interesting. However, within the financial community, and when you consider the scale of these two industries that we're talking about, like two of the biggest on earth in terms of stock market capitalization, in terms of fixed and long term assets, in terms of cash flow, everything, there's quite a bit of implication in the financial market for what is, to be honest, that's sort of dry sounding thing, which is there is a dividend yield paid

out by oil and gas companies, there's a dividend yield paid out by utilities. Historically, utilities have had a relatively high it end and relatively lower growth compared to oil and gas. Oil and gas companies have had a relatively no dividend and relatively high growth in equity prices and valuations. And what we've seen in the last four months is that that has switched and now utilities are actually paying out less in dividend than oil and gas companies are paying.

And what that means for those of you out there in radio land is that you can think about this. A company can reward its shareholders in two ways. It can either reward them with a stock price that is going up all the time, so you're benefiting from growth. Or you can reward shareholders for holding your stock by paying them a fixed amount of cash based on the share price. That would be a dividend. And historically utilities are said, well, you know, we're very very stable, we

have a very predictable market. We're going to give you a lot of cash, one in the form of dividends as a way of saying thank you for owning our stock. And oil and gas companies have saying, goin, we need money to invest, so we're not going to pay you a lot of cash. We're going to then return an advantage to you in terms of an increasing stock price. And that's the way that you're going to benefit from owning a share in x y Z company. Now, when

those things shift, it's a really really big deal. When a company makes a decision that it needs to start paying out more in a dividend, it implies all kinds of things. One is you need to reward shareholders for holding onto you more, so they in order to do that, you pay them more money. But within that, there's also a question about the nature of your future growth prospects.

It's saying, maybe there's less of an option to have a high amount of growth in the share price, and if people want to hold onto this equity, we need to give them a reason, and the reason is give them more money in cash. And you're seeing this industry wide for the energy stocks, that's right. So what I did is I took the S and P five hundred, which has within its sub indicase one for utilities, one for what they confusingly call energy that's actually oil and gas.

Yet sorry, everybody, out there, SMB energy is actually oil and gas, it's not energy, and you can just very easily pull the dividend yield on those for it's going as far back as you want. In this case, I went all of that to and you can see this this nice trend, this compression over time or rather convergence I would say, over time between the yields and these two sectors. And then this crossover point which happens sort of midsummer, ends up being quite a big deal. Can

you go back and describe why this change started to happen? Well, the change started to happen because what my co author and the indenting said is roughly that the oil price option in equities is pretty much gone, so companies are really no longer pricing their their future vision with a huge amount of upside in the oil price. That's not to say that it might not happen, right, you might get spikes in oil that go to who knows what a hundred and fifty three hundred dollars a barrel or

something like that, but it's not viewed as structural. The way that the oil market activity of the early two thousands was wherein you had primary energy demand and fuels demand in excessive economic growth. So you gave people a

reason to invest in a growth story. And if that is sort of coming off the boil and you were expecting nowhere growth, then you're now competing with the whole host of other low growth industries like let's say real estate or utilities and things that traditionally return a lot of benefit to investors in the form of cash. And so now you're having to compete with that message to the market in a very straightforward way with money by

just paying people in the form of the dividend. I thought it was really interesting that you called the utilities of the past, or our interaction as consumers with the utilities and mindless transaction. What has changed with the utilities now are going forward to make them a bit more exciting. Well, I'm not certain that they're necessarily that much more exciting, although in a relative sense, they're more exciting. Right. This is like from a financial markets perspective, they're being priced

more excited. And I should clarify, a mindless transaction is that you don't really think about your monthly electricity bill. We did it. We did an episode a little while back about the changing business models and utilities, but for the most part, we don't tend to think about our monthly electricity bill. And that's why we said mindless transaction.

That's right. Well, listen, we are all sitting here in this lovely climate controlled studio, the beneficiaries of trillions of dollars and more than a century worth of investment in property, plant equipment, uh, synchronization, optimization, all of that sort of stuff to make sure that these things work without us really knowing about it. We're not hand cranking a dynamo to have flickering lights and recording under wax disks here

in the studio. You know, We're actually, we're actually the beneficiary of something that has embedded itself into every other sort of process and subprocess that we have in modern day, which I would say was very apparent um just earlier this month when my family out in California had their electricity shut off, and we could say that that's exciting in a way and not dull, but all jokes aside. It's a It's a sign of a couple of things.

One inherent physical brittleness in the power infrastructure and architecture of northern California. In particular the WUI, the wild land urban interface where so many of these homes are being shut off for wildfire risk, but also the sense that there is a great deal of things that need to change and can change within the utility, the utility business

and its physical stuff. If you want to invest to harden PGENS infrastructure in order to not have these fire shut offs, it's on the order of I don't even know the exact numbers, but at the minimum, tens of billions of dollars, if not hundreds of billions of dollars worth of investment, which is all capital that needs to be deployed, which is probably capital that you cannot be

paying out to shareholders as you used to know. Is that the reason for the growth story, you know, to to maintain status quo or get back up to the status quote or is it a you know, exciting, bold new frontier. It's a transformation narrative for sure. And and actually, as you can see from whale and gas interest and utilities, there's a sense of competition with you know, at the

margins within these two very established businesses. Let's think about it as as you change the way that you energize the vehicle fleet, So you're no longer pumping distalates, you know, through a network of physical pipes, and your essentially substitutingal nectron sent through wires. It's unclear who exactly is going to own that end point, but one of the other company can't. We see plenty of oil and gas companies

buying charging networks, for instance. Um, you could also argue that they're buying charging networks and tagging into the end of trillions of dollars worth of power infrastructure already owned by big companies who could probably do it on their own. So, uh, there's there's more. There's more excitement in this part of the margins than there would have been ten years ago. What should we be watching for in this particular dynamic, Just well, watch watch my my simple squiggling line chart

and see see how this goes over time. Watch as well, the waiting in the s the SMP five hundred that energy companies get in the early nineties. This is going way back now, but in the early nineties the energy sector had a higher weighting in the SMP than technology stocks. It now has barely any more than utilities. I think it has less than pharmaceuticals. And healthcare, which is really an extraordinary, extraordinary tangle about the transformation of the U.

S economy. But it's also just a sign that these these are not, you know, the double digit percentages of the proxy for the global or the United States economy and the market that they used to be so pivoting a bit the energy story that we're talking about, his energy story that those of us who listen to a podcast right now probably experience. There's another article that you also wrote for Bloomberg Opinion that's called big Energy Companies

see Cole's Last Stand. And one of the things you really point out in this particular piece is that they're that Cole's story is one actually of countries that are developing energy infrastructure in places where maybe there wasn't as much or there wasn't these predictable all the lights are on, all the electricities available. Can you delve into that a little bit? Sure? So that if you watch the long term narratives that go through that go through sectors, it's

always interesting to watch how they change. Right So, from the early days of the analyzes that Mark and I were doing, you can look at the coal sector and its argument is what we're the cheapest right, like like you don't, We don't need to have any debate about any other merit. We are the least cost provider of the synchronized electron on the grid. There you go, As you have competition from other resources, you see another sort of layer that adds on that narrative. You can probably

still make that argument and many plates. But then the next one is, well, we're reliable. Right, Um, we may be domestic in some cases. Right, this is the molecules of freedom argument. More on us in the United States. We we we are, we are reliable, we're domestic, we're

predictable in terms of supply, we're not intermittent. And look as technology to uh synchronize to the grid every they're kind of renewable and intermittent energy you might have becomes better and better, and those are simply so cheap that even the integration costs are not really a problem. Then the argument has to continue to shift in some way, and the argument has shifted out of a domestic argument in the higher cost markets in Europe and in the

United States too. Well, you know, China still builds a coal plant every week. This is not only not true, it hasn't been true for quite some time. Then the argument becomes, well, you know in India, f India is going to will actrify in the same way that China did, then it's going to turn out that same way. Fair Enough, China has like China, it's like four times the amount of energy capacity that that that India does per capita.

Is it going to grow to the point and you're going to grow to the point where it becomes just as much an energy economy in terms of power generation capacity per capita as what you would have in China. Potentially potentially not. But at the same time it's also the beneficiary India is in this case of into acting with all of these technologies as they're really really mature, right so finding wind and somewhere as the cheapest cost

of new build electricity and markets like this. So the shifting rationalizations and justifications are a sign of a market that is very, very mature and that is being intersected in multiple ways and in multiple places by new technologies. One of the things you also bring up are the different scope one two in this case three emissions of

the steel industry and various industries. And I think I have a sub question here, which is not just about the utility industry, but just generally how deeply anybody's going to look at Scope three because it's so difficult for companies to actually calculate out should we do it, should we do a family roundtable? And what Scope three emissions actually are? Absolutely, go for it, Mark, I'm not I'm

not your guy. Scope three emissions. Scope three missions for for those of you out there in radio land, are

emissions from the value chain of your customers. If you're a company, right, So there are the emissions in the case of take, for instance, BHP the mining group, the emissions that people make from using your product, so that it's it's possible to have very very low Scope one emissions and two emissions which are related to your own use basically, but have extremely high Scope three emissions because you're selling coal into a market that uses it to

make steel or to make power. And in the case in particular of coal's use and steel, uh, the reason that it's used as is that it's hard to substitute for, it's cheap, it's reliable, and there are, as Mark can tell you, like physical chemical reasons why you need to

use it in a lot of processes. What's interesting to see is we begin to see some of these big, publicly englisted, internationally diversified mining metals and mining companies starting to address this issue, mostly from a research and development perspective, but as a way to I think, start working around own the inherent issues that might come from their very very large scope three emissions. And if you think about it in the case of steel, there's there's really two

ways to do that. One is substitution at the combustion level, right like that the process level to make steal the way you traditionally do, and that is a hydrogen argument

for the large part. But then there's another argument that might call ether for this piece David Fickling looked at pretty closely, which is the same thing that really gutted the primary steel industry in the United States, which was electric arc furnace recycling is probably going to take hold in China, in particular, given the fact that China has been deploying half the world steel for about ten years now. So you you have substitution and you have essentially non

consumption as you're as you're competing. Thing that might start changing that scope three emissions landscapes in theory and theory, one could make steel that has zero emissions for most of the process if you use an entirely renewable electric arc furnace in the process of making recycls deal scope three emissions, as I previously stated, are difficult to calculate, and I think that companies in the energy industry, if they started to integrate this in this may have an

impact on their attractiveness from an E s G standpoint. Tying it back to the first article that we were actually talking about earlier, how do you see this potentially having an interplay with these balance and dividends and stock price and just attractiveness of these companies overall. So as as a as a proper commentator, I don't get to talk at all about whether or not this makes companies

better investments or not. But what it can definitely do is that a labor of distinction, right, So I think you could you the institutional investor will ask yourself in the process of doing analysis whether this whether and focus on E s G. Environmental, social, and governance is a matter of alpha. So it's a way of making an

outsized return compared to peer groups. If it's a matter of beta, if it's a matter of producing risk and sort of uncorrelating your risks from your peer group, or whether it's just something that is essentially preparing you better for the future. Let's put it in another way. If you had I don't know, a thirty five percent growth rate as an industry, and you had increasing gross margins and you had decreasing unit costs, you can probably get

away with saying we are just the growth story. You don't really need to think about e s g. As a major lens on the performance or the future prospects

of the company. If, however, you have less of a growth story, and you're in a mature industry with well analyzed peer groups, so without a lot of sort of disruptive innovation frontier around you, then it's probably sensible to start start applying lens is like this to that sector, because there they are ways of making distinctions, right they could they could lead to better returns, that's a matter of deep financial analysis. They could be reducing risk or

un correlating it from the rest of the sector. So I think I think we'll start to see that more and more applied the very mature industries, not just because they might have the very technical exposures around emissions and things like that, but simply because it's another way of analyzing things that are otherwise quite well analyzed. Okay, so

let's go back to the emerging markets team for a minute. So, if you'll indulge me, I heard this thing yesterday that Southeast Asia, who has historically built been the ones promoting coal these days. Right, they've stopped and they've completely shifted their focus to hydro Right, which carries its own set of problems. But at least it's not they're saying, at least it's not coal. Right, So it was the kind of last stronghold of coal new build um, but it's

gone for the most part. Well, there's there's a there's an element in all of these things that doesn't really make its way into a lot of macro modeling, which is what do people want? So people, people, people. If we think about energy from a very classical perspective is energy is just the ability to do work. So I don't go out and buy a quantum of fuel or a you know a certain number of electrons. I actually I actually hire them to do a job, which is

run the lights. Uh, you know, energized rotating machinery, help me move, help me heat, whatever it might be. And again you can make the argument when the spread in economics between something renewable or zero carbon and something high carbon but very very reliable. When that spread is very very wide, you can make the argument that mitigates in favor of let's just do more cold because it's cheap, reliable,

domestic whatever. When the economics of those can press forward quite a bit such that there's either very little or no difference in the levelized cost of energy from one versus the There, I think you sort of start to look into sort of secondary characteristics that are imputed to each of these different sources. So people say I want something clean because now I know that there's no difference

economically between them. Uh. But in another way, people have preferences, and as incomes rise, as people are past the point of sort of abject poverty and more into the sort of approaching middle income country status, people don't want air pollution.

People have a sensitivity around baking in thirty years worth of worth of emissions, and it actually is much more localized than it is than it is sort of generalized and climactic you can think of it is it's more of a local environmental issue than a global climate issue that you see people manifesting all of this objection around, so people saying, look, okay, they may not actually care in the least about the global war, the carbon emissions aspect of having a coal plant in one's back yard.

What people do care about is local air quality. Look, you can walk on the street here in London and see that we're soon to be and what is it, the no emission zone. We already are. We are in the ultra low emission zone we're recording today and where Mark and I live separately outside of a little bit further out, we will be an ultra low emission zone in and it does ultimately come down to air quality

and human health. That's right, now, let's be is that the bow you can tie around all this Sorry, well it's it's it's part of the bow because it's the next thing to look for, right, It's the thing to watch for the intersection of behavior that's not institutional investor behavior but is personal aggregated personal preference behavior. Right, So, from a climate perspective, your ultra go emission zone in

London does basically nothing. It's not that big of a deal from an air quality, from a children's health quality perspective, it does quite a bit. Now, London had the Great fogs, you know, as recently as I believe the nineteen fifties, right, so just the big smoke, the big smoke, appawning air quality issues at a time when there was no alternative to energize and heat, so you use coal for everything.

Coal plants were local, you know, the ones that have become both swanky apartments and a museum here in London. We're both operating. But London, relatively speaking, got rich, and so it's stopped really wanting that you had alternatives somewhere else. In an extent, you just sort of globalize the pollution issue by sending it somewhere else. You build the nuclearor fleet,

you built gas whatever. But we're going to see more and more I think awareness of issues at a local level that when you aggregate them start to be significant for change. And what's very interesting about them is that, um, you can't really litigate them away, like I don't know, I don't know that there are they're probably forces trying to intervene and prevent the ultra and the emission zone

from expanding. Good knock right, good luck to them. There is the element though, where change does take a long time, and I think you pointed this out specifically in reference to India, where the average age of a coal fired

power station in India's ten years. So because these are such big infrastructure projects, you know, we may end up seeing a coal industry that actually has a reasonably flat, maybe not growth, reasonably flat future for some time to come, and tell the lagging installations of new builds actually catches potentially.

I would also I would also raise the possibility for analytical thinkers that, um, the frameworks we've used in in our economies wherein we operate stuff for forty years past its economic life, may not necessarily be the paradigm in a lot of different markets. If if there are enough environmental changes out there that, say, I don't know, impair the watershed that you need to cool your coal plant, well, then it doesn't matter if it's eight years old or

eighty years old. You may not be able to operate it. Um, if there's enough local objection to it, then people may want things to go away. So we've already been through this phase of shifting things quite a ways out. And you know, this is economic modeling that says that the coal point has a forty year life. There are plenty of things that are lemons or elephants shortly after they're completed and they and they really may not be may

not be doing that. So I I think it's prudent to still model things based on you know, inexpected economic lifetime. I think it's also worthwhile to consider a counter argument about whether or not things are actually going to be operating for forty years just because they've been built. Um, there are plenty of examples of oil fired power plants that were built. Uh, they were built at certain periods of time that are now essentially absolute immediately in many

cases because they were substituted for coal. Uh. You know, there are there are plenty of times and places when substitution can happen, when there are alternatives, and where people make their own economic decision, which is I'm just not going to do this anymore. We had this happened throughout throughout the United States fleet, right, We've even got a time right now, it's almost like a great test case in which we've been sort of stripping regulations around around

particular emissions and things like that. That in theory should be great for a coal plant, But investors making a rational decision look forward and say, well, not only am I not going to build anything new, I'm also going to shut down something old because I have I have an alternative. I have an alternative to that service that's being provided. And that's kind of what's well in a way, driving the growth story for the utilities in a way, yes,

because actually more investment is good. And you know, utilities, as you add wires, you're you're adding a recurring and for restable cashflow to investors in needs in the United States paradigm of investor on utility. But as things get cheaper, as you get more options, you you have other areas you can expand that's right, right, I mean, in theory, if I'm a utility, I should be the beneficiary of

every new wire that gets built. Exam. I may not be capturing the value of every new electron that's generated, but I should be getting value out of every electron that's being delivered. Right now, I could be competed away at the margin or maybe even at the heart by highly distributed energy, or I could have a plane that myself.

I could be providing the electrons and the infrastructure to energize an electric vehicle fleet, or I could be competed away by by an oil and gas company doing that, or by a technology company doing it, or any number of other people that decide to tap into the existing electricity network, build in points onto it, and come up with a different business model than what you might already have right now, Nat, thanks for joining us. Always a pleasure, guys,

See you next time. I'm on another Bloomberg Anya is a service provided by Bloomberg Finance LP and its affiliates. This recording does not constitute, nor should it be construed as investment advice, investment recommendations, or a recommendation as to an investment or other strategy. Bloomberg an e F should not be considered as information sufficient upon which to base

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