Summers’ Law Strikes Again

Lawrence Summers famously wrote, “there are idiots, look around” in an attack on the theory that markets are rational. What some have called “Summers’ Law” certainly applies to the markets’ response to the slide in the price of oil as it relates to stocks of renewable energy companies.

First, a word about the oil slide.  The price of oil is not something that most investors typically follow every day, unless they happen to be commodities traders.  There have certainly been moments in the recent past that oil prices have been a topic of discussion, but it has not generally been a topic of equity markets chatter on a day-to-day basis, particularly in the last few years during which many industry commentators spoke of a “stable” price range for this traded commodity.

Neither the actual commodity market traders nor the investing public at large were ready for volatility in the oil markets, but that is what happened.  Suddenly every squawk box talker has a daily view on oil and, despite almost universal agreement by actual experts that the current severe dip is time limited, all the chatter has been negative.  Unless you have a position that relies upon oil reaching US$100 per barrel, you can pretty much count on a price recovery in the next few months to a year.  But that doesn’t stop the drumbeat of bearish news.

So what about renewables?  “Energy stocks are down again” is what we heard throughout the winter, and they weren’t kidding and weren’t being picky either.  Renewable energy stocks were selling off also.  Why?  Generally, renewable strategies compete with carbon-based energy and if oil is selling at half price, that can’t be good for renewables, right?  Actually, this is wrong in many cases.

We have heard that several big renewable projects in Mexico have been scrapped for now.  This makes perfect sense since Mexico relies heavily upon diesel to fuel its grid, and that price has fallen.  But what about the United States?

In the United States, the grid is mostly coal-fueled, and increasingly uses natural gas.  Hmm.  The price drop in oil really doesn’t impact coal, which is going out of style for health and environmental reasons, not because its price is too high.  Gas prices fell a few years ago.

While the falling oil price did start to further depress gas prices, it’s not so easy to switch from coal to gas — or anything to gas.  Gas needs infrastructure: pipelines, gas-to-liquid plants or LNG terminals all cost big bucks.  The main gating issue for this kind of big-ticket infrastructure investment is long-term use.  While long term take or pay contracts are lovely, they are not so easy to get.

If I were considering a long-term risk on the use of natural gas infrastructure, I might think twice if prices slide further since, at some price point, it stops making sense to frack for gas — which is part of the current challenge in the Marcellus. This is a long way to say that further falling gas prices don’t immediately, or even eventually, result in greater use of gas to power the American grid.

So the market response to falling oil in selling shares of all energy companies, including U.S. renewables, was, at a minimum, uninformed.  What drives renewable energy in the U.S.?  Policy, including tax policy still, to a large extent.  But also, increasingly, basic economics, as renewables, particularly distributed solar, becomes an increasingly attractive alternative to the power utilities, coal, gas, oil or otherwise.  This, in turn, is driving the utilities to re-tool and start to increasingly add more renewables to the mix, and they already have the infrastructure in place for base-load.  This is a sea change, and a dip in the oil prices isn’t changing that any time soon if ever.

Finally, many of the publicly traded renewable shares are of companies that are about growth and not current income, bets on new technologies and the long-term future of energy. If a dip in oil prices meant “sell” then it wasn’t a good investment in the first place, since oil is, after all, a traded commodity and the risk of long or short term fluctuations was always there.  Was the market admitting an error, thinking through a complex matrix of structural factors in the US energy mix or, well, simply being…like Larry Summers said.

Lead image: Oil pipeline. Credit: Shutterstock.

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Joel Moser is Founder and Chief Executive Officer of Aquamarine Investment Partners, a real asset fund focusing on energy infrastructure and real estate.

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