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To understand what is currently happening in Europe, you must consider the key energy policy of the block.
Approximately 25% of Europe's annual electricity supply comes from burning imported natural gas and coal. These two fuels perform mission-critical load balancing services, which are activated during periods of high demand, which usually occur in cold winters. Therefore, being able to provide enough coal and natural gas for winter is vital to supply security. This is the surprising fragility of European energy policy.
An unfortunate consequence of the deregulated market design in Europe is that power plants do not have much knowledge about future generation capacity-only those who offer the lowest price will be able to generate electricity in the next 24 hour window. If you happen to be a relatively expensive generator, such as coal and natural gas, you can never be sure how much fuel you will need in the future.
Most importantly, Europe has the most stringent decarbonization target in the world, and its goal is to shut down most coal and natural gas power generation by 2030.
Therefore, by design, the European power generation sector relies on the global spot market. For example, large-scale LNG export projects and pipelines tend to leave about 10-15% of the spot market, and this usually ends up in gas turbines in Europe. When the global offshore energy supply is sufficient, the system works well-but when the global fuel supply is tight, this is a very difficult operating environment.
The global transition to renewable energy is a complex ESG journey
Since 2016, the upstream (gas exploration, extraction, and production) has been underinvested for a long time, and finally when Covid-19 hit, the global upstream sector entered a survival mode. As we now know, energy demand rebounded strongly. This allows marginal buyers of fuel, such as European generators, to scramble for supply.
Russia is widely regarded as the main force in solving the European gas dilemma, but Gazprom-the world's largest natural gas company-has supplied about 40% of Europe's natural gas demand, and the increase in Gazprom's production has Occupied by Turkey and China. Frankly speaking, Gazprom is selling its incremental capacity to buyers who are willing to bid the highest, thereby diversifying its customer base.
result? Europe has no choice but to obtain natural gas from the spot market, which is why natural gas prices have risen by more than 300% this year—a record high. This led to the rationing of industrial demand.
Green finance: clear at a glance
Decarbonization may be the most important investment super cycle of our generation, and Europe is ahead of the rest of the world. However, as we transition from fossil fuels to renewable energy, what we are now seeing may be a mismatch between growing energy demand and undersupply, and an underestimation of the basic need for more investment.
Natural gas will be part of the solution because its carbon emissions per unit of power generation are half that of thermal coal-but the natural gas market will remain relatively tight in the next few years until the main new LNG capacity goes online in 2024.
The United States is the world's largest natural gas market, but currently exports less than 10%. Until recently, US natural gas producers had little incentive to invest. But this situation is changing. The price arbitrage between US$5/unit of natural gas in the United States and US$30/unit in Europe provides the impetus for investment in production and export capacity. Our analysis shows that by 2025, the US LNG export capacity will increase from 60 million tons to 120 million tons per year.
Our global investment portfolio has approximately 8% of conventional energy exposure, and as we transition to renewable energy, we prefer companies that benefit from increased natural gas demand. Our two main holdings are Coterra Energy and Technip Energies.
Coterra has approximately 5% of the U.S. natural gas market and operates in the prolific Marcellus and Permian basins—its production costs are extremely low, less than US$2 per unit. Unlike many of its peers, Coterra has a strong balance sheet, and if you feel that the price is too low, you don't have to hedge natural gas prices. In addition, it is a shareholder-friendly company committed to paying at least 50% of free cash flow. As the unhedged production enters 2022, according to the 2022 forward curve, the company's out-of-spot cash flow valuation is about 5 times.
Technip Energies designs and manages large-scale energy projects and is one of the largest players in onshore and offshore liquefaction plants-building more than 20% of the global LNG operating capacity today. It is the company of choice for oil giants to bring LNG capacity online-and it is very capable of benefiting from growth markets such as hydrogen, carbon capture and storage, and sustainable chemistry. These markets are only half the size of the existing LNG and downstream potential markets, but they are growing rapidly at a rate of approximately 5-15% each year. Technip is one of the few energy service companies with a long history. It plans to transform to a green economy with a backlog of 18 billion euros and annual revenue of 6 billion euros. Its valuation is 10 times its earnings next year.
Alison Savas is the portfolio manager of Antipodes Partners
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