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Energy And The Democratic Primary: No More 'All Of The Above'

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Includes: BEP, CHK, CVX, EOG, FRAK, ICLN, NLR, OXY, PXD, TAN, XOM
by: Tristan R. Brown
Summary

The ongoing Democratic presidential primary has seen several front-runner candidates propose to eliminate nuclear power and unconventional fossil fuel production in the U.S.

This marks a decided shift away from the "all of the above" approaches to energy policy that characterized the Obama presidency and, to a lesser extent, 2016 Clinton presidential campaign.

Mainstays of the current U.S. energy sector could come under threat, and the 2020 presidential election campaign merits investors' attention as a result.

In the not-so-distant past, U.S. presidential elections primarily had a neutral-to-positive impact on energy sector investing. Presidential candidates would differ in terms of which energy pathways they proposed to incentivize (e.g., unconventional oil & gas, solar PV, on-shore wind) but, at worst, the candidates would simply ignore those pathways that they did not want to encourage (e.g., coal). As recently as 2012 President Barack Obama's re-election campaign adopted an "all of the above" strategy that encompassed renewable energy, "environmentally responsible" oil and gas production, nuclear power, and even "clean coal." The Democratic Party's 2016 presidential nominee Hillary Clinton adopted (in private, at least) positions of support for hydraulic fracturing and domestic fossil fuel production that differed from those of the political party that she represented.

2020's presidential election, on the other hand, has a substantial probability of becoming the first such election in modern history in which one of the two eventual nominees wants to eliminate entire pathways from the U.S. energy mix. Senator Elizabeth Warren of Massachusetts has been surging in both the polls and the betting odds over the last several weeks. While she still trails fellow Democratic candidate and former Vice President Joe Biden by a substantial margin in the national polls, last week Ms. Warren became the first Democratic candidate to exceed a 35% probability of eventual nomination in the RealClearPolitics betting market average (this has since increased still further to 38%). Meanwhile, Ms. Warren has routinely led President Donald Trump in the head-to-head polling since early 2019. While this hardly makes her a lock for the Democratic nomination, let alone victor in the November 2020 general election, it does make her energy policy positions worth considering by investors in the energy sector.

Those positions have rapidly come into focus in recent weeks due to statements that Ms. Warren made during September's CNN "climate town hall" and subsequent Democratic primary debate. During the town hall she announced that, as president, she would prevent the construction of new nuclear power plants in the U.S. and implement policies that would see the last of the country's nuclear power plants, which currently provide 20% of its electricity and a large amount of its zero-emission energy, shut down by 2035 ("and I hope we're getting it done faster than that"):

Ms. Warren expanded upon this pledge later that week by promising, on her first day in the Oval Office, to impose a "total moratorium" on new leases for the drilling of fossil fuels offshore and on public lands. She further pledged to implement a national ban on hydraulic fracturing, which in 2018 (in the form of horizontal drilling) produced volumes equal to 85% of U.S. natural gas consumption and over 30% of U.S. petroleum consumption:

Two important caveats should be stated. First, U.S. primary elections have a well-deserved reputation for being characterized by the adoption of policy positions that are radical relative to those that are ultimately adopted in the subsequent general elections. The keenest party members (and, in many states, only party members) tend to vote in primary elections, forcing the candidates to move towards their parties' respective fringes in order to capture that party's nomination. The nominees then move back towards the political center in order to prevail in general elections in which the entire electorate, which in the U.S. is roughly evenly divided between Democrats, independents, and Republicans, participates. The positions on energy policy that Candidate Warren is espousing are almost certainly more radical than those that Ms. Warren would champion as the eventual Democratic presidential nominee.

Second, as the below screen grab from late on November 8, 2016 shows, even the betting markets can be wrong (despite having a forecasting track record that is superior to that of the usual election polls). The betting markets gave Mr. Trump a <16% probability of winning the presidential election as late as 7 PM eastern time on election day only to see the odds almost invert over the subsequent four hours (see figure). A similar outcome occurred with that year's Brexit referendum. Ms. Warren's current odds place her at the front of the Democratic pack, but this does not mean that victory for her campaign for the Democratic nomination, let alone for the White House, is assured.

2016 general election betting market probabilities. That said, Ms. Warren's status as a front-runner, and the stark differences between her energy policy proposals and those that the Trump administration has pushed over the last 2 1/2 years, means that investors should be familiar with her announced positions. A national ban on hydraulic fracturing activities in particular would have major implications for the U.S. energy sector. The U.S. Energy Information Administration estimates that the country had enough technically recoverable reserves of natural gas as of 2017 to meet production at current rates for 80 years, or enough proved reserves to do so for 10 years. Even the latter estimate, which would increase if natural gas prices increased from 2017's comparatively low levels, has contributed to a sustained period of inexpensive natural gas over the last decade relative to the prior decade (see figure). This has in turn has had important implications for a broad array of other U.S. sectors including electric utilities (especially those operating nuclear power plants), renewable electricity generators, and midstream pipeline firms.

Chart Data by YCharts

The most immediate impact of Ms. Warren's proposals would be to sharply reduce the share prices of America's major shale producers. While large petroleum and gas producers such as Chevron (CVX), Exxon Mobil (XOM) and, to a lesser extent, Occidental Petroleum (OXY) own sizable reserves in shale plays, their diversified operations would largely insulate them if those reserves lost most of their value because their extraction had been banned. The operations of less diversified firms that are focused on U.S. shale plays such as Chesapeake Energy (CHK), EOG Resources (EOG), and Pioneer Natural Resources (PXD), on the other hand, would be hard-hit in the event that hydraulic fracturing was banned or limited throughout the U.S.

Some ETFs would also be impacted if Ms. Warren's proposals were implemented. The VanEck Vectors Unconventional Oil & Gas ETF (FRAK) is heavily exposed to U.S. shale producers, including a number of specialized, less diversified companies. Likewise, the VanEck Vectors Uranium+Nuclear Energy ETF (NLR) is exposed to both uranium mining firms and electric utilities with large nuclear power fleets, although that ETF does provide a measure of diversification through the inclusion of firms in other countries (in particular those in Asia) in which political leaders are more supportive of nuclear power. On the other hand, large producers of renewable power in the U.S. such as Brookfield Renewable Partners L.P. (BEP) and associated ETFs such as Invesco Solar Portfolio ETF (TAN) and iShares Global Clean Energy ETF (ICLN) would likely benefit as demand for renewable electricity increased to offset reduced supplies of natural gas- and nuclear-derived electricity.

An outright ban would be difficult to implement barring a sweep by the Democrats of House and Senate seats in 2020, such as the one that occurred in 2008. Countering this fact, though, is the reality that three of the top five Democratic presidential candidates in the national polls - Ms. Warren, Senator Bernie Sanders, and Senator Kamala Harris - have pledged to ban hydraulic fracturing in the U.S. if elected. Only two - Mr. Biden and Mayor Pete Buttigieg - have proposed to allow the process to continue operating, albeit under a less lenient regulatory regime than has existed to date.

The 2020 general election has already been notable for its energy policy implications despite the fact that the start of the opposition party's primary elections/caucuses is still months away. The Democratic primary to date has been characterized by many of the front-runners actively distancing themselves from Mr. Obama's presidential legacy, and this has been especially true with regard to nuclear power and hydraulic fracturing in particular. While the "Keep It In The Ground" environmentalist movement, which proposes to limit future greenhouse gas emissions by limiting fossil fuel extraction (and consequently making the value of those fossil fuel reserves mostly worthless), did not find success in 2016's presidential election, it has much more support from the 2020 presidential election's slate of Democratic candidates. The favorable policy environment that has existed for producers of nuclear power and unconventional fossil fuels since President George W. Bush was in office could begin to wane as soon as next year.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.