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As the Earth Breathes



Three years to save Earth according to a group of United Nations scientists.  Can 150 years of planetary abuse undo over four billion years of evolution?  As the Earth breathes even climate neutralists concede probability may be at least a 51/49 percent proposition.


Global consensus reached during Paris climate accord talks demonstrates as much despite political challenges since the recent US election.  Apolitically, senior military personnel attest to the prospect of climate change remaining a significant national security risk for the foreseeable future.  Today contention persists due in large part to wariness of Western apologists seeking to redistribute wealth and reengineer cultures at perceived disadvantages.  Equally significant issues such as equity in absolute carbon emission volume measures and fairness in competition act to temper political arguments, offering economic transparency during environmental debates.


Observations in the International Energy Agency 2017 World Energy Investment whitepaper note flat levels of spending in alternative and conventional energy technology in recent years, the former driven by public spending and latter by private investment in research and development although current statuses are characterized by overcapacity and oversupply.  Given the range in governing energy equations, not surprisingly natural resource allocations (coal, natural gas, oil) coexist with renewables (wind, solar, hydropower) and science (nuclear).  Innovation in technology continuously reduces the levelized cost of energy and resets the supply/demand dynamics of conventional and renewables composition in energy equations, driving competitive marginal unit cost translations and renewables scale within the overall balance of equation weights.


Survey of government policies and corporate strategies reinforce the premise of a one energy equation not a series of separate or nascent policies.  Realistically (and importantly) fossil fuels remain a stalwart of energy generation capacity and consumption, acting as vital bridge fuel sources in evolving national policies (US, Germany, Japan, China) ceding its allocations only by renewables referendum but increasingly on a kilowatt basis.  Implications for investment strategies reveal populist and unpopular themes spanning the breadth and depth of composite energy portfolios.  In relevant macro- and sector-based momentum trend (CAPE) and thematic (Cleantech) Beta portfolio strategies, sentiment captures varying degrees of directional equity price movement.  However, with limited or indiscriminate attribution, a more deliberate approach to portfolio construction is required.


Data sets derived from publicly-sourced ETFs work well across the energy equation as benchmarks, managing the performance drivers of its investment universe.  For instance, energy policy portfolio allocations (Oil&Gas – XLE, Coal – KOL, Nuclear – NLR, Renewables – PBW) serve as a basis for industry vertical dropdowns on the equation’s two ends from Oil&Gas (Sector – XLE, Exploration & Production – XOP, Oilfield Services – OIH, Refiners – CRAK, Shale – FRAK) to Renewables (Sector – PBW and PZD, Wind – FAN, Solar – TAN, Smart Grid – GRID, Lithium – LIT, Water – FIW) and advances the utilization of sector/industry/subindustry/vertical/thematic ETF proxies as fundamental indexes for derivative applications.  Illustrating sovereign energy posture in this manner begins to support management of its tenets and assessment of data and policy trends on capital markets including corporate catalysts and balance sheet transactions.  To advance analysis, needed still is a reconciliation of specific business segment operations among representative component members apart from the general sector designations presented in standard fund reporting.


In just one example, business segments operations of widely accepted bellwether Tesla populate many ecosystems (autos, fuel cells, lithium, battery storage, solar systems...let alone space!) all with differing capital requirements and levels of profitability.  Conglomerates also display a pronounced but topical view of the business segment operations schema.  General Electric and Siemens, two competing multinational corporations, reflect distinct aspects of the one energy equation by encompassing Oil&Gas and Wind along with traditional power generation and energy efficiency business lines.  These business segment operations challenge each other as well as leading industry and independent niche players of all sizes (Large-, Mid-, Small-cap) in segments globally.  Recent divestitures of product lines in both companies, and the addition of others, highlight the importance of assessing differentiated growth rates and demands on capital structure within an organization and among competitive peers.  Intuitively, evaluation of corporate performance is readily accomplished at the operational level.


At Venn’s intersection, sets and subsets of competing interests endure.  Proprietary research suggests its dynamic principle in relation to business segment operations is three-fold: 1) multinational and Large-cap companies function as benchmark sector/industry/subindustry proxies based on scale and business segment operations, 2) Small- and Mid-cap companies compete as peers and are delineated by business segment operations and 3) among subsets of 1) and 2) are vendors provisioning multiple economic sectors, asset classes and geographies.  Successful trading strategies (systematic, momentum, thematic) isolate value in Growth by not overlooking the prospective Alpha drivers directly associated with ecosystem and supply chain verticals or profiles of Small- and Mid-cap companies functioning as competitive peers and, hence, acquisition candidates.


From a portfolio management perspective, designing strategies based on business segment operations lends the advantage of iterative index applications by exploiting the inefficiencies in third party data nomenclature assignments which inevitability skew peer group analytics and valuation.  While means and methods vary of course, a latticed framework—gleaned from competitive market information, built by segments/classifications, interpolated for integrity—exhibits the proportionality revealed by business segment operation considerations and distinguishes differentiated growth rates beyond simple revenue line aggregation.  Additionally, a developed thesis for security selection in the Energy complex incorporates: 1) a barbell to CAPE as an extrapolation, 2) a barbell of Cleantech to diversified industrials as a foundation and 3) a barbell of Value to Growth implicit in corporate anatomy.


Common portfolio position weight allocations (0.5% < x < 4.0%) may be aligned consistent with long/short peak-to-trough cyclical/counter-cyclical exposures and emerging technologies among individual and multi-listed component members.  Importantly, often discarded negative P/E companies are included to capture points of inflection for cash flow growth and forward earnings momentum.  In the end, a structure of analysis in the Energy complex is borne from the examination of business segment operations within diverse companies across economic sectors plus, on a standalone basis, competitive peers—by definition, Alpha is singular.


…fortunately for Earth, data trends reported by the IEA indicate a decoupling of worldwide carbon levels from the pace of economic activity.  So can we now then just wait for natural gas to permeate throughout energy equations, plant more trees, and lever cellphones and the Internet of Things for productivity gains to ensure posterity?  Likely not as the agreement promoted by Paris signatories provides for significantly disparate country carbon intensities over an extended time horizon.  Success of institutionalized agendas nonetheless is often best evaluated by the profitability of corporations engaged and are a direct result of policy scalability, public fortitude and company-specific operational rationality.  Green progress in black and white.



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