Expansion and Investment into the Energy Industry

2397 words (10 pages) Business Assignment

13th Oct 2020 Business Assignment Reference this

Tags: Business AssignmentsEconomics

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Introduction

Energy is impeded in all nations and cultures which propels their innovation and growth. For majority of human history animal and human labor was the primary source of power that let nations to grow and prosper (The Gale Group Inc, 2019).  For the United States the first production of coal was in the 1740’s in Virginia and sixty years later Maryland was the first city to light their streets with gas that was produced by coal (The Gale Group Inc, 2019). Coal was used as the main energy provider for an extended time, but when petroleum (gasoline) was discovered and utilized during World War II then petroleum became the main energy resource in the U.S. (The Gale Group Inc, 2019).  Also, after World War II was when nuclear power stormed the American energy industry (Union of Concerned Scientists, n.d.).  The need for petroleum increased exponentially as America become more industrialized and the need for fuel to vehicles increased; increased demand for electricity to power buildings, technology and communication , and to increase electricity production in a more affordable process the introduction of nuclear power plants was the answer (Union of Concerned Scientists, n.d.).  In the 1970’s the demand for energy overtook the supply of it and therefore the U.S. had to increase imports to balance out the shortage and provide enough energy (The Gale Group Inc, 2019). Increased population and new technologies were introduced the more energy was needed in the U.S. and therefore the relicense on the Middle East to provide the supply of energy increased as well (The Gale Group Inc, 2019). The one energy that has experienced increased demand throughout the years and will continue to grow is electricity (The Gale Group Inc, 2019).  Empirical analysis of the impact of energy to the integrity and viability of the Earth from numerous independent firms shifted the energy industry to alternative energy that is renewable and sustainable that has minimal effect to the ecology of the Earth.  The shift would mean a direction away from limited resources such as coal, oil, and natural gas. Due to economies of scale renewable energy will achieve lower costs across the energy value-chain just like the limited energy resources did when it was first explored and later grew to the size it is today. The struggle would be realizing the high prices of renewable resources as it grows from its infancy and making the shift from limited resources once the cost-to-efficiency is comparable. Another hurtle would be to get the big players to shift their ideology and preference from limited resources to renewable resources and once the U.S. general public is able influence and maintain the path to full renewable resources then the big players will follow its consumers and make the invests and shift as well.

The energy industry is massive and contributes in an excess of four trillion-dollar market (DiLallo, 2017). The industry is so robust and has experienced a fifty percent growth in the global market since the 90’s and it is going to continue to grow as our technology advances (Energy Premier, 2018).  The industry is segmented by five subsectors and they are as followed:

  • Power: Subsector that produces and distributes power and electricity to consumers (F.S. Investments, 2019)
  • Services & Equipment: Subsector that provides services and equipment for the energy industry (F.S. Investments, 2019).
  • Upstream: Subsector that invests capital on finding and extracting energy such as oil and natural gas (F.S. Investments, 2019).
  • Midstream: Subsector that provides the infrastructure to process, market, transport and store energy in the energy supply-chain (F.S. Investments, 2019).
  • Downstream: Subsector that turns energy resources into usable products and sells them (F.S. Investments, 2019).

This paper will focus on the energy subsectors of upstream, midstream, and downstream and how investors can invest and profit from them. Also, it will investigate the risks involved in the energy industry. Lastly, the energy industry will be compared to the information technology industry.

To take advantage in of an industry with various risk tolerance and diversification there are plenty of exchange traded funds that are available that takes advantage of investor’s strategy (upstream, midstream, downstream, growth, value, income, growth, etc.) (Brewer, n.d.).

Analysis 1

There are many ways to invest in the robust energy industry and in this section the focus will be on three subsectors that were previously mentioned. The upstream subsector of the energy industry is attractive for high risk tolerant investors. Since the upstream subsector of the energy industry is affected by price changes and investors would be investing in producers of energy, such as oil, investors would need to be able to brace for the low prices and not to get too high on the rise of prices (DiLallo, 2017). Within the upstream subsector investors can invest in exploration and production organizations, integrated oil companies, or exchange-traded fund energy stocks (DiLallo, 2017).  The advantage of investing in exploration and production companies is that investors are able to fully realize the reward of increases in oil and gas prices since the firms performance and financials are directly tied to the market-price of their product is sold in the market (DiLallo, 2017).  The risk is that these firms (even “low-risk”) are not hedged enough to soften the downturns of a decreasing price on energy commodities (DiLallo, 2017). For example, ConocoPhillips which is recognized as a low risk exploration and production behemoth with a top of a line balance sheet and well diversified portfolio (in comparison to other companies in the subsector) had its stock decreased by almost 30% between 2015 to 2017 (DiLallo, 2017). If investors would like to take advantage of a natural hedge due to how a company was formed then investors should invest in integrated oil companies (DiLallo, 2017).  Integrated oil companies have exploration and production assets plus capital that turns energy resources into useable products (downstream component) (DiLallo, 2017). The additional component of owning facilities that turn energy into resources means that these companies benefit from falling energy prices and therefore is the natural hedge to integrated oil companies since they have two components (which one benefits from higher energy prices and the other that benefits from lower energy prices) (DiLallo, 2017). For investors that would like to take advantage of the broad energy industry without having to invest in a multitude of securities and to spread risk then investors should invest in exchange-traded funds on energy stocks (DiLallo, 2017).

If investors would like to reduce their exposure to price swings then the midstream subsector would be the place to invest in (DiLallo, 2017). Companies in the midstream subsector handles transportation, storage, and processing of energy resources (DiLallo, 2017). These entities make their money by charging fees for their services (DiLallo, 2017).

When economists and investors expect energy prices to decrease then investors should invest in the downstream subsector (DiLallo, 2017). Since the downstream subsector takes oil and gas and turn it into usable products such as gasoline, diesel, and other products then they would benefit from lower energy prices because they need to buy the crude product and transform it (DiLallo, 2017). Companies in the downstream subsector make their profits from the spread of buying energy resources, transforming it, and selling it (Brewer, n.d.). It would be advantageous for investors to know the output of oil and gas that is being refined , the production of chemicals, and the companies margins before making an investment in downstream entities (Brewer, n.d.).

Electricity is ever growing and the global demand for it will only continue to grow and therefore investors should invest in electricity.  Energy entities that are in the utility subsector that has a renewable power component because it captures the renewable energy trend but still has traditional energy components and one company that has this is Duke Energy (Brewer, n.d.).

In the following section systematic and nonsystematic risk will be defined and accessed within the energy industry.

Analysis 2

In this section systematic and unsystematic risk will be defined and how that affects the energy industry will be discussed. Systematic risks cannot be predicted and generally not able to be diversified and unavoidable because it affects the global marketplace (Fontinelle, 2018).  An example would be if a war breaks out with the middle east which would reduce the U.S. demand for their energy resources and affect the market.  Also, if inflation increases that is another systematic risk that would affect the industry. Conversely, a recession would be a systematic risk that would affect the industry as well. Another example would be if a natural disaster hit where energy capital is located and inhibits production. Another example is when nuclear power plants experience a disaster and nuclear power must be revaluated since the dictators has long-term effects (Energy Premier, 2018). Three Mile Island and its power plant meltdown opened up the eyes of the American public because nuclear power plants had this Titanic perspective where a nuclear disaster would never happen and then the iceberg of mechanical and operational mishaps brought the untouchable nuclear power plant notion down to Earth (Union of Concerned Scientists, n.d.). In order to address systemic risk investors should utilize asset allocation to diversify their portfolio and have least amount of exposure to systemic risk that affects their industry the most (Fontinelle, 2018).

Unsystematic risk is diversifiable risk that is inherent or expected (Chen, 2019). Unsystematic risk would be a new player in the energy industry with initiative approach and technology which would affect the current players in the industry and affect investors. Another would be the risk of running out of resources that are used in the energy industry (Pierret, 2012).  Also, unsystematic risk is when a big player in the industry is under new management (Chen, 2019).

In the next section energy industry will be compared against the information technology industry.

Analysis 3

The information technology industry is increasing due to the demand of information. The industry consists of organizations that provide internet services, software and IT services (Lending Club, n.d.). The industry has three subsectors and they are software/services, hardware/equipment, and semiconductors (Lending Club, n.d.) The industry affects energy because it provides services such as analytics which informs the energy industry of where and how to efficiently and effectively gather, produce, and distribute energy. Also, the energy industry provides the information technology industry the infrastructure (unless the entity is vertically integrated) to provide their services, such as powerlines. The industries support each other’s advancement (Tropin, 2019). However, depending on the sector of each industry there would be options to invest in instruments that has low correlation. For example, storage of technology hardware and oil refineries would have a low correlation.

In the final section the conclusion to the paper is presented.

Conclusion

In conclusion, systemic and unsystematic risks is a factor that the global marketplace must deal with and there are options to mitigate their effect. The energy industry is one of the oldest industries and yet it is still experiencing changes and shifts. Investors need to take their risk tolerance and their investment strategy into consideration before investing in the any industry and its subsectors.

References

  • Brewer, R. G. (n.d.). Investing in the Energy Sector 101: . Retrieved from Here are some of the key details investors need to know before buying energy stocks.: https://www.fool.com/investing/investing-in-the-energy-sector-101.aspx
  • Chen, J. (2019, June 16). Unsystematic Risk . Retrieved from Investopedia: https://www.investopedia.com/terms/u/unsystematicrisk.asp
  • DiLallo, M. (2017, October 28). How to Invest in Energy. Retrieved from The Motley Fool: https://www.fool.com/investing/2017/10/28/how-to-invest-in-energy.aspx
  • Energy Premier. (2018, February 16). Everything you need to know about the energy industry. Retrieved from Energy Premier: https://medium.com/energy-premier-blog/everything-you-need-to-know-about-the-energy-industry-df92e0e07ebc
  • F.S. Investments. (2019, March 26). INVESTING IN ENERGY: A $4.7 trillion universe. Retrieved from F.S. Investments: https://fsinvestments.com/learn/pages/investing-in-energy
  • Fontinelle, A. (2018, December 28). Systematic Risk . Retrieved from Investopedia: https://www.investopedia.com/terms/s/systematicrisk.asp
  • Lending Club. (n.d.). Information Technology Sector: Overview and Funds. Retrieved from Value Penguin: https://www.valuepenguin.com/sectors/information-technology
  • Pierret, D. (2012, July). The Systemic Risk of Energy Markets. Retrieved from https://epge.fgv.br/conferencias/commodity-prices/files/DianePierret.pdf
  • The Gale Group Inc. (2019, August 13). ENERGY INDUSTRY. Retrieved from Encyclopedia: https://www.encyclopedia.com/history/united-states-and-canada/us-history/energy-industries
  • Tropin, A. (2019, April 9). Industry Profile: Energy & Utilities + Technology. Retrieved from GQR: https://www.gqrgm.com/industry-profile-energy-utilities-technologies/
  • Union of Concerned Scientists. (n.d.). A Short History of Energy. Retrieved from Union of Concerned Scientists: Science for a Healthy Planet and Safer World: https://www.ucsusa.org/clean_energy/our-energy-choices/a-short-history-of-energy.html

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