Oil companies love to say that their ownership is the average American retiree, and utilities can often claim the same. Look at your retirement account or, should you be so lucky as to have one, your company’s pension plan. Odds are that it is heavily invested in the US energy sector.
Shifts in the parameters for measuring company and share values are rare, but shifts from one sector to another as circumstances and markets and regulations evolve are less so. Attracting investor money, which makes company management not only generally richer but gives them greater operational and strategic latitude, is often as much a matter of comparison with the potential of other sectors where that cash could alternatively go. Energy companies, in the context of the stock market, compete with the growth prospects of retail giants, tech firms and pharmaceuticals nearly as much as they do with each other.
And the winds of change are blowing their way across the trading screens.
The practices for valuing publicly-traded energy company equities are set to evolve this year as analysts and investors take into account shifting relative tax exposure and the impact of hedging rules currently being implemented. The prospects of the US energy sector have already broadly improved as the shale drilling revolution has shown strong production results, but the winners and losers of that boom are still being sorted out.
First, the good news. Tax policy is set for the most sweeping makeover it has faced in decades, as governments struggle to pay off debt levels that went from worrying to panic-inducing over the course of the financial crisis.
Oil companies may find some of their tax benefits (we’ll avoid the word “subsidies” for now) lost, but in the scale of comparative corporate taxation, energy companies are not the lowest hanging fruit for policymakers. Information technology superstar Apple seemed to dodge a Congressional bullet in hearings this month on its astounding tax deals with places like Ireland, where it reportedly pays as little as 1% on some of its revenue, though it pays closer to 25% in total according to some estimates. The general corporate tax rate in the US, all other things being even (as they never are in the morass of the tax law universe), is about 35%.
That makes companies like Exxon Mobil, which pays roughly 41%, practically heroes in the taxation debate on Capitol Hill.
It also means that as analysts review their sectoral comparisons and investors wonder which sector to focus on in their allocations this year, sectors like technology that face unresolved taxation issues and potential long-term shifts to their bottom line assumptions may suffer by comparison.
No one’s going to be happy with the tax changes in the corporate world, but what matters in the stock market may be as much a matter of who is going to be least unhappy when the IRS comes calling.
Then there is the less good news.
Stock markets like predictability. They liked it so much in the late 90s and early 2000s that they gave billions to companies that massaged their earnings or even (Enron, we’re looking at you) just made them up with the goal of hitting the market expectation.
Hedging has been used as a tool to help manage earnings volatility for decades, and at energy companies with very specific and often very large exposures to commodity markets volatility, hedging using swaps markets has been an essential tool for helping turn in reliable, consistent results for investors.
With the new massive compliance costs and compliance complexity currently being put in place by the Commodity Futures Trading Commission and other regulators under Dodd-Frank, all but the largest firms are slowing their hedging activities and sometimes dropping out of the swaps markets altogether. They can rely on exchange-traded futures contracts, but as former energy company CFO Brenda Boultwood of MetricStream pointed out recently in conversation with Breaking Energy, the result of moving off of targeted swaps could mean greater volatility in earnings for all but the biggest firms.
While that doesn’t mean that individual shares will suffer, especially if consolidation activity – like the takeover of NV Energy by Warren Buffett’s Berkshire Hathaway announced earlier this week – continues. But broader sector volatility generally isn’t what the trillions of dollars in developed economy retirement funds are looking for.
So is it a wash for the energy sector? Do energy stock prices become more expensive or less? In the stock market, perhaps more than anyplace else, forecasting is a fool’s business, but being aware of upcoming threats to your portfolio is a prerequisite to not losing your shirt.
