Sean Kenney:
Hi, I'm Sean Kenney and welcome to the MFS All Angles podcast. Today we're focused on one of the biggest economic transformations since the Industrial Revolution, the energy transition. Energy has historically been a pretty sleepy industry, but it's fast becoming the foundation of the digital revolution. It's fueling advancements in AI, cloud computing, and cutting edge technologies that are truly reshaping how we live, work and connect. This is also a very well covered topic in the media, so our goal today is to go beyond the headlines and focus on the truly investable themes emerging across the transition. To do that, I'm joined by MFS portfolio manager and energy sector team leader Jude Jason. So Jude, thanks for joining me today.
Jude Jason:
Thanks for having me, Sean.
Sean Kenney:
This is going to be an awesome topic because if you look at the intersection of all the big headlines in the news, whether it's AI or the energy transition, it all comes back to what you cover. So if you think about your career, you started 20 years ago in the investment business, you started at MFS 13 years ago.
Jude Jason:
Yep.
Sean Kenney:
And you started covering technologies and then you took on the energy sector as well. Could you have imagined 13 years ago that really technology and energy would intersect in the way that they have?
Jude Jason:
No, I would not have imagined that. It's been pretty surprising. It has been really fascinating to see those two sectors intertwine, those two worlds come together. Actually, I used to get the exact opposite question years ago, "Oh, you covered technology, you cover power, you cover energy. How does that make any sense?" But now they've come together in a way that they're coupled because they need each other symbiotically, and it's been interesting to also see how the stocks have correlated. So it's interesting. I'd say that while I wish I could take credit for being a leading indicator right? But regardless, thematically, it makes a lot of sense the way they're coming together. It's important for the businesses and it's also important for the AI buildup.
Sean Kenney:
Yeah. Well, if you think about the energy industry growth would be measured in single digits historically, right? And then if you think about technology, it was multiples and double digits.
Jude Jason:
Yes.
Sean Kenney:
And so it is interesting to see these things come together. Let's start there. So we're going to talk about really the investment themes that you and the energy sector team are identifying through this transition. To do that though, it's helpful to start with a bit of lay of the land. Let's talk about the industry and the industry structure and maybe start by what's changed. If you look at the last one, two, three years, what's really changed in the energy industry?
Jude Jason:
So generally speaking, the energy sector hadn't been in focus for some time, right? And the reason is because it's been stagnated. So if you take a look at the performance of the sector over multiple timeframes, it's really lagged the S&P 500. But over the last one to two years or so, I'd say that even the most casual observer would say that something's different now, right? It feels like something important is happening. And really what that is, it goes back to exactly where we started, the advent of artificial intelligence. And what that means is artificial intelligence runs on data centers, and these AI data centers are very power-hungry.
Okay. And to put that in some perspective, if the estimates, the Wall Street estimates of one of the large semiconductor businesses is to be believed, over the next five years or so, we should expect in the U.S. alone from a baseload energy demand perspective to see something like 100 gigawatts of demand from this, which is a lot. And some AI companies would have you believe it should be higher than that, right? And just to put it in perspective, one gigawatt is enough to power about a million U.S. homes, and that volume is on top of the burgeoning key drivers that the sector was starting to see anyway from growth in electric vehicles, growth from industrials, essentially reshoring, and growth from electrification of certain industries like manufacturing and buildings and so forth, right?
And so what that translates into is you're seeing a power sector that over the past two decades or so have been relatively flattish, that's starting to inflect up for them toward 3% plus, which actually translates to higher revenue growth for the companies in the ecosystem that participates in that and further growth still in terms of the earnings of those companies.
Sean Kenney:
So electrification was a theme before even this new wave of AI and the investment cycle required to fuel the AI growth into the future, that's fair?
Jude Jason:
That's fair.
Sean Kenney:
So if you think about the growth of the energy sector, has it been broad-based? Is everyone participating in this or is this a tale of have and have-nots?
Jude Jason:
Yes. While we're seeing a bit of a resurgence in the sector, to your exact point, it's haves and have-nots. So let's start with the have-not. So certain fossil fuels in the oil sector, for instance. So the oil companies and the businesses surrounding that complex have still somewhat stagnated. Part of the reason is because the fundamentals don't really have much tailwind when it comes to demand from artificial intelligence. And we're seeing some supply come in the oil sector for various reasons, including the fact that OPEC has opted to increase supply, and that could be due to certain geopolitical factors as well. And there's also a bit of a tinge of terminal value risk in there as well.
And by contrast, when you take a look at what's happening on the electricity side, now that's a have, right? Essentially, as the economy becomes more digital, the demand for power is outstripping supply, which is what's leading to talks of a bottleneck, which I can get into. But going back to how we started, the other thing to keep in mind that this is leading to is artificial intelligence and the dynamics around that has really led to a coupling of not just technology and energy, but also energy with industrials, right? So investors are thinking more broadly about what it means to invest in energy because some of the industrial companies that revolve around picks and shovels and equipment for the grid essentially qualify to a certain degree.
Going back to your question though, in terms of haves and have-nots and the electricity side being a have, what we've seen broadly in terms of U.S. demand for electricity, that grows about 1 to 2%. But there is a bifurcation where oil companies are still somewhat flattish, but the electricity side, power and so forth, that's inflected as I talked about from flattish to about 3% plus. And that basically is a mirror of what's happening structurally in the economy becoming more digital and also suggests that oil is losing share of the energy pie in general. And the companies around the power complex are benefiting. So those would be utilities and those would be anyone who supplies into that complex, including the picks and shovels that go into that, natural gas, nuclear and so forth.
Sean Kenney:
Okay. So I'm hearing a lot of potential investment opportunities through that. We'll get into that.
Jude Jason:
Sure.
Sean Kenney:
I do want to get to the bottleneck piece as well, but you mentioned geopolitics. And when you think about the regional makeup of this, you've got different structures around the world when it comes to energy. You've got the national security, the AI race. We've got regions around the world that really need to invest in infrastructure when it comes to their electric grid and things like that. What would be a theme or two regionally that you would point to?
Jude Jason:
Geopolitics is the right way to start. I mean, energy is nothing if not an object and subject of geopolitics, right? And the regional dynamics and themes that I would point to are exactly where you started in terms of what's happening with the AI race and what's happening from a national security standpoint. And the key regions I'd point to are China and Europe. We've been talking about the U.S., but China and Europe I think matter here. From an AI race perspective, certainly a lot of different countries and regions can get pulled into that. We can talk about the Middle East, Southeast Asia, parts of Europe, Japan, et cetera. But the race, realistically speaking, is really between the U.S. and China in terms of IP, in terms of talent, in terms of access to power.
Where most experts would suggest that the U.S. is leading when it comes to IP, intellectual property, in terms of semiconductors, chips and things like that, and China is leading in terms of access to power. If we think about just last year alone in 2024, China added north of 400 gigawatts of power onto its grid. That's about a third of the U.S.'s grid in total, right? And so the implications of something like that is it puts impetus, it puts pressure on the U.S. to not lose the AI race, so to speak, and to continue to invest and keep a floor in how we invest in AI, particularly invest in the energy infrastructure.
The other aspect that you mentioned and that is worth talking about is national security. And national security has been topical for a few years now when it comes to deglobalization or reshoring, which is also leading to an increase in the need for electricity, broadly speaking, but also in Europe. And the other thing that you would have to add onto that when it comes to Europe is recently the conflict with Russia and Ukraine has led to a shortage in natural gas. And all of that brings to bear the need to invest, invest aggressively and invest in infrastructure.
And so that has positive effects on certain companies in the supply chain, those who provide picks and shovels, those who provide various things for electrifications and renewables, and even from an LNG perspective, liquefied natural gas, basically gas that is shipped overseas, the U.S. is supplying Europe with LNG in order to overcome that natural gas shortage we talked about.
Sean Kenney:
Yeah, it's very interconnected energy around the world, but also very important how each of these countries is approaching their own independence from an energy perspective, right?
Jude Jason:
Yes.
Sean Kenney:
So if you think about, you mentioned bottlenecks, and if you think about the opportunity to invest through these bottlenecks, where is the ability to meet the demand? So if you think about the AI race or just the electrification trend in general, we need to meet that demand. We as in the energy sector needs to meet that demand. It sounds like it's optimistic to think that we can, where are these bottlenecks that you're seeing or that the team is seeing?
Jude Jason:
This is one of the crucial questions. I spoke about the 100 gigawatts, which is material, okay? And this is something that a combination of teams and sectors have actually come together to wrap our hands around. So what we've done several times is we've seen the energy team, the technology team and the industrials team come together to wrestle and grapple with key questions having to do with artificial intelligence. Because effectively those three sectors are effectively what is building up the build out of artificial intelligence and have keen insight. And one of the key questions that we try to wrestle with is can the power sector meet the challenge, the demand that is coming from artificial intelligence? And a conclusion is that it would only or mostly be possible under a very optimistic scenario where we had a palpable sense of urgency and collective will that galvanize the industry toward this, okay?
And the reasons for that is because there are just so many constraints on the grid, so many constraints to think about from moving as fast as we want. Some of the key constraints include gas turbines, fairly scarce. Right now what we're seeing is a multi-year lead time to get enough gas turbines online. Labor is also a very important bottleneck, okay?. Certain skill trades such as welders, plumbers, pipe fitters, electricians, there's a scarcity in those and that is an important shortage for the broader industry in general. We have grid capacity issues where we've under invested in the grid and the grid readiness to be able to handle this is also an important consideration. And lastly, we have to think about affordability because as affordability basically get away from us, it could have reputational and political consequences as well.
And so what that summarizes into is we probably end up in a world where we're still somewhat short, and tech companies really have to have an approach where they scour the universe and do everything that they can to source needed power. And that is going to be a situation where rising tide lifts all boats. Some of that is going to have to be a patchwork of Band-Aids. And some of that has actually resulted in certain things like coal plants that were supposed to be decommissioned staying online longer. One thing that's been somewhat interesting has been Bitcoin miners have actually caught a bid because they've been bought out because they have access to energy and backup diesel generators as well. So it's been an interesting time.
Sean Kenney:
That is a patchwork.
Jude Jason:
Right.
Sean Kenney:
Of solving the bottleneck, but I would imagine with a bottleneck there creates opportunity and there's a massive hype cycle around any big transition like this. So if you think about what makes a great business, as the energy sector team leader, as a portfolio manager for client assets, you're working with that sector team and other sector teams to think about ultimately what's the driver of great businesses that we can invest in through this transition. So given the bottlenecks and given the industry dynamics, what in your opinion makes a good investment, a good business, whether it be quality and durability and some of those factors that you tend to look for?
Jude Jason:
Sure, sure. Let's lay it out. So we have a range of strategies and portfolios across the firm, and certainly certain portfolios may approach this in different ways depending on their mandate strategy, various dynamics like that. But I think what we would all say and have in common is a shared philosophy around relative quality and underappreciated dynamics that could benefit these businesses and construct portfolios of relatively strong operators that could navigate tricky environments over time depending on how different things develop. So in practical terms, okay, in the near term, there are a lot of reasons to think that a wide range of the businesses in the industry should benefit.
I've talked about a range of the industries that are seeing tailwinds, including utilities, including nuclear, nuclear fuel, natural gas, so on and so forth, okay? But as we start to inch into the longer term, it is really worth considering the fact that this is an industry that in its heart has some cyclical dynamics, where ultimately speaking, there is an aspect of supply that chases where the demand is. And we have to sort of be thoughtful around that, which means that we would lean toward businesses that are strong and benefit now, but should be able to navigate whatever comes. And so we do that through a combination of owning durable businesses with advantages that we would want to own no matter what.
But oh, by the way, they happen to be getting a tailwind from artificial intelligence. And some of those businesses are businesses in the picks, shovels and equipment space, regulated utilities to some degree, although they don't have as explosive of leverage to the AI theme. Some businesses that also qualify where we would want to be a little bit more selective and do some stock picking would be the independent power producers, which are effectively unregulated utilities, and they're strong operators within that field based on where they are geographically or their operations or exposures that would matter.
And in the midstream space, essentially businesses that transport natural gas through pipes or by boat, there are some relatively strong operators as well. On the other side of that, there are some businesses where we would want to be even more selective with our client's capital, including businesses that are a little bit early or where the technology is unstandardized, some SMRs come to mind, some of the coal-exposed businesses come to mind. That's not to say we would stay away from these businesses entirely, but we would want to be fairly thoughtful about their durability, their ability to sort of navigate trickier times.
Sean Kenney:
That's helpful. And I would imagine, you mentioned SMRs, can you just define that for me?
Jude Jason:
Small modular reactors, and those are effectively a smaller version of the larger nuclear plants that we're accustomed to.
Sean Kenney:
Okay. So I would imagine with that landscape we just talked about, we've got a massive energy transition that will happen over decades. We have bottlenecks in the system with this incredible amount of demand that people can step into to satisfy or at least appear to satisfy. I would imagine that companies would be stepping into that and there would be a lot of opportunity to raise capital, but their outcomes could be binary where they need certain things to happen in order for their growth to be met. Is that fair?
Jude Jason:
That's fair.
Sean Kenney:
And so just coming back to what you and the team look for is those quality, durability, thinking cross-cycle about those investments, is that right?
Jude Jason:
Yes. So in terms of what we look for are businesses that are going to be durable. So if we think about the timeframe of how things are going to play out, right? In the near term, again, many stocks are going to work, right? It's been relatively easy, somewhat, right? And because of the step change in demand that we've seen, it hasn't been very surprising to see that some of the stocks that have had the most significant upside have been stocks that are somewhat prone to volatility to a bit of speculation, right? But to be fair to them, the need has been that great and they've played a role, okay?
And as we think about the next 5 to 10 plus years or so, as we start to navigate the key dynamics, it's important to also remember that the supply-demand balances can shift very quickly. To the extent that demand stays as strong as it's been, then everyone continues to benefit. Okay, that's pretty straightforward. But to the extent that supply factors start to change a little bit, as we think about what could take place over time where gas turbines, the capacity that's been fairly tight, the capacity there could increase, can improve as the key players increase the capacity.
The other thing that could play out over time is that battery storage businesses and the technology itself becomes more viable over time and becomes more long-lived over time from around four hours now to eight hour plus in the 2030s or so. We could also see small modular reactors also evolve over time to become more scalable and more standardized. We could also see also newer technologies essentially become part of the landscape. If we want to speculate, we could also potentially see nuclear fusion become viable, longer-term, geothermal, et cetera, et cetera.
And so as we think about all those, to your question about business durability, we would really want to be in businesses that could get tested by different scenarios and continue to thrive. And again, those businesses that we suspect would stand the test of time around that would be certain picks and shovels, would be regular utilities to the extent in particular because they're a conduit for electricity, certain new technologies that emerge, and also electrification companies that have the ability to adapt. So that durability and thinking in terms of long-term to sort of test that theory is a key approach that we take.
Sean Kenney:
Yeah. I mean, I have to imagine that if you're an energy analyst covering an industry within energy and you didn't have your colleagues in industrials and technology and you're trying to piece all this together, find the risks, find the opportunities, and understand everything from these different angles, it would be pretty difficult.
Jude Jason:
My goodness, absolutely. And this is a time of just accelerated change, right? And I think one thing we do particularly well here at MFS is we approach things with a combination of humility, with the desire to do insightful work and derive insight and collaborate. And I think at a period when so much is changing from various perspectives and angles and in various fields, everyone's going to have blind spots, right? Technology's changing and evolving very rapidly, and so we have the privilege and luxury here to have colleagues where the culture celebrates collaboration, and that is a way that we seek to navigate through an environment like that, yes.
Sean Kenney:
So maybe to close things out, because we've covered a lot, but to close things out, just to play on that theme a little bit more, if you think about really understanding what you don't understand, there's a lot of things that, as you've mentioned, are fast changing and evolving, and a key to investing isn't necessarily having all the right answers at every moment in time, but knowing what to look out for, what to assess and what to uncover through research and working within the industries. Looking forward, what are some of the key opportunities, risks, things to look out for that you and the energy sector team are thinking about going forward?
Jude Jason:
So there are multiple things to keep in the back of our minds, in the fore of our minds as well. I'd say macro essentially plays heavily here because of how it can impact supply and demand dynamics, and also because this is a period of a build out where spending is needed. And in order to fund that, you need macro to be supportive to a certain degree. So it's important to pay attention to that. It's also important to pay attention to the direction of the technology and the adoption of these technologies, not just from an artificial intelligence standpoint, but also specific to the technologies that impact the energy space, electric vehicles. Ultimately what happens with robotics, because that's basically the electrification of labor, what happens to the various alternative energies that we briefly touched on?
It's going to be important to also think about the direction of regulations and policy because it could incentivize or de-incentivize certain industries that matter in the field. It's important to think about order backlogs and power costs because of the political implications that we talked about when it comes to power. And also more to the point in terms of risks as well, the industry is trying to do a lot at the same time, right? The build out is happening across the board, and so it's really important to think about the risk to supply chains and the risk to execution and actually accomplishing this.
Sean Kenney:
Yeah. Well, we covered a lot. Thank you for your insights. I'm going to try to distill this into three key takeaways, and I'm going to check in with you to make sure I have it right, okay?
Jude Jason:
All right, sounds good.
Sean Kenney:
The first one that I take away is that the center of gravity is clearly moving towards energy and the electrification trends accelerated by the AI trend. And maybe the core takeaway there is it's not just about energy, it's about the sort of tangential sectors and industries that touch that, like industrials and technology. Is that a fair takeaway?
Jude Jason:
That's fair, yes.
Sean Kenney:
Okay. The second one is understanding the businesses, each individual business and how durable their business model is and how reliant it is on any one, two or three things happening in the industry to drive success for that business. Is that fair?
Jude Jason:
That's very fair. And this is also a time when because the shortage in the industry has played out the way it's played out, a lot of businesses have worked, but it's also important as we think about active stock picking and management, that it's important to understand that there are certain risks baked in that haven't arisen yet, but we should really think about around speculation and binary outcomes that could play out over time.
Sean Kenney:
Okay, that's helpful. And then the third one is timeframes matter. So you could be right for a very long period of time, but not actually have it manifested in the stock or in the company. So timeframes matter, understanding supply and demand dynamics and where the companies are in the cycle is critical. So are those three core takeaways that we can take from this?
Jude Jason:
That sounds good to me.
Sean Kenney:
That's helpful and I really appreciate the time, the insights, and really great to hear the stories of how you and the team are navigating this transition for our clients. So thank you. And thank you for joining today. If you found this episode helpful, be sure to subscribe so you don't miss any feature episodes. Thank you for listening to All Angles. And until next time, be sure to consider your investment decisions from all angles.
The views expressed to those of the speaker and are subject could change at any time. These views are for informational purposes only and should not be relied upon as a recommendation to purchase any security or as an offer of securities or investment advice. No forecast can be guaranteed. Past performance is no guarantee of future results.
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