AI, Oil and Gas: Misadventures in Capital Allocation- Kailash Concepts

As AI Software Gorges on Funding, are we taking the Oil and Gas Sector for Granted?

Our recent pieces, How to Value Tech Companies and External Obsolescence: Tech Investors’ Newest Nightmare?, discussed how AI algorithms, big data, and machine learning could be undermining the moats of tech stocks that now sport multiples last seen during the dot.com mania. We noted that our empirically driven and evidence-based models had kept KCR overweight tech for nearly our firm’s entire 13-year operating history. Those same models finally went underweight tech in December of 2021.

Our general observation in those pieces was that the extraordinary run in a select group of tech stocks this year was driven largely by empirically dubious stories. Today’s missive has a simple goal: to contrast the euphoric narrative tropes about the digital transformation from AI with the oil and gas industry to highlight just how ridiculous the market’s pricing structure has become.

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The “Oil and gas, AI” comparison strikes us as the ultimate in contrasts. Intangibles vs. tangibles. A sector associated with a future of allegedly infinitely scaling profits vs. one that, while essential to basic human life, has been deemed obsolete. Optimism vs. pessimism.

Before diving in, let’s just take a quick look at price. What investors are valuing the two industries at. The light blue line shows that US Tech stocks are now valued at roughly $12 trillion US dollars. In contrast, the navy-blue line shows that the US Energy sector is valued at just shy of $2 trillion and falling.

So, investors believe US tech stocks are worth a solid $10 trillion dollars more than the US energy industry. How much of that valuation disparity is due to sentiment vs. fundamentals? While using an admittedly naive framework, this paper suggests that one credible answer is “all of it.”

We believe a reasonable person can conclude that the entire $10 trillion valuation discrepancy between oil and gas companies and tech valuations is based on investors’ assumptions about the future.

Having led out with a low-key assertion like that, KCR asks that you read the four quotes provided below:

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Oil market sentiment is nearing lows not seen since Covid 19 – a time when government lockdowns collapsed oil demand and fears of full storage sent oil prices briefly negative. Since peaking in June 2022…oil prices are

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SOURCES

^[i] https://www.ogv.energy/news-item/over-100-oil-and-gas-companies-went-bankrupt-in-2020

^[ii] https://www.worldoil.com/news/2021/6/2/iea-criticizes-oil-and-gas-industry-s-green-spending-expecting-a-fourfold-increase/

^[iii] https://www.ecowatch.com/iea-methane-emissions-2023.html

^[iv] https://www.iea.org/reports/oil-2023

[v] https://www.bloomberg.com/graphics/2020-peak-oil-era-is-suddenly-upon-us/

^[vi] IBID, pages 8, 11, 43, 45, 47, 50, 66

END NOTES

[1] August 31, 2000 – August 31, 2010, the S&P 500 index returned -16.71% cumulative or -1.81% per annum

[2] Ironically, the most empirically credible one is for interest rates to go back to zero, the dollar to hold its value and the economy to grow quickly, yet this argument has, understandably, never been put in front of us!

FAQ

As a reminder for our Financial Advisors: our models are available on a continuous basis, and most have been in production for over a decade. If you are looking for a simple, concentrated, low turnover, and hard-hitting GARP investing strategy, we would like to talk with you. Similarly, if you are looking for a model portfolio of the most proven and durable dividend payers that is simple to implement, please let us know. KCR also offers a wide range of easy-to-use but sophisticated tools like our Equity Duration product, which allows you to estimate a given portfolio’s interest rate and inflation risk. Over the last 12 years, KCR has built and offers time-tested and class-leading products built by experienced and proven money managers for fixed to low prices.

Kailash Capital Research, LLC ’s sister company, L2 Asset Management, runs market neutral, long/short, large-cap, and mid-cap long-only portfolios with a value and quality bias. L2 employs a highly disciplined investment process characterized by moderate concentration, low turnover, high tax efficiency, and low fees. While nobody can predict the future, we believe the recent resurgence in risk-adjusted returns seen across all products is the beginning of what may be a long period where speculation is punished, and prudence and patience rewarded.

SERVICES

As a reminder for our Financial Advisors: our models are available on a continuous basis, and most have been in production for over a decade. If you are looking for simple, concentrated, low turnover, and tax efficient model portfolios we would like to talk with you. KCR also offers a wide range of easy-to-use but sophisticated tools. Our toolkits can help identify mispriced stocks with the best and worst risk/reward characteristics, estimate a stock’s duration and warn you when a company is engaging in low-quality accounting. Over the last 12 years, KCR has built and offers time-tested and class-leading products built by experienced and proven money managers for fixed to low prices.
Kailash Capital Research, LLC ’s sister company, L2 Asset Management, runs market neutral, long/short, large-cap, and mid-cap long-only portfolios with a value and quality bias. L2 employs a highly disciplined investment process characterized by moderate concentration, low turnover, high tax efficiency, and low fees. While nobody can predict the future, we believe the recent resurgence in risk-adjusted returns seen across all products is the beginning of what may be a long period where speculation is punished, and prudence and patience rewarded.

Disclaimer

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