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Oil supply should ‘put a pretty hard floor’ under energy prices: Strategist

SS&C ALPS Advisors Chief ETF Strategist Paul Baiocchi joins Yahoo Finance Live to discuss the outlook for oil, energy prices, supply and demand, the Inflation Reduction Act, and the shift towards EVs.

Video Transcript

[AUDIO LOGO]

JULIE HYMAN: Despite pulling back from their July peak, energy prices continue-- or energy stocks, I should say, continue to be the best-performing sector year to date as a tight global supply outweighs concerns about demand. Joining us now to discuss is SS&C ALPS Advisors Chief ETF Strategist Paul Baiocchi.

Thank you for being here. As we look at what's going on with energy right now, it seems like a lot of investors are still fans of the group, even as we've seen this pullback from the highs and as we've seen pullback in underlying energy prices as well, oil prices in particular, which continue to drop today. What do you think the outlook is for the rest of the year? And do you think investors are going to stick with the group?

PAUL BAIOCCHI: So I would say that the flows into XLE, into the broader energy sector, haven't necessarily been as robust as you might expect considering XLE and the energy sector's outperforming the S&P 500 by nearly 70% year to date. So it hasn't been a sector that's been necessarily super popular. But going forward, you look at these companies from a fundamental perspective, and they're in a place where they're generating significant free cash flow. And that free cash flow has gone to things like deleveraging, increasing dividends, and share buybacks.

Now, in this market context, that's sort of hard to come by, companies that are in this type of fundamental shape and, at the same time, trading at valuations that, at least relative to history and relative to the market, are significantly lower and, quote unquote, "cheaper" than they've been and-- than the market is and some of the growth-oriented sectors. And so that combination of both the valuation and fundamental story is paired with a macro backdrop that is still fairly robust. When you think about, as you mentioned, the supply backdrop, it's a very tight global market for crude oil. It's an even tighter global market for natural gas.

And despite the fact that we've seen negative GDP prints for two quarters running, and therefore are on the precipice or perhaps in a recession, and therefore perhaps a decline in demand is expected, the reality is, is that supply and demand globally for both crude oil and natural gas remains very tight. And that should, at the very least, put upward pressure on crude oil and natural gas prices or, said another way, put a pretty hard floor underneath energy prices and be fairly constructive for earnings in the space and free cash flow, which has been the lifeblood of this performance.

BRAD SMITH: And so, Paul, I mean, we've also got to take into account the Inflation Reduction Act and some of the energy incentives baked into that as well. So with that in mind, I mean, when do we expect some of those incentives to start to really take hold and be factored into the sector as a whole?

PAUL BAIOCCHI: Well, it's interesting because if we're going to-- as California has now mandated the adoption of electric vehicles or every new vehicle sold in 2035 be electric and the sort of widespread adoption of electric vehicles that's expected, we're going to need electricity, and more electricity than we have now. And part of the Inflation Reduction Act is aimed at improving our grid and transitioning us away from traditional sources of electricity.

But the reality is, is that we're going to need a tremendous amount of natural gas to support that increased electricity demand through the transition, which I think bodes well for energy infrastructure companies in the business of transporting, storing, and processing. And to that end, I think there's also some pieces in the Inflation Reduction Act that are relevant to traditional energy companies, specifically an increase in 45Q credits, which is the price that the government is going to credit these companies for carbon.

And you look at Exxon, you look at Chevron, you look at some of these midstream companies, energy infrastructure companies who are either in the business now or exploring and investing in the opportunity to sequester, to capture, and to repurpose carbon dioxide, that's become much more economical with the increase in the price of carbon embedded in that deal. And so I think investors ultimately have sort of a binary stance on energy-- you're either in renewable energy or in you're in legacy energy.

The reality is, is a blended approach is probably more appropriate where you still have exposure to the energy sector and you have exposure to the emerging renewable energy companies in the renewable energy segments, which span multiple sectors. You've got semiconductor companies or companies classified as semiconductors in that segment. You've got a number of companies in the EV space, in the battery space that are participating in that transition in that renewable energy segment.

And so pairing something like XLE or AMLP or ENFR with something like, say, ACES, which is a renewable energy portfolio, allows investors to not only get exposure to the here and now of energy, but also to the transition in some future state, and also, in theory, get exposure to some of the benefits and fiscal stimulus embedded in that Inflation Reduction Act.

JULIE HYMAN: Right. And also a good conversation to be having during climate week here in New York. Just quickly, Paul, what about the idea of grid efficiency and technology on that end? It seems like there's not a lot of investment opportunities for public markets out there right now, but is that something that you guys are looking at?

PAUL BAIOCCHI: It certainly is, and it's a piece of our renewable energy portfolio, which has seven themes, including energy efficiency and grid improvements. But the reality is, is that the grid, as it's constituted, would not be able to handle the type of mass adoption of electric vehicles that's being proposed by governments in the United States, and even globally when you look at some of the foreign grids. And the reality is, is that tremendous investment from the government in public markets and in private markets is going to be needed to ensure that transition comes without significant impacts to the consumer.

And I think investors would be wise to look at the various opportunities in the market currently to invest in that segment of the market, but also there's indirect beneficiaries, companies like the previous guest talked about in the industrial sector who are providing some of the equipment and some of the technology that will allow us to build a grid that's more robust and more resilient because that's ultimately what's going to allow us to undergo this transition in earnest.

BRAD SMITH: Paul Baiocchi, who is the SS&C ALPS Advisors Chief ETF Strategist. Paul, we appreciate the time here this morning.

PAUL BAIOCCHI: Thank you so much.

BRAD SMITH: Definitely.