Editor’s Edition: Will rising rates and inflation crush green investment?

The fortunes of fossil fuel and clean energy investments have reversed in 2022, with oil and gas stocks surging amid blistering profit. Meanwhile, investors have largely turned against wind, solar, and other green energy investments that outperformed at the start of 2021.

How will the clean energy sector fare with interest rates on the rise and mounting recession concerns? Kevin Krausert is CEO and co-founder of Avatar Innovations, a Calgary-based venture capital firm and startup accelerator that pairs entrepreneurs with the biggest companies in Canada’s energy patch.

“Investors are retreating to business fundamentals, and the valuations that were happening in the clean tech stock indexes were all predicated on the expectation of future cash flow,” he told Yahoo Finance Canada’s Editor’s Edition. “In an uncertain world, you see a retreat to safety.”

Krausert also weighed in on the recent deal between BP and Cenovus Energy. He said the Calgary-based company’s decision to double-down on the oil sands, and BP’s expansion off Canada’s east coast, show each company is narrowing its focus on core competencies.

And as Canada’s energy industry holds its breath for the next Alberta premier, Krausert spoke about the challenges and opportunities that lay ahead for Jason Kenney’s successor.

Got a question for Kevin Krausert? Email Jeff.Lagerquist@yahoofinance.com and let him know what interests you in the world of clean energy and technology.

Jeff Lagerquist is a senior reporter at Yahoo Finance Canada. Follow him on Twitter @jefflagerquist.

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Video Transcript

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JEFF LAGERQUIST: Welcome to "Editor's Edition." I'm Jeff Lagerquist with Yahoo Finance Canada. Canada's oil sands will be more Canadian following a deal between Cenovus Energy and British oil major BP.

Under the terms, Calgary-based Cenovus will gain BP's 50% stake in a project in Alberta. BP gets Cenovus's 35% stake in an undeveloped Bay du Nord project off the East Coast. We'll dig into that deal on today's episode, and we'll also talk about the tough times for clean energy investments.

On top of that, we'll look ahead into Alberta's political future to see what a new premier could hold for Canada's energy capital. Joining me to break it all down is Kevin Krausert. He's CEO and co-founder of Avatar Innovations. It's a venture capital firm and startup accelerator that pairs entrepreneurs with the biggest companies in Canada's energy sector. Welcome, Kevin.

KEVIN KRAUSERT: Hey. Good to see you, Jeff. Good to be back. It's been a while.

Like I said off the top of the show, this means Canada's oil sands are set to become more Canadian. You can see some of the details of the deal here. Cenovus will pay 600 million in cash to own the Sunrise Project, plus a contingent payment of as much as $600 million that expires in two years. And the deal is expected to close in 2020.

JEFF LAGERQUIST: Kevin, we've got Cenovus doubling down on oil sands and BP walking away to expand its offshore oil portfolio. Before we get into BP expanding on the East Coast, what does this transaction say about how each company views the oil sands?

KEVIN KRAUSERT: Well, first off, I think this was actually, you know, a really smart move by Cenovus. You know, Cenovus has demonstrated they can bring some of the most impressive cost reductions in the industry at its portfolio facilities and bring them down as lift costs down to single digits. That is a tremendous amount of value if they can bring the same leadership and the same technology they've got at their other assets into their Sunrise asset.

So I see this as a huge value creation opportunity for Cenovus that really speaks to, you know, its corporate strategy. You know, it sees its enduring competitive advantage as, you know, being one of the lowest-cost, lowest-carbon oil producers in the world, which will benefit them very well as the world sort of moves on.

You know, Offshore Labrador is a far riskier player in my opinion. It's environmentally harsh. There's a lot of development permits that need to be going. It's a little more of an uncertain future, whereas BP does have a lot of core competencies in environmentally harsh offshore conditions.

And so I really see this as an opportunity for both companies to drive value in their portfolio assets and sort of stick to their core competencies. And I think that's, you know, part of a thread you're seeing across the industry and speaks more to where the respective companies think they can drive value than it is in, you know, any sort of commentary about the oil sands.

JEFF LAGERQUIST: So I suppose it's sort of a, you know, do a few things right rather than try and take a crack at every form of energy sort of thing.

KEVIN KRAUSERT: Yeah. Like, there used to be this, you know, conversation around diversification, having many sources of supply, whereas I think what we're demonstrating in the oil sands is we've got a very reliable, very secure source of energy for decades to come. And the companies that can extract as much value out of that by driving down costs, driving down their carbon emissions, are gonna be well positioned for the future where we start talking about energy security in a way that we haven't for many, many years.

JEFF LAGERQUIST: So, of course, BP is not the first international player to leave Canada's oil sands. Ecuador left to focus on Atlantic Canada. And others like Shell and Marathon Oil and ConocoPhillips have either reduced or eliminated their exposure over the last couple of years.

Obviously, there's a lot of factors here. And oil prices have been all over the map in that time. What would you say was behind those older exits from the oil sands? And is the Cenovus-BP situation different?

KEVIN KRAUSERT: Yeah, the Cenovus-BP situation, I would say, is very different. You know, it's been several years since you've seen a international oil company, uh, move or leave the oil sands. And, you know, a decade ago, it really started with this conversation and this historical belief that the oil sands were a high-cost, high-carbon producing jurisdiction.

And capital was flowing at the time into areas of oil production where you could see quick returns. You could go and drill a well in the Permian, and it paid out in 18 months, whereas the oil sands uses more of a facilities-based approach, and so you'd have to invest over a longer period of time.

So there was this sort of financial impetus of how could international oil companies divert their cash flows and their investments to faster returns. And then, also, you saw it as the rise of the ESG movement where, you know, it was seen as high-carbon.

Now, both of those assumptions have been turned on its heads. You know, as Cenovus and other companies are leading-- when the oil sands was built 15, 20 years ago, the expectation was that it was sort of a list cost of around $60 a barrel. Now you're seeing lift costs in the oil sands in the single digits. That competes with Saudi Arabia and some of the most pristine oil jurisdictions in the world.

And you're already seeing the efficiency gains and the carbon intensity efficiencies found driving some pristine oil sands assets in line with the same carbon intensity as a West Texas Intermediate barrel. So if the oil sands can get their carbon capture facilities off the line, there's an initiative called the Pathway Zero Alliance, which is all the oil sands producers looking to build these types of things-- if they could get to an upstream zero-carbon barrel at the type of list cost that they have, you have a highly reliable source of oil that is competitive not just on cost, but also on carbon.

And so it doesn't matter what oil forecast scenario you see into the future. Whether we're burning 140 barrels of oil a day or 50 million barrels of oil a day, the oil sands is very, very uniquely positioned to be delivering them in any forecast in any scenario for the future.

So I see this as being a very different-- a different investment thesis that is undergoing with this acquisition than you saw in the past. This is an investment in the confidence of the future of the oil sands as a significantly global energy-- and reliable energy player for decades to come and that the value is gonna be coming from driving down costs and driving down emissions.

JEFF LAGERQUIST: So you mentioned ESG while also talking about how times have definitely changed in the oil patch, both in terms of cost and in terms of environmental footprint. But RBC late last year said ESG headwinds could see more international players leave. But, at the same time, they said investors should be happy about deals between asset owners because there's no integration risk there. They're already familiar with the assets as a partial owner. They basically described it like a share buyback. Do you agree with that idea?

KEVIN KRAUSERT: Um, I disagree that I think you're gonna see a further exodus of international oil companies from Canada. I think that that narrative is long gone. However, you know, the thinking that companies are gonna be able to sort of do what they do and do it better than others is, I think, a sustained source of competitive advantage. So I see this as a very positive development for-- let's the A-team run the A-team assets rather than having a little bit of everybody's pie.

JEFF LAGERQUIST: All right. We've certainly seen some of the big oil companies shake up their portfolios. Suncor comes to mind with their plans to divest from wind and solar and focus more on hydrogen. And I believe they're also selling North Sea assets.

Given sort of what these companies are up to in terms of, I don't know, maybe sticking to their knitting and drilling down on a few things, what are the strategies you see these big oil majors following these days?

KEVIN KRAUSERT: Well, I think there's really four strategies that I think that are unfolding from different energy companies and different oil companies. You know, the first, which is probably predicated a lot by the sort of juniors and intermediates is they are an oil and gas company, and they're going to high-grade their cost resilience in a world of certain volatility and maximize that type of benefit. We're gonna get it out of the ground as cheaply as possible, and that's who we are.

You see what I think that-- you're starting to see the Canadian majors start playing out this strategy that they're gonna be a sustainable hydrocarbon producer with their core portfolio remaining oil and gas. But they're gonna invest in the decarbonization technologies that make it the lowest cost and the lowest carbon barrel.

Then you're seeing, you know, sort of what I would describe sort of many of the super majors doing, which is they're gonna become a transitioning energy supplier. They're gonna, you know, maintain their core portfolio of oil and gas assets. But they're gonna invest in wind and solar and a variety of these other initiatives.

And then, you know, I think there's probably the fourth, which is defined probably most notably by Orsted in Europe, which they're gonna become a low-carbon energy supplier and basically switch out their oil and gas assets. Now, I think there's a viable shareholder value capture thesis for all of these corporate strategies. But the one I think that makes the most sense for Canada-- and frankly, for the world-- is probably scenario two.

How can you be a sustainable hydrocarbon producer while the world has a voracious need for reliable and responsible sources of energy but also invest in the decarbonization technologies that ensure that you are moving alongside the world and investing in the future?

So, you know, I think there's value to be had for each. But I'd say those are the four strategies I see playing out with oil and gas companies. And depending upon the asset, depending upon the size of the company, depending upon its geography, they're taking different tactics.

And so the question of who wins is, well, it's really how well you execute. And I think the Canadian energy majors are pretty uniquely positioned to execute very well because we know the geography. We know the subsurface. And we know the technology. So we're going and getting it done.

JEFF LAGERQUIST: How much of these plans are gonna be determined by investors, and a lot more of them retail these days who seem laser-focused on returns to shareholders and capital discipline, and basically, giving me back my money?

KEVIN KRAUSERT: Yeah, so I don't know exactly the influence retail investors have. I say it's larger than it was in the past because you had the democratization of the stock market. Anybody can go in their phone now and buy, you know, a particular stock of interest as opposed to having to go through one of the institutions.

So I'd say the institution-- or the retail investors are definitely having a bigger impact than they have in the past. And where I think they're probably making the biggest impact is on, you know, some of the meme stocks-- the, oh, I just want to hold this stock because I think it's what the future is that drove valuations up to unsustainable levels. And then, you had a bunch of hedge funds sort of chasing that rise.

And so, yeah, retail investors are gonna be playing a bigger and bigger and larger role. The question is the energy transition is gonna be difficult. It's gonna be messy. It's gonna be hard. And so you probably need an investment class that's not the first out of the door as soon as you hit a bump in the road.

And that's, I think, the approach a lot of the institutional investors are taking is, you know, how can we maximize value while investing in the future that I think that the world knows the market is moving towards? Yeah, I guess my roundabout way of saying I'm not sure.

JEFF LAGERQUIST: Fair enough. Fair enough. Let's shift gears to greener forms of energy.

While the price of oil and natural gas and the related equities have soared in recent months, the same cannot be said for clean energy investments. The iShares Global Clean Energy ETF is down about 19% this year. That's a $5 billion basket of a lot of solar and wind that you can see there in the blue line. There's also the smaller Invesco clean energy ETF, and that's down 47% as well. You can see that there in green.

Sorry. I think that first graph turned out red. It was blue when I looked at it. Anyways, it seems like a lot of pain for these kind of companies.

Peter Tertzakian, one of my favorite energy observers, described the situation as the manure hitting the wind turbine. You can read those lines-- read between those lines there. Kevin, in early 2021, I was talking a lot about how strong the performance was in this sector. What's changed?

KEVIN KRAUSERT: Well, in an era of almost certain increasing volatilities, investors are retreating to business fundamentals. And the valuations that were happening in the, you know, clean tech stock indexes were all predicated on the expectation of future cash flow. And so as a result, in an increasingly uncertain world, you retreat to sort of safety.

So I think there was a lot of, you know, hype that was happening in the space in the sense that the world definitely wants to decarbonize. But the reality is, is this is-- going to be a multi-decade opportunity and not a quarterly return-focused hype market? You know, energy transition is not like digital tech, where you can scale massively and quickly because, you know, anybody with a cell phone is your market. We're talking about hard infrastructure, hard chemistry that we're working with.

And so as a result, I think there's been this awakening amongst many of the investors that this is gonna take decades. And so the reality is I think that this puts the oil and gas industry in a very prime position, in the driver's seat, to be able to drive the energy transition because we can't just flip a switch and go from somewhere-- go from our sort of current energy system to a brand-new energy system tomorrow.

So I think that is a little bit of actually sanity probably coming to the market. However, I think that there's positives in this because what it will do is it will drive capital discipline. It will drive bringing technologies to market faster. The good companies will succeed.

So I don't see this as tough times, if you will. I see this more just as sort of normal times. And I'm optimistic that investors and the public will realize that to get to a net zero future, it's gonna require an all-hands-on-deck approach.

We can't have this sort of oversimplified narrative that there's good energy and there's bad energy. This is a complex issue that is going to require everybody to be driving. And if you look at any energy transition in the past, they've used the existing infrastructure to contribute to the new energy future.

And so I think it's gonna look a lot similar today. We've got trillions of dollars of existing energy infrastructure. How can we use that to decarbonize and meet the urgent need of a net zero 2050?

The simplest, fastest, and cheapest way to get to a net zero future is gonna be to use the infrastructure we already have in place in new and creative ways. The slowest, most complicated, and most expensive way to get to a net zero future is to go and invent some brand-new energy system.

So let's start running at this in the same way. And I think there's a big opportunity here, you know, that the energy transition is an and story. It's wind and solar, and it's carbon capture. And it's biofuels. And it's hydrogen. This is what really excites me, and I think this is where the growth opportunities lie.

JEFF LAGERQUIST: So I hear a lot of smart people talking about recession risk these days. And we're definitely in a rising interest rate environment. How do you figure those macrofactors are going to change maybe the pace of investment or the sort of size of investments in the sector? Will these clean energy companies have to, you know, tighten their belts like the oil and gas companies did when crude prices crashed and their stocks fell?

KEVIN KRAUSERT: Well, I think capital discipline is a smart, you know, a smart approach for any established company. So, you know, the recessionary risks, I think, are very real. I think energy is gonna be a little bit isolated from it because the geopolitics of energy are gonna be driving a lot of the energy prices, which is contributing to the inflationary risks.

So, you know, from a clean energy perspective, yes, capital discipline and efficiency is always a good strategy to behold. And so, you know, what further efficiencies can they find?

JEFF LAGERQUIST: When we look at, you know, investors looking at this space, would it be advantageous to perhaps invest in a clean tech company that has exposure to the fossil fuel sector, maybe carbon capture or electrifying parts of the oil process, that we get sort of the hard commodities exposure but also the, you know, transition tailwind or the transition momentum?

KEVIN KRAUSERT: Yeah, there's not a lot of public companies that one could invest in. You know, generally speaking, those are private companies. And I think that because of the longer technology development road map that a lot of these companies are gonna have, it makes sense to sort of be in the private markets as opposed to the public markets because you can find the investor class that's willing to take a longer-term investment thesis so that when, as I mentioned, we hit the first bump in the road, they're not the first investors out of the door.

And I think you're sort of starting to see that in the clean tech space that, you know, these valuations are becoming a little more sane. But I think that also, again, puts the oil and gas industry in a prime position where they hadn't been looking at buying a lot of these technologies in the past because the valuations were too high.

Now that the valuations are a little more sane, I think this puts the oil and gas industry with its record-breaking cash flows in a prime pole position to basically be able to adopt this technology, buy this technology, and implement the technology.

JEFF LAGERQUIST: So continuing with the oil and gas industry, you were recently at a big event in Calgary, the Global Energy Show, formerly the Global Petroleum Show. Maybe, first off, what does the name change say to you? And then, you know, what did you notice about the event compared to previous years?

KEVIN KRAUSERT: Yeah, you know, I think the name change is just in line with the realization that oil and petroleum are part of a global energy mix that includes many different sources. And so I don't read too much into the name change.

What was interesting for me was, especially on the trade floor, you know, previously, you'd walk around the trade floor. It was, you know, the cast of characters on the service companies trying to sell their latest and greatest model car. And this year, they were there. But predominantly, it was sort of emissions reductions technologies they were demonstrating. And it was emissions reduction technology sort of startups.

And that, to me, was a little bit reflective of the conversation everyone is having in this industry is that, you know, we know we are the, you know, responsible energy producers. And we can do that really well. But we've got to run faster on reducing emissions.

And so it was almost to say where the narrative is driving-- the fact that the service companies, you know, instead of selling their latest and greatest frack setup or their latest and greatest drill setup, they're selling their latest and greatest emissions reductions technologies. And so I think that speaks to where the industry is going is, how can we responsibly deliver energy while lowering emissions as quickly as possible?

JEFF LAGERQUIST: Well, I guess that must reflect where the money is going if, you know, these companies are getting out, being public, renting booths, shaking hands, and doing all that good stuff. Lastly, I want to stay in Alberta, as our show so often does. I don't know if you've heard about this, Kevin. But Premier Jason Kenney is leaving office.

KEVIN KRAUSERT: Yes. Yes. I'm surprised you guys heard about that in Toronto. But, yes, we've heard about that one in Alberta.

JEFF LAGERQUIST: Yes, yes. The news made its way to Toronto. Kenney announced the decision after receiving just 51.4% in a party support vote last month. He's been premier since 2019, leading Alberta through some pretty interesting times for the energy sector.

We saw oil prices go negative in the early months of COVID-19 and ESG take off in the world of finance and, you know, the Keystone XL drama. And, of course, the world became increasingly focused on climate change. Kevin, how would you describe Kenney's legacy when it comes to the energy industry?

KEVIN KRAUSERT: Well, you know, first and foremost, I'd like to thank the premier for his service. Public service is a difficult job and very clearly a blood sport. But throwing your hat into the ring to help make people's lives better in the public service is a noble cause. And I'd like to thank him for that.

You know, I'd say that the energy industry has changed pretty dramatically from when he was elected, that we were elected-- he was elected in a low oil-price environment. There was a narrative that the challenges that were facing the energy industry had been predicated not by the low oil prices, but by inability to access global markets, and a perception that certain actors in Canada were trying to put the business out of-- put the energy business out of business.

Now we're in a world where we've got exploding energy prices that are, you know, risking running the world into a recession. We've got really, really bad geopolitical actors using energy resources for war crimes, essentially. And so-- and, you know, this is going-- and that we have to decarbonize.

And I'd say that, in Alberta, there's been this increasing realization that the oil and gas industry can, must, and is a meaningful and powerful partner in the energy transition, that there's no light that's kind of gonna be switched off. And so I'd say that, you know, amongst, you know, the streets of Calgary, there's this sanity that's gonna be in there that, OK, how do we responsibly deliver energy while reaching a net zero future? And how do we get there together?

And so, um, you know, I'd say, you know, the premier did his best. But, you know, to his party members, I guess it wasn't enough.

JEFF LAGERQUIST: Yeah. I mean, I certainly can appreciate being in a difficult position with the influence of both the oil and gas sector and the sort of global pressure to be a part of a transition. How much uncertainty has Kenney's departure injected? I guess the important question to ask you is, how influential is an Alberta premier when it comes to the fortunes of the energy sector, you know, particularly oil and gas, where prices are set internationally?

KEVIN KRAUSERT: You know, I'd say that the premier has the-- any premier has the opportunity of really being the primary champion for the economic engine of not just Alberta but of Canada. And so being able to align the messaging and the championing of that sector in line with the aspirations of the rest of Canada is what's needed. And I'm hopeful the next premier recognizes that we're going to need some stability.

You know, there is conversations around pore space dynamics. We have a very capable energy minister in this province who's staying in her position to manage that through during this period of uncertainty from the premier. So, you know, I'd say, from a nuts and bolts government perspective, the government operates well. The bureaucracy works well. And we have some capable ministers on the energy file.

You know, I think the question is, where does the campaign go, both the Conservative Party leadership race as well as the general election that will be happening in about a year? And if we have a suite of candidates who run against inflation, which is essentially they're gonna want to run against. They're gonna blame it on three possible things.

They're gonna blame it on the energy transition. They're gonna either blame it on oil companies, or they're gonna just blame it on government generally. And so I would encourage any of the leaders running to be responsible to recognize that the way we win this race is by investing in the technologies, like carbon capture and hydrogen and biofuels, that are gonna make us competitive in the future.

And a lot of those are predicated on the work that has been done over the last several years to make the investment structures work. And if there's a lot of noise from the pockets of leadership races, I'd say that the oil and gas industry is gonna be struggling with-- frustrated with that because it will bring a new level of uncertainty when we're just about to get going on these carbon capture projects and on these biofuel projects and these hydrogen projects.

So the leaders that I think the industry would support would be ones who would recognize the importance of that investment and the importance of smart public policy to promote an investment climate where we can get these projects done.

JEFF LAGERQUIST: Like you say, it's a pretty critical time for the energy industry in Alberta. What's the political field like? Which way are the winds blowing? Any frontrunners emerged as of yet? I know it's, of course, still early days.

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KEVIN KRAUSERT: It's-- if I knew that, I would be smarter. But if-- and-- and-- I don't think anybody in Alberta has an idea of-- of how this goes. But, you know, I wish all the parties and all the leadership candidates the best. And I encourage them all to think about how Alberta wins the energy race in an increasingly volatile and decarbonizing world.

JEFF LAGERQUIST: All right, Kevin. That feels like a good place to end. Thank you so much for joining me.

KEVIN KRAUSERT: Thanks, Jeff.

JEFF LAGERQUIST: For all the latest news on clean energy and the broader world of Canadian finance, please visit the "Yahoo Finance Canada" website. I'm Jeff Lagerquist. I'll see you next time.

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