The Federal government has released its first offshore petroleum exploration permits, ensuring growth in the oil and gas sector at a time when it is seeking to boost its climate change credentials. The government’s divergent approach is symptomatic of a dilemma facing investors in the energy market – which way to play the energy crisis.

On the one hand Russia’s invasion of Ukraine, along with the global post-COVID economic recovery, have sent energy prices, especially for gas and coal, soaring and may keep them elevated for some time. This can be expected to ensure bumper profits for Australia’s two main ASX-listed oil and gas companies, Woodside Energy Group (ASX:WDS) and Santos (ASX:STO), making them an attractive prospect for traders and investors.

“The increase in profits in the oil and gas sector is almost entirely due to the rise in global oil prices, creating windfall profits that could never have been generated by increased operational efficiency,” said Chris Iggo, Chief Investment Officer, Core Investments at AXA IM.

On the other hand, as concerns about climate change drive the world toward a lower-carbon future, there are legitimate doubts about the nature of future demand for oil and gas. While a growing number of investors, self-directed and advised, simply want to avoid the sector altogether to focus on companies helping in the transition to a net zero carbon economy.

One superannuation fund, NGS Super, recently sold its entire holdings in Woodside and Santos for this very reason and expects other super funds will need to do the same to align to investor demand and fulfil publicly stated emissions reduction goals[1].

Equally the economic slowdown in China and efforts by the Western world’s central banks to tackle renewed inflation with higher interest rates could also ultimately hit energy prices.

Energy investment dilemma

These countervailing trends, increasing energy prices now with the prospect of higher share prices for energy producers and falling prices at some point in the not-too-distant future, with potentially weaker demand for energy companies within portfolios on account of the rising profile of ESG factors, create a dilemma for investors. Especially given there are no programs and timetables, yet, from governments here and overseas on how they expect to manage this transition.

The nature of the dilemma, the promise of strong returns for income and momentum, investors are concerned by the risks of shorter-term volatility and the uncertainty around the longer-term energy transition, means that a smarter approach to may be needed to drive returns.

Diversified approaches may help investors walk the line

One way to view it is to take advantage of the simple cost-effective array of options in exchange traded funds (ETFs) on the ASX, which can help investors easily and cheaply target the strategy they favour.

Taking a shorter-term view of the market, with the Ukraine war dragging on and the northern hemisphere winter approaching likely to keep oil and gas prices firm, there is the option to invest in the BetaShares Crude Oil Index ETF-Currency Hedged Synthetic ETF (ASX: OOO) or the BetaShares Global Energy Companies ETF (ASX: FUEL).

The Crude Oil ETF tracks an index providing exposure to WTI Crude Oil futures, while the FUEL ETF invests in the largest global energy companies outside Australia.

However, if your preference is to focus on the renewables side, then there is the VanEck Global Clean Energy ETF (ASX:CLNE), launched in March 2021 as the first ASX-listed clean energy ETF. CLNE tracks the S&P Global Clean Energy Select Index which measures the performance of thirty of the largest and most liquid companies with businesses related to global clean energy production, technology and equipment, from both developed and emerging markets.

Share options – giants vs minnows

In terms of specific Australian energy shares, Woodside (ASX:WDS) and Santos (ASX:STO) remain the larger options by market capitalisation by some distance.

Woodside has recently expanded its operation with the purchase of BHP’s oil and gas business in June to become a global giant. Woodside shares are up over 50 percent for the year to date.

Santos has been fully benefitting from the higher oil and gas prices and at the half year mark, reported underlying profit up 300% to US$1.27 billion, statutory net profit up 230% to US$1.17 billion and free cash flow up 199% to US$1.71 billion. Its shares are up nearly 20% for the year to end August 2022 and 30% for the past 12 months.

John Lockton, Head of Investment Strategy at MST Financial, said of the two energy giants he prefers Santos. “That's partly because of the oil story, but we also think there's adjustments that Santos can make to its business, particularly its assets, which can release value,” Mr Lockton said.

On the renewables side, there is nothing on the scale of Woodside or Santos. There are some smaller players such as Tilt Renewables (ASX: TLT), Infratil (ASX: IFT), Contact Energy (ASX: CEN) and Genesis Energy (ASX: GNE). However, these are largely in the electricity generation area using renewable energy sources like wind and solar.

Get a foot in both camps

For those investors looking for individual stocks to play the energy transition story, Mr Lockton singled out Macquarie Group (ASX:MQG) as an example of a more indirect strategy but one which could help navigate a challenging energy investment scenario.

Although Macquarie Group is a global financial services company, it is also a major player helping industries and companies in reducing carbon emissions, and accessing renewable power, clean fuels and sustainable transport.

“In the energy markets, the Macquarie Group have got key competitive advantage with a lot of expertise on energy, technology and commodities. They also provide a lot of funding for green and new energy infrastructure,” Mr Lockton said.

“It is one way that investors can get a foot in both camps. Macquarie Group can earn significant amounts of money in the old world of gas and oil, or the newer area of green energy-related commodities,” he added.

The current global energy crisis looks set to deepen, but as prices rise and consumers adjust it may also serve as a catalyst for a bigger energy transition.

For now, it may be time for investors to look more favourably on energy companies because of their expected strong oil and gas revenue. But as the transition to a decarbonised economy gathers pace, it may be time to switch to those companies taking the net zero challenge much more seriously.

[1] NGS Super dumps $125m of Woodside and Santos shares

https://www.afr.com/policy/tax-and-super/ngs-super-dumps-125m-of-woodside-and-santos-shares-20220803-p5b6tx