In Light of Increasing Energy Expenses, The Significance of Energy Resources Remains Underappreciated
Revised Article:
In the current economic climate, the book values of energy and infrastructure assets are significantly underestimated, according to experts. A perfect storm of escalating costs, strained supply chains, labor shortages, and rising prices for new equipment have culminated, making it impossible to replace or replicate these industrial assets without incurring substantially higher costs.
This situation creates a unique scenario - existing asset footprints are likely worth much more than investors currently comprehend, and the costs associated with competing with these asset footprints likely reduce competitive pressures from new entrants. Additionally, the future capital needs of these companies, particularly those with older assets, are likely underestimated.
Material costs, such as steel and aluminum, continue to skyrocket. Since these materials form the backbone of oil and gas, infrastructure, and other industrial assets, their soaring prices directly inflate the value required to replicate these assets. Steel prices, for instance, have risen dramatically due to restricted global supply chains, increased tariffs, and geopolitical tensions. Aluminum prices have followed a similar trajectory, driven by higher energy costs and supply chain disruptions. It's worth noting that these heightened material costs have yet to be fully reflected in current asset valuations, creating a potential gap between existing book values and the realistic replacement costs of these industrial assets.
The labor market transformation is another influential factor. Historically, labor-intensive sectors benefited from the availability of cheap labor. However, with stricter immigration enforcement, demographic shifts, and skilled workforce shortages, labor costs across North America and Europe continue to rise. This ongoing labor market evolution means existing assets hold greater intrinsic value, as reproducing them today would entail significantly higher expenses. For energy and infrastructure companies, whose value is predominantly derived from physical assets like pipeline companies or oil sands companies, the high upfront infrastructure investment required further exacerbates this problem.
Moreover, post-COVID-19 economic dynamics have resulted in significant increases in new equipment pricing. Persistent supply chain disruptions, inflationary pressures, and tariffs imposed on Chinese manufacturers have also caused equipment costs to climb. Equipping new projects with essential components like semiconductors and specialized machinery has become more challenging and, consequently, costly.
These issues aren't the full extent of the challenges the industrial sector faces. Climbing costs of permitting for new projects contribute to the problem. For instance, on a current project, the permitting costs alone are twice as much as the costs for the pipe itself. Adding to the complications, if legal battles or delays occur, these costs could potentially reach hundreds of millions of dollars. This heightened cost of capital eventually translates to increased expenses for consumers.
All of this implies that energy and infrastructure companies will experience a significant recalibration of asset values. Traditional accounting practices that rely on historical cost and depreciation schedules may understate the actual replacement cost of legacy investments. Consequently, this could serve as an underestimated tailwind for asset-heavy companies and create barriers for high growth entrants. The outcome is likely to be growing returns for incumbents and a desire among incumbent operators to extend asset lives. Historically, energy and infrastructure companies have returned their cost of capital. However, with many assets unable to be reproduced cost-effectively any longer, returns are expected to increase continuously.
- The rising costs of steel and aluminum, key components in oil and gas, infrastructure, and other industrial assets, are not fully reflected in current asset valuations, emphasizing the need for a recalibration of asset values.
- Highlighting the ongoing labor market evolution, existing assets hold greater intrinsic value as reproducing them today would entail significantly higher expenses, especially for energy and infrastructure companies whose value is predominantly derived from physical assets.
- Infrastructure investment costs for energy and pipeline companies have escalated due to factors like material price hikes, new equipment pricing increases, and tariffs on Chinese goods, necessitating a reevaluation of asset values and potentially serving as a competitive advantage for incumbent operators.
