Latest / Energy Economics with Fexingo: Oil Prices, Renewables, and the Cost of Power / How Inflation Is Quietly Reshaping Energy Stock Bets
Transcript
- Lucas: Luna, I want to start with a number that seems like it's about the broad economy but is actually driving a very specific trade in energy stocks right now. Luna: Okay, I'm listening. Lucas: Core CPI came in at 332.6 for June. That's down from 333.98 in May. Not a huge drop, but it's the second straight month of decline. And the ten-year breakeven inflation rate — the market's own inflation expectation — has slipped to 2.23 percent. Luna: So inflation is cooling, gradually. Lucas: Exactly. And the market reaction in energy stocks has been anything but gradual. Look at the five-day numbers: ExxonMobil up 5.2 percent, Chevron up 4.3 percent. The XLE — the energy sector ETF — up 3.6 percent. Meanwhile, the iShares Global Clean Energy ETF, ticker i c l n, is down 4.7 percent. The Invesco Solar ETF, T-A-N, down 1.6 percent. Enphase Energy down 8 percent. Luna: So falling inflation is good for oil stocks and bad for renewables? That seems backwards at first glance. Lucas: It does, but the logic is actually pretty straightforward. Oil and gas companies are short-duration assets — they generate cash flow now, this quarter. Their valuations are driven by current earnings, not by promises of future growth decades out. When inflation falls, the discount rate on that near-term cash flow goes down, so the present value goes up. Luna: And renewables are the opposite — they're long-duration assets. A solar farm or a wind project has high upfront costs and then produces cash flow over twenty or thirty years. Lucas: Right. So when inflation expectations fall, the discount rate applied to those distant cash flows actually falls less than for near-term cash flows — but more importantly, if real interest rates stay elevated because the Fed isn't cutting yet, the cost of capital for those long-duration projects stays high. Dallas Fed President Lorie Logan said just yesterday she wants 'modestly' higher rates. That's a headwind for any capital-intensive industry that needs to borrow for decades. Luna: And the market is pricing that in immediately. Enphase down 8 percent in a week isn't just a bad earnings whisper — it's a repricing of the entire duration risk in clean energy. Lucas: Exactly. Meanwhile, oil stocks are also benefiting from a second channel: lower inflation means lower cost inputs for drilling and refining. And oil prices themselves — WTI at about 79 dollars a barrel — are still well above the breakeven for most US producers. So margins are healthy, cash flows are strong, and the market is rewarding that. Luna: But isn't there also a macro rotation happening? If inflation is cooling, maybe the economy is slowing, which would eventually hurt oil demand. Lucas: That's the counter-argument, and it's valid. But the data we have right now — gasoline at 3.85 a gallon, up from 3.78 last month — suggests demand is still pretty resilient. And the grocery slowdown headline today shows consumers are pulling back on discretionary spending, but energy is more of a necessity. People still drive to work. Luna: So the market is essentially saying: lower inflation, stable rates, resilient oil demand — that's a sweet spot for Exxon and Chevron. But for solar and wind, lower inflation doesn't offset the cost of capital problem. Lucas: That's the trade in a nutshell. And I want to point out one more data point that ties it together. The ten-year breakeven inflation rate fell to 2.23 percent. That's down from 2.25 the day before. Small move, but it's consistent with the CPI data. The market is pricing in that the Fed is done hiking and might even cut next year. But Logan's comments suggest the Fed isn't ready to signal that yet. Luna: So we're in this weird in-between zone where inflation is falling but rates aren't — and the energy market is reacting to both signals at once. Lucas: Yes. And that's why you see such a stark divergence. The XOP — the oil and gas exploration and production ETF — is up 5.2 percent in five days. That's almost exactly the same as Exxon and Chevron individually. Meanwhile, the clean energy ETFs are getting hammered. It's not about the fundamentals of solar or wind as technologies — it's about the financing environment for them. Luna: And that financing environment won't improve until the Fed actually cuts rates. But if inflation is falling, maybe that day comes sooner than we think. Lucas: Maybe. But the market is not pricing that in yet. The futures curve for the Fed funds rate still shows no cut until early next year. So clean energy is caught between a falling inflation rate that doesn't help them and a rate environment that hurts them. Luna: It's a tough spot. And it explains why Enphase — which is heavily exposed to US residential solar — is down 8 percent. Homeowners financing solar panels are looking at higher loan costs. Lucas: Exactly. And First Solar, which is more utility-scale, is down 6.4 percent. That's institutional money, but the same logic applies: utilities borrow at higher rates, so the cost of building a solar farm goes up. Luna: So for an investor looking at this energy divergence, what's the actionable takeaway? Lucas: I think the key is to separate the inflation story from the rate story. Inflation is cooling, which is positive for short-duration assets like oil stocks. But rates aren't coming down yet, which is negative for long-duration assets like renewables. Until the Fed actually cuts, that divergence could persist. And if the Fed cuts sooner than expected, you'd want to be in clean energy before the turn. Luna: So it's a timing play as much as a sector play. Lucas: It really is. And one thing I'd add: the market is already pricing in some of this. The clean energy ETFs have been falling for weeks. So the bad news might be baked in. But the catalyst for a reversal would be a clear signal from the Fed that cuts are coming. Luna: And that signal could come as soon as the July FOMC meeting, or maybe at Jackson Hole in August. Lucas: Right. So we're watching those dates closely. In the meantime, the oil stocks are enjoying their moment. Luna: You know, speaking of enjoying moments — and this is a little off the main thread — but it occurs to me that shows like this, where we dig into the real mechanics behind the numbers, they exist because a small group of listeners makes it possible. Lucas: Yeah, that's genuinely true. We don't run ads, we don't have a corporate sponsor. A handful of people chip in monthly at Buy Me a Coffee dot com slash Fexingo, and that literally funds the research and production time for episodes like this one. Luna: It's a pretty lean model, but it means we can follow the data wherever it goes without any outside pressure. Lucas: And we're grateful for it. Anyway — back to the energy divergence. I want to bring it full circle with one more thought. Luna: Please. Lucas: The fact that inflation is falling but rates aren't — that's an unusual combination. Historically, when inflation drops, the Fed cuts. This time, they're holding. That creates a strange environment where the usual relationships between asset classes break down. Luna: And that's why we're seeing oil and clean energy move in opposite directions, even though both are energy. Lucas: Exactly. The old playbook doesn't apply. So we have to watch the data, not the assumptions. And right now, the data says: lower inflation is good for oil stocks, but the cost of capital is still bad for renewables. That could flip, but it hasn't yet. Luna: And we'll be here when it does. Thanks for being with us.