How the Upcoming U.S. Election Will Shape Regulation

A look at utilities, energy, and the budding cannabis industry in a continuation of the Trump presidency or a new Biden administration

Dave Sekera, CFA 28 October, 2020 | 4:28AM
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White House and Election graphics
When it comes to regulation, the contrast is clear: With a second term for the Trump administration, the rollback of regulatory restrictions would generally continue. A Biden administration would look to quash many of the deregulation efforts that have been made under Trump.

Plenty of industries would feel the impact of ramping up regulation or scaling back. But one industry the Biden-Harris campaign proposed rolling back restrictions on would create major momentum for a budding industry: cannabis.

Growing Cannabis After the Upcoming Election
Sen. Kamala Harris recently pledged to help decriminalize cannabis. If a Biden Administration is elected and this campaign promise becomes policy, motivation for further easing the federal prohibition could follow.

Loosening restrictions would help the cannabis industry mature. Banks and other ancillary services have stayed away from servicing cannabis companies owing to legal risk. These companies’ stocks are currently limited to trading on the over-the-counter market and Canadian exchanges. Decriminalization could prompt U.S. markets to allow these stocks to trade on U.S. national exchanges. This change would allow cannabis companies greater access to the capital markets for growth.

Now, many institutional investors are precluded from investing in over-the-counter stocks because they lack sufficient liquidity. But with this potential catalyst on the horizon, those same investors are beginning to do their homework, so that they will be ready to go when cannabis stocks move to an exchange.

Companies that could benefit from deregulation and see greater investor demand include Curaleaf (CURA) and Green Thumb (GTII). Both stocks have rallied over the past few weeks and are trading near their 52-week highs. Yet even at these levels we see value for investors in both stocks. We rate Curaleaf with 4-stars as it is trading at only a 0.74 price/fair value. Green Thumb is rated 3-stars but does offer upside potential as its price/fair value is 0.85.

The Future of Fracking and Electric Cars
Under a Biden administration, we expect many climate change policies will be implemented that would present headwinds to the U.S. oil industry. However, even after incorporating those changes into our supply and demand analysis, we continue to think the energy sector is undervalued.

Among the policies that we expect from a Biden administration, there will likely be a reset that would include reentering the Paris Agreement, reversing Trump-era policies, and halting permitting for drilling new wells on federal land.

While the federal government can stop the permitting needed to allow new drilling on federal land, it can’t ban fracking on private land, where most shale oil firms operate. If there’s a ban on permitting on federal land, we don’t expect a significant impact in our supply and demand analysis.

Congress could pass a new law to ban fracking, but we think that would be highly unlikely for two reasons. Biden has stated that he would not look to ban fracking outright. And banning all fracking would severely cut employment within the energy industry and among its suppliers as well as increase the cost of oil, which in turn would have a negative impact on the economy.

Vehicle fuel efficiency standards would likely be increased along with policies to build out charging station infrastructure nationwide. A Biden presidency could also provide financial incentives for the transition to electric vehicles. Our current forecast for the percentage of new U.S. vehicle sales that are electric or hybrid is 15% and 25% in 2025, respectively. Under a Biden administration and Democrat-controlled Senate, we would increase those percentages to 25% and 35%, respectively.

Yet, even in the Biden scenario, we forecast that U.S. gasoline demand would decline by only 3% by 2025 and by 9% in 2030 as compared with our base case. U.S. gasoline demand accounts for only a third of U.S. crude consumption, which equates to only a 1%-3% decrease in U.S. crude oil demand, globally, U.S. crude oil demand is only 20% of global demand.

The increase in electric and hybrid vehicles will also provide a boost to the lithium industry. We forecast that lithium demand will grow more than 6 times from around 300,000 metric tons in 2019 to roughly 1.9 million metric tons in 2030. Among the suppliers in the lithium industry, we rate Sociedad Química y Minera (SQM) with 5-stars as it trades with the cheapest price/fair value ratio of 0.61. The next most undervalued is Albemarle (ALB), which we rate with 4-stars based on its current price/fair value of 0.75. Finally, we rate Livent (LTHM) with 3-stars as it trades with a price/fair value of 0.80.

A Biden administration will need to be judicious as to how much and how rapidly to implement proposed changes. If they move too rapidly, the changes could quickly drive up fuel prices and hamper economic growth, as well as increase the amount of imported oil and increase the country’s reliance on foreign suppliers.

There are many different ways to invest in the energy sector. Across our coverage universe, the price/fair value of the energy sector is by far the cheapest and contains the greatest number of 4- and 5-star stocks. In fact, at a current price/fair value of 0.54, the only time over the course of our equity coverage since 2002 that this sector has been cheaper was March 2020, when oil traded at a negative price.

Among global oil companies, ExxonMobil (XOM) trades at less than half of its fair value, and in the oil services industry, Schlumberger (SLB) trades at about one third of its intrinsic value. Across regional oil companies, Pioneer Natural Resources (PXD) trades at 53% of our estimate, and within master limited partnerships, Enterprise Product Partners (EPD) trades at 67% of its fair value.

Renewable Energy Buildup
No matter who wins the election, renewable energy will continue to grow as a percentage of electricity production and will become the second-largest source of power generation in the U.S. by 2030, according to our forecasts.

As a percentage of power generation, coal has been declining over the past two decades and will continue to do so. There are no new coal plants being built in the U.S. currently, and hundreds have been retired or will be retired in the coming decade. We forecast that growth of renewable power will increase 8% annually based on renewable energy policies as dictated at the state level as the primary growth driver as opposed to federal regulation.

The Trump administration has largely stayed out of the way and has allowed the trend toward renewable power to play out. Biden’s energy platform calls for the U.S. to reach net zero emissions by 2050, but the majority of U.S. utilities has already made this pledge.

As utilities companies invest in retrofitting and upgrading their power production assets, we see solid long-term growth opportunities for the sector and note that some high-quality utilities are available at reasonable prices.

The most obvious beneficiaries are utilities that already own a significant amount of their own, or are supplied by, renewable energy assets. This includes NextEra Energy (NEE), Xcel Energy (XEL), and CMS Energy (CMS). We note, however, that the market has not only already incorporated this trend into those companies' valuations, but we think the prices for those stocks have risen too high and rate them with 1- or 2-stars.

Utilities that we think are undervalued and will benefit over the long term include 4-star rated Edison International (EIX), NiSource (NI), and Portland General (POR). One 3-star company that will benefit from this long-term trend is Duke Energy (DUK).

Among those utilities companies whose long-term outlook will be constrained by the trend toward renewable energy are those that are unregulated. In particular, those with a heavy reliance on legacy fossil fuel or nuclear power generation could face margin pressure as low-cost renewable energy increases its share of wholesale power markets. Examples include Vistra (VST), NRG Energy (NRG), and Exelon (EXC). In our view, the market has already incorporated that constraint to their long-term earnings potential, and we rate each of those stocks with 3-stars.

What Investors Should Know
The implementation of the key priorities of the next administration will certainly have an impact on the valuation of firms that are directly affected. Until Election Day, investors should take into consideration the potential impact to the companies they invest in. While it may be prudent to evaluate making a few modest changes in your portfolio, we recommend focusing on your long-term investment goals.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar Rating
Albemarle Corp90.88 USD-0.66Rating
CMS Energy Corp62.47 USD1.74Rating
Curaleaf Holdings Inc5.66 CAD-4.55Rating
Green Thumb Industries Inc15.44 CAD-4.93Rating
Livent Corp3.29 USD-4.64Rating
NextEra Energy Inc75.41 USD4.58Rating
NiSource Inc31.01 USD1.47Rating
Portland General Electric Co47.69 USD1.99Rating
Vistra Corp72.58 USD-9.35Rating
Xcel Energy Inc56.36 USD2.21Rating

About Author

Dave Sekera, CFA  Dave Sekera, CFA, is chief U.S. market strategist for Morningstar.

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