Markets are prone to bubbles as the herd instinct takes over from cool common sense. This is not a new phenomenon – witness the South Sea bubble in the early 18th Century, and the even earlier Tulip Mania in the Netherlands – but markets seem to be as prone to these as ever. The dot-com bubble of 1995-2001 saw money pouring in to internet start-ups, most of which have since disappeared.
IT may have transformed our lives, but for every Amazon or Google, there are hundreds of companies that never made a profit. There are of course always commentators who will point out the dangers of such investments, but the temptation to put money into a sector that has shown exceptional growth in expectation that the growth will continue seems irresistible to many.
There are also warnings of a different sort; that a company or sector is overvalued because of structural factors and that it’s time to cash in. There have been many warnings over recent years of the overvaluation of conventional energy companies because of the problem of stranded assets. The argument goes that, to meet carbon dioxide emissions targets, a large proportion of the reported proven oil, gas and coal reserves will have to remain in the ground. Since an energy company’s stock market valuation is based in part on the value of reserves, this means that current share prices are too high.
The benchmark FTSE 100 index this morning stands at just under 7300, compared to around 6200 a year ago. For comparison, over the same period, the price of BP shares has risen from 350p to 466p, and the oil and gas sector as a whole has risen by 32%. There have been inevitable ups and downs with fluctuations in the price of oil, and BP is to some extent a special case because of the legacy of the major Gulf oil spill (the Deepwater Horizon disaster) in 2010, but there is no sign of investors taking the message of stranded assets to heart. Some would argue that this is a sign of wilful blindness, but the more likely explanation is that investors continue to believe that the conventional energy sector will remain productive and profitable for many years to come.
Those who talk about the inevitable decline of oil, gas and coal (in a way akin to capitalism bearing the seeds of its own destruction, perhaps?) point to the rosy future for renewable energy. Given the commitment from governments and the healthy subsidies on offer, this is not surprising. But cautious investors might want to look twice at a sector that requires ongoing subsidy to be viable, and the available data shows a less optimistic picture.
For example, if we look at the S&P Global Clean Energy Index, the value has moved from 569 to 541 over the last twelve months, with little volatility and no consistent trend. This has all the hallmarks of a stagnant market, with little investor interest. Looking further back, however, we see a classic bubble. Ten years ago, the index stood at 2,600 and rose as high as 4,000 by 2008. But the crash came at the end of the year, with the index losing 75% of its value and never rising above 1,500 since.
Now, we may be witnessing a further bubble, as we read that Tesla’s market value overtakes Ford. On April 2, Tesla, committed entirely to all-electric cars, was valued at $49bn compared to Ford’s $46bn. Tesla has been growing fast, but from a small base. It sold 25,000 cars in the first quarter of the year, up by two-thirds over the same period last year. Most people in the UK and many other European countries will have seen several sleek Tesla model S cars on the road, but total deliveries in 2016 were just 76,000. The figure for Ford was 6.7 million.
Tesla’s financial report shows income of about $4bn in 2015, with a net loss of $888 million. Net losses per share were just under $7. In the same year, Ford reported revenue of $140bn and a pre-tax profit of $10bn. Nevertheless, some investors clearly see Tesla as the future and are prepared to bet that it will become the Google rather than the Alta Vista of the personal transport market.
Elon Musk, the company’s chief executive, is certainly ambitious and, so far, has been very successful. Having made his fortune with PayPal, he has bet much of this on Tesla, and SpaceX, which is developing reusable rockets for space travel. More recently, the company has invested $5bn in the so-called Gigafactory, producing lithium batteries on an enormous scale and thereby hoping to cut their cost. As well as going into cars, these batteries are being used in the Powerwall product, intended as a domestic energy store to smooth out the supply of renewable energy. SolarCity, a major supplier of solar panels, and Hyperloop, a proposed high speed transport system using air pressure to push capsules along dedicated tubes, are two more of his projects.
To some people, Musk has the Midas touch and can do no wrong. Certainly Tesla has developed the best all-electric car yet available in the model S, but its price makes it a popular choice for prosperous first adopters rather than a replacement for the internal combustion engine in the mass market. They are aspirational and now have the same position in the market as the Toyota Prius did when it was first launched.
Since then, Toyota has sold millions more Prius models, but this truly is a replacement for conventional cars, albeit a more expensive one. The company also makes a whole range of other models, and its overall strong market position and success comes from this mix. Although a relative late-comer to the sector, Ford also has a significant involvement in hybrid and electric vehicles as part of its product mix. Tesla, on the other hand, is committed to a single technology and its future will surely depend on the new model 3, its first mass market model which will be launched in the USA soon.
This is the point at which the bubble may burst. People who can afford the very-desirable model S would surely have other transport options for the long journeys all-electric cars are not appropriate for. The middle market, on the other hand, will be asked to pay a premium for a no-doubt well designed car that will have distinct limitations. This may work in some parts of America, at least in big cities such as Los Angeles that are dependent on private cars. But whether this is a business model that can ever justify the current stock market valuation is a moot point. A canny investor might be more inclined to go with Ford or Toyota.