This is Blog #2 in our series of blogs to Jan 31 on overlooked “Lasting Changes To Oil & Gas” that emerged/solidified in the last several months and that are reshaping (both positively and negatively) the 2019 to 2025+ outlook for oil and natural gas. The timing for this blog was driven by two events this week – the lack of consensus from the Poland climate change talks, and the IEA”s new report “Coal 2018 – Analysis and forecasts to 2023” that calls for growth in coal demand in 2017 and again in 2018 following declines in 2015 and 2016. The IEA report reminds that energy trend lines aren’t always straight as evidenced by the rebound in coal demand. We believe there have been multiple speed bumps in the march to a world of accelerating renewable energy market share and an early demise of coal and oil. The driving force for this shift to renewables is governments regulating change. The unified global approach to climate change is no longer, and we are seeing leaders not accept climate change, forced by their citizens to pull back on climate change, or are just quietly not pushing on climate change. These speed bumps may not change the direction, but have to have an impact on the speed and timing for the demise of fossil fuels. Its hard for anyone to believe the rate of regulated changes to renewables isn’t slowing down. And if so, it also points to stronger than previously expected mid and long term cash flow generation from oil. One of our upcoming blogs is the most significant lasting change – the oil and gas sector has proven they can produce way more than expected and these shifting supply chains are causing price dislocations in the short term and a lower but still strong price in the mid to long term. Even still, the speed bumps in the march to renewable energy add to why we believe there is a lot more money to be generated and made from oil and natural gas in the mid and long term, but just not as much as we expected a year ago.
The most important factor is government regulated changes and, absent a series of major disruptions around the world, we believe most governments around the world will, to the most part, continue to regulate to a path to a world where renewable (clean) energy growth accelerates and fossil fuels (coal first, oil second, and natural gas third) reach peak demand and then decline. This view led to capital leaving what is viewed as a soon to be declining sector. The build up of regulations post the Kyoto Protocol in 1997 have created the initial push to renewable energy, which was given extra momentum by the coming together of two major global leaders – Obama and Merkel. The path to this renewable energy future is driven by new regulations, layered on top of the existing regulations. Its not just incentives for renewable energy generation, or penalties for dirty power generations, its regulations leading to auto manufacturers to look for when they will stop producing internal combustion engines. But the just finished Poland climate change meetings revealed that a unified global push has gone away, at least for now. Most of all, we are seeing multiple speed bumps that are going to slow down (in some cases reverse) the rate of government regulated push to renewables. Its primarily all about the pace of government regulated changes.
The IEA forecasts coal demand up in 2017 and in 2018, it reminds that energy trend lines aren’t always straight. The original global climate change agreement, the Kyoto Protocol, was signed in 1997. Since then, coal has been the poster child for dirty fossil fuels for the past two decades since the Kyoto Protocol and the #1 target to reduce emissions, in particular in the major western developed countries in the US, Canada, and western Europe. The demise of coal and its role in the global energy share has been considered an inevitable trend. This week, the IEA released its 5 year forecast for coal and said “Coal 2018 – Analysis and forecasts to 2023” [LINK]. What caught our attention was the IEA saying “The global coal demand declined in 2015 and 2016. In 2017, it rebounded, and our estimates suggest it will grow in 2018 too.” We don’t believe the 2017 and 2018 growth in coal changes the long term trends, rather it just shows that the trend line isn’t straight and the transitions are being delayed.
The need for supporting infrastructure is a key reason for the delays in the speed of the march to renewable/clean energy. The EIA sees the growth in global coal demand in 2017 and 2018 being driven by China and India. We believe this points out a key reason why there are delays in the speed of transition – the buildout of energy infrastructure to displace an increasing chunk of fossil fuels takes time. China is an excellent example. Their primary replacement for coal will not be from renewable energy, but what they call clean energy – natural gas. China’s seriousness and urgency in fighting pollution became evident in the summer of 2018, and it was the reason why we wrote our Sept 20, 2017 blog “China’s Plan To Increase Natural Gas To 10% Of Its Energy Mix Is A Global Game Changer Including For BC LNG” [LINK], At that time, we wrote “There seems to be a greater urgency to switch from coal to natural gas before the winter to fight pollution. This is what got our attention over the summer and caused us to focus on China’s plan to increase natural gas in its energy mix. There has been an increasing flow of news this summer on actions to fight pollution.” At that time, the market was negative on LNG and believed there would be continued LNG oversupply. China’s urgency in switching led to LNG markets meant the market was wrong and that LNG markets were tight, LNG prices would be stronger and there would be the need for LNG FIDs like the Shell led LNG Canada project. But the other story from this China pollution push is that their natural gas infrastructure wasn’t in place and there were natural gas supply chain shortages, which is a key reason why we China’s coal reliance has dropped as quickly as expected.
The push to clean energy and reduce coal in China and India is being impacted by the cost of LNG. One of the lasting changes is that the relative cost of clean energy is a factor in the speed of reducing coal. Our June 17, 2018 Energy Tidbits memo noted comments from BP management (the CEO and the Chief Economist) on their long term energy outlook. They noted that China is managing its coal price to ensure a certain level of coal power. But also highlighted the high cost of LNG. In the Q&A, the BP CEO made a joking comment a Chinese person joking about natural gas saying natural gas is like French perfume – it smells nice, is rare and very expensive. Also in the Q&A, the Chief Economist related his story specifically on India’s slower pace to replace coal with natural gas. He said an Indian executive said it was because the cost of natural gas was significantly more expensive than domestic coal. The push in India is to get more power to more poorer people, but if natural gas is significantly higher, it can’t be done, they have to rely on coal.
Most of all, multiple speed bumps have emerged that have to lead to slower regulated changes in the march to renewables. Government regulations are the driving force for this march to renewables. The big lasting change that has emerged is a series of speed bumps that are delaying the march to renewable energy by slowing the pace of government regulated changes. Up until 2018, there was a strong global government consensus among all the key countries to keep moving regulations to support the march to renewables. That has clearly changed in 2018. Some of the speed bumps are driven by new leaders that don’t believe in climate change (ie. US, Brazil), some are being forced away from climate change by their citizens (ie. Canada, France) and some are just quietly moving away from the renewable push (ie. Saudi Arabia). This lack of strong global government consensus was shown in the lack of a strong unified global climate change push from the just concluded Poland climate change talks. But most of all, there these speed bumps point to a slower pace of new government regulated actions to drive this march to renewables.
- New leaders who don’t believe in climate change and the push to renewables. President Trump’s anti climate change stance has been backed up by his actions reversing a number of Obama climate change initiatives. Two examples this month were the Dec 3 comments by Director of the White House National Economic Council Kudlow that subsidies for EVs “will all end in the near future” and then pointing to 2020/2021 for this timing, and the Dec 6 EPA announcement that it was rolling back some of the regulations on coal fired power plants [LINK]. Trump’s actions don’t fully dictate the US but they no question slow the march to renewables. States like California have a big impact of the total US push and aren’t stopping their march to renewables. The IMF ranks the US at the top economy at $20.4 trillion vs China at $14.0 trillion. Brazil’s President-elect Bolsonaro is another who doesn’t buy into the climate change push and is appointing key cabinet ministers (Foreign Minister Araujo) who are even more extreme against climate change. Google the foreign minister and multiple anti climate change comments pop up. The IMF ranks Brazil at the #9 global economy at $2.14 trillion, just behind Italy at #8 at $2.18 trillion and ahead of Canada at $1.8 trillion.
- Leaders being effectively forced to slow down their push to renewables because their citizens won’t put up with the effective cost of renewable energy – its just too expensive on their day to day costs of living. We believe a great part of the unrest is due to incomplete messaging. Citizens hear how the costs of generating energy from renewable keeps getting cheaper (we don’t dispute this), but then, once full cycle costs are rolled in, the citizens see substantially higher energy bills or other taxes. We believe this messaging problem will continue as governments really don’t want to be forced to message the full cycle cost of switching a substantial portion of the energy supply chain from fossil fuels to renewable energy. We don’t expect PM Trudeau to move away from his push for Canada to be a global leader in climate change, but the shift in Ontario will impact the speed of Trudeau’s pan-Canadian march to renewable energy. Ontario’s move away from coal and natural gas to clean energy led to high electricity costs being the major election issue leading to the defeat of the Wynne Liberal Ontario govt, which went from a majority (55 seats) in 2014 to being almost wiped out (7 seats) and the majority Ford Conservative government. Similarly, we don’t expect France President Macron to back off his climate push, but the recent protests/riots have forced him to back off, at least temporarily, some of his new climate change regulated actions like new gasoline taxes. France is significant because, to date, the major western European countries have always just seemed to accept, but deal with, high energy costs. The IMF ranks France as the #5 global economy at $2.93 trillion.
- Leaders who are quietly just not pushing as fast on their renewable actions. The best example is Saudi Arabia and its big push for solar power. We have written extensively on the potential impact oil demand in the 2020’s if Saudi Arabia uses solar to replace oil for electricity ie. eliminating ~400,000 to 500, 000 b/d of oil demand and much more during peak summer demand. The push to solar was another key part of the Vision 2030 plan. Bloomberg’s Dec 15 story [LINK] “It’s Hard to Be the Saudi Arabia of Solar, The kingdom has grand ambitions in greener energy, but virtually nothing to show for them” highlighted this pause. Bloomberg wrote “Over the past six years, the Saudis have announced investments of more than $350 billion aimed at making the sun-drenched kingdom the, well, Saudi Arabia of renewable energy. But virtually no construction has begun, and with crude more than doubling from early 2016 to this October, the Saudis’ commitment to renewable energy has wavered, says Fatih Birol, executive director of the International Energy Agency. “There has been a lot of stop and go,” Birol says. “There’s a need to increase electricity generation, decrease oil-based power, and make use of the huge solar potential.”
The upcoming spring 2019 long term energy outlooks should reflect these speed bumps and push back the speed and time to reach peak demand for oil and coal. Every spring, major global agencies, economists, and super majors issue their updated long term energy outlook. Peak oil demand has been highlighted over the past few years with a wide range of timing depending on the assumptions. Post the Poland climate change meetings that showed the increasing global splits, the range of speed bumps in major global countries (US, Brazil, France, Canada, Saudi Arabia, etc,) and the reality of the added costs to citizens for this march, we find it hard to believe that these forecasts will simply look thru these speed bumps and not delay or push back their speed and timing for their march to a renewable world. After all, the driving force for climate change is government regulated actions and many major governments either will not or cannot move at the same previously assumed pace. We think these forecasts cannot simply look thru these events. And if they reflect the 2018 events, it will also give them more confidence in their call that peak oil demand doesn’t happen until after 2030. For example, BP’s 2018 long energy outlook forecasts peak oil demand sometime after 2030 and for oil demand to be flat from 4,864 million toe in 2030 to 4,836 million toe in 2040, and peak coal demand after 2030 with coal demand to be essentially flat from 3,821 million toe in 2030 to 3, 762 million toe in 2040.
BP Energy Outlook: 2018 Edition
Source: BP Amoco
A pause/ delay also means better mid to long term oil prices and cash flows, One of our upcoming blogs is the most significant lasting change – the oil and gas sector has proven they can produce way more than expected and these shifting supply chains are causing price dislocations in the short term and a lower but still strong price in the mid to long term. We believe global oil and natural gas markets will adjust to the changing global supply dynamics and this will sort out over 2019. For the mid and long term, we believe that any delay in the timing and speed of the march to renewables from these speed bumps is why we believe there is a lot more money to be generated and made from oil and natural gas in the mid and long term, but just not as much as we expected a year ago. Pushing peak oil demand further out or increasing confidence that peak oil demand isn’t going to happen before 2030 may only bring back a portion of capital back to oil and gas, but it should help to keep capital in the space for a longer period. And having more investor eyes and capital on the space will only help once we get thru the seasonally low demand period for oil in Q1/19.