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Will The Demise Of Oil Take Longer, Just Like Coal? IEA and Shell Highlight Delays/Gaps To A Smooth Clean Energy Transition

By Dan Tsubouchi

We expect one of the major global energy themes in 2021 will be that the world is not on track for a smooth energy transition to a world of clean energy.  And this will be elevated to the #1 global energy theme if Joe Biden becomes President and moves to “rally the rest of the world to meet the threat of climate change.”  There has been no pull back from the aspirational goal of almost every country for a clean energy transition, even in the face of a global economic crash. It is going to happen. The world is on a path for clean energy at the cost of fossil fuels. But this transition is not just adding more wind and solar. Rather it is complex, requires advancing a wide range of “critical energy technologies” and, most of all, a major jump up in investment capital. The IEA has just provided data to show the world is far behind in “critical energy technologies” and in invested capital for the energy transition.  And this week, Shell’s CEO noted his concerns (similar to the IEA) that also point to a disorderly energy transition. If the world isn’t ready for this energy transition, it should point to a need for more oil and gas to fill the delay gap, and this should lead to delays in oil demand declines on the path to peak oil demand. We don’t think the energy transition will impact oil demand by millions b/d.  However, even if the energy transition delay only reduces oil demand declines by 0.5 mmb/d or more, it should help push back peak oil demand a few years.  And this should be happening as non-OPEC oil supply sees an impact from the lower upstream capex over the past couple years and the massive capex cuts in 2020.   And we think this helps support a higher WTI oil price by $5 for the 2022 to 2027 period whether you believe in the current forward strip for WTI averages ~$44 for 2022 thru 2027, or, if you are like us, believe in oil above the strip. Its support for a view that oil in the 2022 to 2027 period will stronger than expected. And maybe the demise of oil will be like the expected demise of coal – it will take longer than expected.

Shell warned the world is not ready for a smooth energy transition. Shell CEO’s message was very clear and was captured clearly in the title of the Bloomberg Green Tuesday story “Shell’s CEO Worries About a Disorderly Energy Transition: Q&A”.  The Shell CEO said “The energy transition is massively complex. It will require orchestration on a scale that the world has never seen. If you don’t start with it soon, it’s going to be highly disruptive at the end or it’s not going to happen. And both are unpalatable conclusions”.   

“The energy transition is massively complex”, its not just adding more wind/solar.  The Shell CEO reminded of something that is overlooked by almost everyone, he said “the energy transition is massively complex. It will require orchestration on a scale that the world has never seen.”  We think the most overlooked aspect of the energy transition is that it is much more than just adding more solar and wind to replace some portion of the fuel supply.  One of the major challenges is replacing an electricity grid that has been built on fossil fuels, nuclear and hydro delivering high intensity energy on a continuous as needed for whatever is needed basis.   Again, its not just adding solar and wind, its having the proper electricity storage, generation and delivery system to support this fossil fuels out/renewables in switch.

The IEA reminds the energy transition has many “critical energy technologies”, the vast majority of which are not on track.  There was an excellent illustration of the many significant areas, or major pieces of the puzzle, involved in an energy transition by the IEA last week.  The IEA also noted the progress of each of the major pieces and the overall conclusion is that the vast majority of the pieces are behind or well behind where they should be to meet a smooth timely energy transition.  It is important to note that these are just what the IEA calls the “critical energy technologies” and does not get into the wide range of other considerations needed to support the energy transition.  The IEA divides these “critical energy technologies “into major groupings and then ranked the progress of each of these pieces in its report “Tracking Clean Energy Progress” [LINK] by on track, more efforts needed, or not on track

IEA’s Progress Ranking For “Critical Energy Technologies” For Clean Energy Transition

Even the “on track” items like solar PV are seeing a pause in growth especially with lower 2019 and 2020 investment capital.  As noted in the above chart, the IEA ranks Solar PV as one of its few green dots “on track” critical energy technologies.  However, the IEA’s tracking update also shows how COVID-19 has led to the IEA revising down its solar PV capacity additions forecast down by ~15% for 2020 and by ~5% for 2021 ie. solar PV additions won’t get back to 2019 levels at least until 2022 or possibly 2023. The IEA explains “Covid-19 has led to construction delays and weaker than anticipated investment, requiring us to revise capacity addition projections down by over 15% for 2020”. 

IEA’s Solar PV Capacity Additions, 2019-2021, October 2019 Forecast vs May 2020 Forecast

No surprise the energy transition is not on track, there hasn’t been enough capital invested in the transition even before COVID-19
.  On May 27, we tweeted [LINK]Seems clean energy supply + related grid/infra won’t be anywhere close to meet aspirational goals of many countries” based on the IEA’s just released that morning major report “World Energy Investment 2020[LINK].  The IEA reviews investment in the full spectrum of energy including in 2020 and provided some excellent insight into the implications of the capital, or lack thereof, for the future.  The IEA notes the required investment capital for clean energy wasn’t being spent in 2019 and COVID-19 made the investment gap larger in 2020.  Prior to 2020, the IEA estimated clean energy spending was relatively flat for 2015-2019, before declining in 2020. As is happening in almost every sector, the world economy crash in 2020 has led to be declines in invested capital in all energy sectors, including power and clean energy.  In discussing renewables, one of the many shortfall IEA comments was on slide 90 “Current investment levels are not aligned with a sustainable pathway. Compared with the average annual investments projected in the IEA SDS, power sector spending in 2019 was about 35% short of the level required a decade from now. There is a continued need for capital reallocation to meet energy security and sustainability goals, to bring in more low-carbon power and to ensure that renewable-rich systems can operate with sufficient system flexibility.  The largest projected growth in investment to align with such a pathway would be required in solar PV and wind, on average an extra USD 160 billion of spending each year. Electricity networks would require an extra USD 150 billion from today’s levels, in addition to a higher level of capital for other renewables and nuclear.”

IEA’s Estimated 2019 and 2020 Invested Vs Future Required Investment

Massive government intervention will be needed to get the energy transition closer to its energy transition miss
.  It doesn’t make a difference what side of the clean energy fence someone is on, everyone knows that the energy transition has been, and must continue to be, driven by governments if there is to be any shot of trying to get closer to the energy transition target. The Shell CEO said something everyone knows – leaving it to the private sector to somehow fit all the pieces together on a timely basis won’t work. It will require increasing government intervention. Bloomberg asked the Shell CEO “All that will need a very heavy-handed government. Do you support that?” And he replied “If we believe that somehow the market is going to take care of this, that you put a price on carbon and everything will sort itself out, or that we can shame companies into doing it by having ESG frameworks that will tell them what is right and what is wrong, then I think we’re kidding ourselves. This needs a very significant interventionist approach, and all industries have to be part of the intervention.”

2021 could see a major global (and Canada) renewal push and commitment to the energy transition aspirational goal. The Nov 3 US presidential elections will determine if there is a renewed and urgent global push on climate change. The united global push for climate change was given a major kick in the pants when, on Nov 4, 2019, the Trump administration announced it was starting the formal process to withdraw from the Paris Accord. The official withdraw date would be Nov 4, 2020, one day after the upcoming US presidential election. And the reality is that the US had effectively ceased to have any interest in working on climate change since President Trump was elected in Nov 2016. It still ~5 months to the election, but Joe Biden is currently running well ahead.  One of his climate change priorities [LINK] is to “Rally the rest of the world to meet the threat of climate change” and he also tries to deal with the need to catch up investment saying “the United States urgently needs to embrace greater ambition on an epic scale to meet the scope of this challenge”.  But, at least in the US, we see Biden’s initial 2021 push for climate change initiatives to be more aspirational than specific programs as he will be restrained to some degree by the increasing US debt and the expected slower recovery of the US economy as noted by Fed Chair Powell yesterday. In Canada, we believe we could see a similar new urgency to climate change in 2021. We recognize it isn’t a major topical item today, but we believe there is a good chance for an early fall federal election and, if the polls hold, the Liberals would likely have a majority government.  We believe that, even with the massive debt increases, this would lead to increasing federal government support for clean energy initiatives in Canada and possibly (likely?) to support clean energy initiatives in developing countries.

The aspiration to spend more will be there, but increasing government debt levels will have to limit government incentives that require government capital or hurt government revenues. The reason why the IEA report caught our attention is that the investing gap was worse in 2020 when 2019 was already lagging  Its hard to see the scenario where 2021 investing jumps up significantly above 2019 to start to close the gap.  Rather, we have to believe the gap will, at best, be maintained in 2021.  No one has to be an economist to know that every country in the world is taking on massive debt in its fight against the economic shut down from COVID-19.  Our concern is that the increased debt has to force all governments to go slower than they would want on the clean energy transition. This will just widen the gap. The countries that have a reasonable financial position will continue to support clean energy advancement, but their pace will inevitably be slowed down due to balance sheets.  Its why we think a Biden presidency will be more aspirational in 2021. Yesterday, the US Treasury Dept [LINK] reported there continues to be an accelerating in US federal government debt. It reached $26 trillion, after hitting $25 trillion on May 5, and $24 trillion on April 7. US debt is up over $6 trillion since the Nov 2016 elections. Our SAF June 7, 2020 Energy Tidbits [LINK] highlighted the Thurs June 4 German government $145b stimulus package and that it included a doubling of EV purchase incentives, but did not include any incentives for ICE vehicles. It was also interesting to see how the German government targeted cheaper EVs as the priority to get a broader EV penetration.  But then there are most countries, such as Mexico, that are having a much tougher time with the economic hit from COVID-19.  On May 16, we tweeted [LINK]Not yet law, but seems Mexico will move to “temporarily” limit renewables. COVID-19 has been impacting near term power/#NatGas demand, but any limit on renewables should restore Mexico’s steady increase in #NatGas consumption as economy restarts and need for US #NatGas supply”.  Mexico’s concern was that it needed to maintain the reliability of the electricity grid in the face of the COVID-19 health crisis, but the reality is that it doesn’t have any financial flexibility to support any new renewable initiatives for the time being.  If governments are going to provide some form of incentive, they need to have the financial capacity to do so and many governments do not have that luxury.  COVID-19 is only going to increase the gap and put the energy transition further behind. This is a key point from the IEA’s reports.

We think the decline rate in oil demand on the path to peak oil demand will be like coal’s demise – slower than expected, especially with the delays and gaps in the clean energy transition. We believe the world is on the path to a clean energy transition and there will be peak oil demand.  But we always think about coal when we think about the energy transition that will lead to peak oil demand.  No one ever disagreed that governments will going to intervene to move to eliminate coal power generation.  But it hasn’t happened anywhere near as quickly as expected.  When we see the Shell CEO comments and IEA reports, its clear that the energy transition isn’t going as smoothly and quickly as expected.  Most importantly, the IEA highlighted that investment in clean energy is too low and there are too many “critical energy technologies” that are not on track.  And to use the demise of coal analogy, this should point to better demand for oil for a good portion of the 2020s.  Our May 27 tweet on the IEA investment report also said “Seems clean energy supply + related grid/infra won’t be anywhere close to meet aspirational goals of many countries. Good for oil/gas prices in mid 20’s, will need more oil/gas just as impact of big capex cuts kick in.” It doesn’t have to be a huge change in demand, even if demand is only 0.5 mmb/d or a little better than the expected decline in oil demand growth rates in the 2020s on the path to peak oil demand.  It will be a positive to oil price expectations as it will happen during the period that will see the impact of underinvestment in oil today from the past couple years, and more so from the massive upstream underinvestment in 2020.  Below is the IEA’s May 27 below graph showing how the underinvestment in oil in 2020 will hurt 2025 production by ~2 mmb/d.  Plus the global oil industry has moved away from long cycle projects like major 100,000 b/d oil sands projects so there aren’t an inventory of large long cycle projects in inventory.  And even if oil prices are much stronger than expected, oil companies won’t re-add long cycle oil projects given that that the energy transition (while delayed) is solidly the goal.

IEA Impact of Lower Upstream Spending In 2020

There is a big difference for oil if WTI is >$50 versus >$40.  There is a big difference to the US/Canada oil sector if WTI is >$50 or >$40. We don’t think we need to see hugely better oil prices, just better visibility looking to oil for 2022 thru 2027.  We think the IEA and Shell views will become more broadly accepted once there is a focus on a post COVID-19 world.  We don’t see a huge impact, but rather believe its reasonable to see this clean energy transition delay will lead to a lesser decline in oil demand growth rates on the way to peak oil demand.  It doesn’t have to be a huge impact, but even if its only delaying oil demand decline by 0.5 mmb/d thru 2027, we could see the potential to impact oil by $5 whether you believe in the WTI forward strips (currently average ~$44 for the 6 years 2022 thru 2027, before WTI reaches $50 in 2028), or if you are already more bullish (as we are) expecting oil above these forward strips. As noted above, these delays should happen when the impact of upstream underinvestment kicks in.  In addition, we don’t expect to see any major oil company approve a large long cycle oil project like the former +100,000 b/d oil sands projects, especially as these major oil companies are all committing to reduce emissions and be leaders in the clean energy transition.  If there is stronger oil demand in the 2022 to 2027 period and WTI >$50, it means that the likely winners will be those with spare capacity (ie. OPEC+), or effective spare capacity from short cycle quality shale/tight oil in US and Canada, and also oil projects that have multi phase quick cycle development like Exxon in offshore Guyana, or even small scale SAGD.

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