There are several shifts underway across the economy. The most salient are the shifts from thermal to renewable energies and from internal combustion engines to electric vehicles. Then there are others like physical to digital in specific realms from currencies to meetings, and from informal to formal across the economy. These are momentous shifts, with transformative consequences. Managing them carefully is important.
The emerging conventional wisdom is that these shifts are more likely sudden disruptions than gradual transitions. This world view is in keeping with the dominant theory of change in the scientific-technological age - innovation >> disruption >> transformation. It's become internalised that change is disruptive.
Accordingly, there is a need to immediately and urgently prioritise all investments and focus towards these emerging technologies and away from those being replaced. The market, it's believed, will weave its magic and show the path towards the shift which minimises the pain and suffering associated with the shift.
There are at least three issues with these views.
One, there is no compelling reason at all to suggest that the shift would be abrupt and not a long transition. History of such transitions, from industrial revolution to automobiles and computers, show that they take time, and very long times. These are very slow and gradual transitions than sudden disruptions.
Two, the legacy industry is too large and with massive capitalised investments as to be accommodated only through the dynamics of market forces. The oil sector alone is an over $2 trillion industry with forward and backward linkages which permeate the entire economy. The thermal power generation industry is even larger and more tightly integrated with economic activities at all levels. Transitioning out of these will involve recalibrations and adjustments along their supply and value chains, running into countless interfaces and sub-sectors. These will require multiple policy changes and painstaking co-ordination across stakeholders, which will hopefully trigger dynamics that can move the private sector.
Three, there are costs associated with any change, transition or disruption, and someone has to bear those costs. Like with all else, costs should be borne by those who are best placed to bear it.
Clean energy transitions will impose steep costs on consumers too. Since consumers would be unwilling to bear such burdens on their existing energy bills, and producers would be unwilling to assume risks and invest without higher returns, it's left for governments to step in and assume the incremental costs required to catalyse markets. But the ambitious pace and scale of transition that commentators call for demand fiscal expenditures that are way beyond fiscally strapped governments. In fact, even in their committed expenditures, like during the pandemic stimulus, the G20 countries allocated only 6% of the $14 trillion stimulus on areas that would cut emissions.
While immediate triggers like pandemic, Nordstream 2 bargaining, and Ukraine invasion explain the sharp volatility in natural gas prices, I would argue that there are systemic trends responsible for this situation. An excessively optimistic energy transition regime has squeezed investors out of fossil fuels, cut down on exploration and downstream investments (LNG terminals in Europe), forced the mothballing of existing storage and generation sites. Ecosystem changes have a natural pace. Complex transitions like in energy, take time, perhaps even decades. Forcing them through in a few years can rebound. I don't know for sure, but I have a feeling, this may be the problem. And it's going to get worse and show up elsewhere over the coming years. And it's going to show up in other fossil fuels too.
According to the International Energy Agency’s net zero pathway, coal use must fall by half this decade in order to stay on track. Meanwhile, electricity generation needs to increase 40 per cent in the same period, according to that scenario, in which emissions fall to zero by 2050 and global warming stays below 1.5C by the end of the century. Doing both at the same time — increasing electricity output while cutting coal — will require huge growth in renewables, especially wind and solar, paired with energy storage.
In the US, coal-fired power generation was higher in 2021, under President Joe Biden, than it was in 2019 under then president Donald Trump, who positioned himself as the would-be saviour of America’s coal industry. In Europe, coal power rose 18 per cent in 2021, its first increase in almost a decade. The global surge in demand has delivered windfall profits for companies such as Glencore, Whitehaven Coal and Peabody Energy, the once bankrupt Wyoming group now planning to expand production after its most profitable quarter ever.
And this
In its annual coal report, the Paris-based group said global power generation from coal was set to jump by 9 per cent in 2021 to an all-time high of 10,350 terawatt-hours, after falling in 2019 and 2020... Overall coal demand — including its use in steelmaking, cement and other industrial activities — is forecast by the IEA to grow by 6 per cent in 2021 to just over 8bn tonnes. That puts demand on course to a new all-time high as soon as 2022 and remain at that level for the following two years, the report said.
Notwithstanding talk about rapid transition, net coal capacity addition, while declining, continues to be high and significant.
As banks, insurers and shipping companies shun Russia, coal consumers in Europe and Asia are now scouring the market for alternative sources of supply and pushing up prices, which last week hit more than $400 a tonne, from $82 a year ago. At those prices, 2022 promises to be another year of bumper profits for the industry. Russia accounts for about 30 per cent of Europe’s imports of thermal coal, which is burnt in power stations to generate electricity.
Glencore has pledged to cap its coal production at 150m tonnes a year — but that figure will still allow room to increase output. The company produced about 100m tonnes of coal last year and will mine about 120m tonnes this year following a deal to buy out partners in a Colombian mine.
A narrative has taken ground about a rapid energy transition. Mining and oil and gas exploration have become stigmatised even in developing countries. Important decision makers and influential opinion makers have come under the thrall of this narrative. This narrative demonises fossil fuels, forces unrealistic and improbable transition timelines, and scares investors away. Given the size of the market, the results of actions prompted by this narrative should have been obvious.
There are at least two problems with such forced supply compression. One, it assumes demand shifts to accommodate the supply squeeze. However, in reality, demand continues to grow or at least not decline. The result is an inevitable upward pressure on prices. Second, it overlooks the large spectrum of unexpected weather, domestic policy shifts, civil conflicts, geo-politics, technology etc related shocks which end up on and off constricting supply in varying quantities. This too ends up boosting prices.
Sample this from an October 2018 FT report,
Oil and gas companies need to increase annual investment by 20 per cent or face a global supply crunch from 2025, a leading consultancy has warned. An analysis by Wood Mackenzie found that the current industry recovery has been more gradual than in previous cycles, with a dearth of funds being pumped into new production. This could lead to a supply gap from the middle of next decade, pushing prices upward. It could also put increased pressure on companies’ growth targets, triggering increased merger and acquisition activity in the coming years...
Development spending rose 2 per cent in 2017 and is expected to rise 5 per cent in 2018. Wood Mackenzie predicts this will increase from a low of $460bn in 2016 to around $500bn in the early-2020s — well below the peak of $750bn in 2014. But it would need to hit annual levels of around $600bn to meet demand for oil and gas over the coming decade, according to the consultancy. Investment is likely to remain low in the short term, however, with companies taking a conservative approach to new projects, preferring smaller scale investments with quicker returns to larger, more expensive ones. They are also under pressure to return money to shareholders through dividends and share buybacks.
The recent memory of losses from massive shale investments too have not helped,
A decade of debt-fuelled drilling and supply growth prompted a backlash from Wall Street, which in recent years has demanded oil companies cut spending on new crude production and use cash to pay dividends and reduce debt. The strategy has improved operators’ balance sheets, but oil production growth has been tepid. A jump in post-pandemic demand, which has set new records, had resulted in a surge in prices even before the Ukraine crisis... The International Energy Agency last year said that in order to reach net zero emissions by 2050, energy companies needed to halt all new oil and gas exploration projects. But executives in Houston said this fails to account for consumption in the near term. “Last year . . . the industry spent only $350bn on upstream oil and gas. It is a figure compatible with a net zero scenario,” said Patrick Pouyanné, chief executive of French supermajor TotalEnergies. “Unfortunately, the demand is going up so it’s not compatible with demand. And now the price is going up — that is the reality of our planet.”
A BCG Report from 2020 provides some numbers to oil investments. It argues that premature "peak investment" in oil and gas would result in a crisis.
It points to an important factor
We estimate that every dollar of capex that is cut today will have twice as powerful an effect in terms of reducing activity than cuts made following the 2014 fall in prices had. Starting in 2014, oil and gas companies cut capex for two consecutive years. At the same time, service sector companies reduced their costs sharply, which helped to support industry activity. This time around, suppliers have less scope to do that. As a result, the recovery in investments is likely to take longer than it did in the wake of the 2014 price drop.
It points out that such investment compression is a recipe for price volatility.
The report concludes that the industry investment will have to rise over the coming three years by at least 25% yearly from 2020 levels to stave off a crisis.
Besides, such investment compression creates its set of distortions. As this NYT article writes, even as private investors have been shying away from oil and gas, government companies in the Middle East, Latin America, and North Africa have been increasing their investments. Its possible outcome,
State-owned oil companies in the Middle East, North Africa and Latin America are taking advantage of the cutbacks by investor-owned oil companies by cranking up their production. This massive shift could reverse a decade-long trend of rising domestic oil and gas production that turned the United States into a net exporter of oil, gasoline, natural gas and other petroleum products, and make America more dependent on the Organization of the Petroleum Exporting Countries, authoritarian leaders and politically unstable countries... Saudi Aramco, the world’s leading oil producer, has announced that it plans to increase oil production capacity by at least a million barrels a day, to 13 million, by the 2030s. Aramco increased its exploration and production investments by $8 billion this year, to $35 billion... State-owned oil companies in Kuwait, the United Arab Emirates, Iraq, Libya, Argentina, Colombia and Brazil are also planning to increase production... The global oil market share of the 23 nations that belong to OPEC Plus, a group dominated by state oil companies in OPEC and allied countries like Russia and Mexico, will grow to 75 percent from 55 percent in 2040, according to Michael C. Lynch, president of Strategic Energy and Economic Research in Amherst, Mass., who is an occasional adviser to OPEC...
In recent months, Qatar Energy invested in several African offshore fields while the Romanian national gas company bought an offshore production block from Exxon Mobil... Kuwait announced last month that it planned to invest more than $6 billion in exploration over the next five years to increase production to four million barrels a day, from 2.4 million now. This month, the United Arab Emirates, a major OPEC member that produces four million barrels of oil a day, became the first Persian Gulf state to pledge to a net zero carbon emissions target by 2050. But just last year ADNOC, the U.A.E.’s national oil company, announced it was investing $122 billion in new oil and gas projects.
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