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Why energy investors need to rethink how they look at energy

Since the financial crisis in 2008, we have seen massive growth in global energy supply, not to mention falling demand across the OECD and weaker than expected demand for energy from countries like China and India, the combined result of which is that we have seen falling oil, gas, coal and power prices. The big question why has this happened? My own view is that it is due to a lack of understanding of the technology changes going on across energy which are impacting not only the supply of energy but also and more importantly the demand for energy.

The conventional view has always been that GDP growth and population growth are closely related to energy growth. And the corollary of this is that one should invest in new capacities in down cycles for the forthcoming economic upturn. This is exactly what the United States did with its shale boom. They brought on massive new capacities of gas but demand increases were not able to keep up with supply and the US gas price collapsed. It was the same with oil. The increase in US supply was so great that it has caused not only oversupply in the United States but an ongoing price war with Saudi Arabia and some of its OPEC allies. As to coal, there is lots of it out there with China being the biggest producer and consumer but China has probably seen peak coal demand in 2014 which has left us with a global glut and falling prices. It is the same with power prices. European, Japanese and US power prices are all lower than in 2008.

Over the last eight years, there have also been massive amounts of money lost by investors across the global energy world. Think of the impact that the low oil prices has had on the budgets of countries like Nigeria, Venezuala or Russia. Or the some $200bn of power generator writedowns we have seen in Europe, not to mention the LNG terminals across the world which are barely covering their variable costs. Coal has been the hardest hit. The prolonged low coal prices has led to a wide range of bankruptcies such as Alpha Natural Resources, the US’s largest producer of coal. The big question now is what will happen going forward.

First and foremost, the energy market will grow again and in fact we are seeing this happen this year with all energy commodity prices up as well as power prices. However, things are different. Energy efficiency technologies such as LEDs or improving fuel consumption in cars are having and will continue to have a big impact on energy demand. The former is one of the major reasons why electricity consumption in the United States, noting that lighting represents 10% of electricity demand, has stayed stagnant in recent years. And fuel consumption improvements from on average 7 litres per 100km in 2008 to 5.5 litres in 2015 is the main reason why UK oil demand has fallen by 15% over this period. Going forward the move to electrify transport and in particularly automobiles will continue to gather pace and electrification is all about improving energy efficiency be it in combination with an internal combustion engine or on a stand alone base and it will increasingly impact the demand for oil.

Then we have renewables and in particular solar which is not only cheap but the fastest power generation technology to install and the most flexible power generation technology we have ever developed. It can be used to power a calculator, or power a home or even a town and we will install more GWs of it this year than any other power generation technology. In those countries that have lots of solar such as Germany or Italy the impact has already been immense. Not only are power prices lower during the day but there has been a decrease in demand for fossil fuel power stations particularly gas, noting that both German and Italian gas demand is much lower than in 2008.

Going forward, batteries be they in the car, in our homes or connected to the power grid will significantly alter the energy world. Batteries together with solar or wind will bring more low costs renewables to the masses which will impact demand for coal, gas and oil (noting that a sunny country like Saudi Arabia generates the majority of its power using oil). And those same batteries, which are decreasing in cost every year, will also power the next generation of automobiles.

So what is my advise to investors in energy? Think about demand. Think about the technology changes going on in energy and realise that this time it is different.