“You’ll find, young man, the future looks rosier through the bottom of a glass.”
– The Three Musketeers by Alexandre Dumas
With the pubs shut, British investors are going to have a harder time imagining a rosy future – right when they could use it the most. The FTSE is down 4% already today as I write this – those who thought we saw the market bottom out last week just took another cricket bat to the knees.
The pandemic is taking its toll. Many fellow Britons now find themselves out of work, while those in the emergency services find themselves with too much of it. A friend in Baltimore noted how it was impossible to think of anything right now, without automatically putting it in the context of the coronavirus.
Still, the hysteria we are seeing play out on social media and supermarket shelves does come with a bright side. With all this uncertainty and fear in our midst, you can be assured that the market isn’t thinking straight right now either – and that means there are opportunities waiting out there for the shrewd who can discern them. Eoin Treacy will give you his take on how the corona-crisis is pushing the next stage of the energy revolution forward below.
I can see sunshine and blue skies outside my window as I write this – a fittingly ironic backdrop to all of this chaos. Sam Volkering was similarly “defiantly optimistic” when I spoke to him this morning; looking past all the noise and fear – to the blue skies that await once all this has passed. .
Back tomorrow,
Boaz Shoshan
Editor, Capital & Conflict
More than a decade ago I began writing about how much of a gamechanger unconventional oil and gas are for the global energy sector. The seeds for what we are seeing today in the global energy sector were sown in the mid-2000s and the influence of the shale revolution is going to be felt in the oil market for years to come.
However, in many respects shale oil is yesterday’s story. Its influence is now well understood and as investors we have to always be forward looking. Therefore, it is worth considering what else is happening that could have a similar influence on the market over the next 15 years. After all, out-sized investment profits reside in future potential, not in what has already happened.
The US’s surging supply from onshore sources, never before exploited in such volumes, has upended the global energy market. Today, the US is pumping 13 million barrels a day and has become an energy exporter for the first time in more than 50 years.
When the world’s largest importer becomes the world’s most prolific producer, it is inevitably going to introduce stress into the status quo. Not only have the world’s energy exporters lost a vital customer but they now have a superpower as a competitor.
Even that was potentially manageable because of China’s growing demand for oil and the potential that India’s growth trajectory would also result in additional demand volume over time.
The price of any commodity is mostly dictated by supply. Demand is usually assumed to be on an inexorable uptrend as the global population expands, living standards improve and per capita consumption rises. The combined influence of those three factors has always been assumed to be the basis on which all investments in additional supply have been made.
In addition to the fact the US became an energy exporter, its per capita use of energy and the number of miles driven per year has been flattening off for years. That suggests even though it is now a net energy exporter, the abundant new supply has not translated into significantly higher consumption.
The US’s demand curve is leveling off or at the very minimum losing momentum. That is a gamechanger for the commodity complex and it has nothing to do with the shale boom.
As an economy becomes more service oriented, it requires less energy for each unit of gross domestic product produced. For example, online sales require far less miles driven to complete than millions of people traipsing all over the city to buy what they need. The ranks of sales people required to travel to collect orders and miles driven to supply stores also contract. Even then, as the economy expands it has led to a levelling off of demand rather than a downtrend in the US.
China is rapidly evolving as a service-oriented economy too so there are now big questions whether it will even approach the level of per capita consumption of energy that more developed countries do. Obviously, China has a lot more people than other countries so it has a clear incentive to inhibit demand growth at all costs.
Batteries are a tiny part of the energy mix today. The hydrogen sector is so small it doesn’t even register and most people dismiss it as a fairytale. However, both of these sectors represent existential threats to the demand curve for oil globally because they are growing at an exponential pace.
The least understood part of exponential growth, which anyone watching the news about coronavirus is getting a crash course in, is that the early pace looks inconsequential relative to the pace of the advance towards the end. Batteries, renewables and hydrogen are on exponential growth curves and that is a potentially fatal threat to many higher cost oil and gas producers.
As long as the global energy demand curve was increased, the energy pie was expanding and there was a market for more and more new sources of supply. Today, the global energy pie is contracting. That has completely upended the status quo and it is happening at a time when competition for the global energy pie has seldom been more intense.
The price war between Saudi Arabia/OPEC and Russia is a symptom of this new market phenomenon. Faced with declining demand growth and increasing competition for markets, the world’s traditional sources of oil production are now in a mad dash to lock down market share.
They are also hellbent on clearing out higher cost sources of production all over the world. That is a particular threat to offshore production, particularly in the ultradeep waters off Brazil. It raises significant questions about the viability of new offshore sources of supply everywhere and is an additional threat to Canada’s landlocked supply in Alberta. Perhaps most importantly, it will lead to a bankruptcy cycle in the US’s energy sector, where highly leveraged independent producers are eventually consumed by larger companies.
Meanwhile, renewables are already at a position where they can compete in many jurisdictions with coal. They are not about to go away and even with the volatility that has plagued markets recently private equity has continued to invest in infrastructure.
It really does just come back to simple economics. When demand growth slows, supply has to be containing in order to balance the market. Russia and Saudi Arabia are pumping for all they are worth so this downtrend is not going to end until supply is withdrawn from the market. Even then, the number of energy producers is likely to fall significantly over coming years as oil faces increasing challenges from the services sector and the growth of renewables.
All the best,
Eoin Treacy
Editor, Southbank Investment Research
Category: Market updates