2021

Aside from the global coronavirus pandemic, it is not an exaggeration to say that the ‘energy transition’ has dominated both the business and mainstream media in 2020.

To those regularly following energy markets it might seem a little odd for the rest of the world to suddenly sit up and take notice of a trend that has been gradually evolving for more than 20 years. Why now, in 2020, have governments, financial institutions, activist investors, oil majors, and the general public all focused attention on energy transition as a key theme?

Money talks (i) – half a trillion dollars of offshore wind projects coming in the next decade

The scale of renewable energy projects of all types has been increasing as the technology matures. Offshore, in contract to other technologies (such as wave and tidal devices) the wind industry has matured well with proven technology and a consolidated supply chain of OEMs and engineering contractors. Individual projects have grown in scale to become, in many cases, multi-billion dollar ‘mega projects’ that attract global engineering and service companies. The days of ‘cottage industry’ are long gone.

Over the next ten years we expect to see over half a trillion dollars of investment in the offshore wind business (based on currently-visible projects). Before anyone gets too carried away it’s worth pointing out that in a ‘good year’ the upstream oil business might see this sum of Capex in a single year. Depressed oil prices in 2020 pushed investment to a low of $300 billion.

Money talks (ii) – are pure-play black hydrocarbon businesses becoming un-investible?

Most readers will remember the late 1990s when, long after the health dangers had been proven, the tobacco industry rapidly fell from favour and companies became exposed to unfavourable (for them) decisions in courts in the USA. Huge tax levies and restrictions (such as banning of advertising and packaging restrictions) were applied elsewhere in countries such as the UK.

No-one is suggesting that the oil industry is anywhere near that stage yet, but it’s fair to say the oil industry is ‘out of favour’ with the general public and at worst there is a prospect that in the future our children might successfully hold these companies responsible for tangible physical damage to their planet unless they play an active part in the solution.

‘Ethical investing’ has thus emerged strongly in recent years as a concept and (cynically) one might suggest this is as much about avoiding “being seen to do bad” (a la tobacco industry) as it is about seeking societal good in investment strategy.

Thus, most energy companies (with the notable exception of one of the largest, Exxon) have done one or both of two things. The easy option is to task their marketing executives to desperately find something vaguely ‘renewable’ they are doing and flood social media with stories about it. The other option is to commit investment into major renewable energy projects (effectively diverting capital expenditure that would have been otherwise targeted at hydrocarbon projects). Of the ‘big six’ public E&P companies BP, ENI, Total and Shell have made progress in this direction including commitments to net zero carbon emissions by 2050 (or 2030 in the case of ENI) whereas US counterparts Chevron and Exxon have thus far taken a different path. Aside from the ‘big six’ some notable moves have also been made in recent years by the likes of Equinor (which changed its name from Statoil to signal a change of direction) and Ørsted (previously DONG) which divested from oil and gas completely to become a renewable energy power company.

The counter argument to this, of course, is that cheap energy has fuelled spectacular economic growth in the last 25 years, particularly in Asia. The relevance of that statement in terms of ‘societal good’ is simple: poverty. In 1990 36% of the world’s population lived below the poverty line ($1.90/day, inflation adjusted). Twenty five years later that same figure was 9.9% of the world’s population. That still leaves some 600 million people globally living in poverty but it’s a huge improvement on the 1.9 billion in 1990. The relationship between economic growth and cheap energy is well proven so if we are to blame energy companies for destroying the planet perhaps we should take a balanced view and acknowledge the positive contribution to prosperity as well.

Money talks (iii) – renewables are becoming cost-competitive for grid-connected power generation

The energy landscape is changing, however. Oil is a mature business in most countries, past peak production and becoming more expensive to extract each marginal barrel. Meanwhile the costs of extracting energy from renewable sources is falling to the point where it is cost-competitive for grid connected power generation vs nuclear or hydrocarbon-powered alternatives. Latest estimates from the Department for Business, Energy and Industrial Strategy (BEIS) in the UK forecast that offshore wind projects over the next decade will produce power at an average cost of £47 per megawatt-hour (MWh) compared to £82 per MWh for new gas projects and £92 per MWh for new nuclear.

These latest projections (as of August 2020) are a material improvement on previous expectations (£103 per MWh). If £47 per MWh seems fanciful bear in mind that projects have already moved forward at even lower prices than this.

The Second Round (2017) UK Contract for Difference (CfD) auction results resulted in two offshore wind projects (Hornsea 2 and Moray Offshore) securing CfDs at a strike price of £57.50, and a third project (Triton Knoll) securing a price of £74.75.

The Third Round Results were announced in 2019 and awarded 12 projects, including 5.5 gigawatts (GW) of offshore wind projects at record low prices as low as £39.65 ($50.05). For comparison, wholesale UK electricity prices have fluctuated between £35 and £65 in recent years.

Rebuilding post Covid-19 devastation

The global policy response from governments to the immediate challenge of a pandemic and the required ‘lockdowns’ of normal life has been a flood of monetary support and stimulus.

Classic monetary policy from central banks has its limits and cutting interest rates as a method of stimulus is tricky when you have near-zero interest rates in many developed countries at present and negative rates seen in countries such as Denmark, Japan, Sweden and Switzerland in recent years. Economists continue to debate the merits of negative interest rates as a useful stimulus tool and as such it is likely that alternative methods of stimulus will come into play.

A ‘glass half-full’ view of the economic destruction heaped upon the world by the pandemic is that it does at least allow an opportunity to reflect on how best to rebuild. We will reach a point soon in this pandemic where we switch from ‘fire-fighting’ to ‘taking a long view’. The hydrocarbon industry has had its heyday and is unlikely to be favoured for stimulus in contrast to industries that will be ‘fuelling the future’.

A two-tier energy transition?

Whilst investors may be able to twist the arms of the ‘big 6’ public oil companies in the developed world, in the developing world it’s a different matter. According to IEA data published in 2020, the share of state-owned energy investments in oil and gas supply is only 10% in advanced economies but 66% in developing economies.

The Brazilian rainforest is a good example of what happens when developed countries politely ask a developing one to not exploit a natural resource. Indeed, whilst European energy companies do everything they can to ‘greenwash’ themselves, elsewhere in the world offshore hydrocarbons are making a gradual comeback.

This can be seen in renewed drilling activity in Mozambique (where Total and ENI have issued tenders for helicopter support), a substantial gas discovery by Total in South Africa, new rig tenders from Petrobras (which has recently awarded Lider and OMNI helicopter services contracts), further exploration in Suriname (and an upgrade to the heliport at Paramaribo) and spudding of the Bulletwood-1 well in Guyana not to mention new a number of new drilling contracts elsewhere including Vietnam, East Timor, Mauritania, Equatorial Guinea and the Bahamas.

There is no doubt that the energy transition is real and gaining some serious momentum. However, the reality for a large proportion of the world’s population is that renewables will become a key part of the energy mix rather than replacing other sources of energy.

Happy New Year from us here at Air & Sea Analytics to everyone that is reading this - we hope that 2021 is a happy, healthy and successful one for you.

Steve & Shabana

Air & Sea Analytics

sr@airandseaanalytics.com