The year starts with a bold but not new prediction from the Finacial Times that the ‘global energy system is on the cusp of a revolution’ and we will see a radical shift to investment in low carbon energy sources. However, this ignores the fact that in our interconnected world, stability is vital for economic growth which in turn is reliant on technology and reliable affordable energy sources. These are the vote winners and the factors that keep emerging economies vital for global growth expanding.
While enthusiastic about the EU's measures combined with and the Paris Agreements intentions to encourage serious capital investment for the transition to renewables, caution and closer analysis of recent trends in the energy mix is critical in understanding the 2018 market dynamics. It is vital not to consider the transition to renewables in isolation because the reality is that it part of a much wider picture and is part of the puzzle of global energy demand, the energy mix which is being driven by the rapid growth economies of China and India.
Understanding the domestic political concerns of these countries and how they are intertwined with energy security and supply play a significant role. It is the mindset of these emerging economies and their need for energy security which will have the most significant influence on any long-term investment and policy decisions.
Geopolitics and energy security are the key market factors
Looking at the facts, it is clear we are witnessing a global transition to renewables, with the middle-east, (specifically the UAE & KSA) and China and India building the most significant capacity. At the same time ignoring the overall increase in demand from these regions for energy, including oil and gas is a mistake. Add to this dynamic the volatility of global geopolitics; Brexit, Trump, Russia and regional unrest, and one suspects that energy security is the real challenge for governments, policymakers, IOCs and NOCs in 2018.
The renewables market is working
Over the last decade, despite sluggish economic growth and slow capital injection growth in renewables market has been significant. Championed by entities such as the Carbon Trust in the UK the transition to third industrial transformation has gathered pace and creating opportunities for investors. The market has moved from being micro, and in some cases not taken seriously, to be a multi-billion dollar industry. The capital regulations discussed in the Paris Agreement which is being driven by Emmanuel Macron will speed up investment in the long run growth of the market.
As it stands Investment in renewable energy has already increased by a factor of six over the last ten years, from $45bn to $270bn/year, such that increases in renewable power capacity accounted for 48 percent of the total capacity increase in the power sector in 2014. However, to meet a 2 C target, Bank of America Merrill Lynch estimates that investment in renewables will need to grow to $900bn/year by 2030.The Paris Agreement envisages climate finance – at a level of $100bn/year – being mobilised, including through entities that are accredited by the recently formed Green Climate Fund (the GCF).
With 29% of electricity generation in the UK coming from wind, solar, hydro and biomass in 2017 there is clear evidence that market is working. However, the capital and innovation are still required to achieve significant growth in the market which is why the stipulations in the Paris agreement are critical for success. (An interesting factor is how ESG reporting is also putting pressure on asset managers and global corporations to be in line with the Paris Agreement)
EU is encouraging capital investment
The EU has signalled its intention to encourage investment in the market by loosening the capital requirements for the sector. These are positive steps, but we have been here before, and one just needs to look at how the Green Investment Bank in the UK under George Osborne was reduced to a small, ineffective instrument to attract capital into renewables. The fact remains that the energy market is a challenging market to predict. ( As noted last year I predicted that oil would end the year at $75 US, while Pierre Andurand bets that oil will return to $100 a barrel. Predictions which have not become a reality)
Shift to renewables may well stumble like gas
This shift to renewables is not absolute, and it is essential to learn from the predictions made about the Gas market. Gas was supposed to be the irresistible fuel of the future. After the disaster at Fukushima, nuclear power stations across Japan closed natural gas imports surged with the result that prices in the north Asian market more than doubled, at times touching $20/mmbtu.
Gas has not matched forecast demand
Driven by demand in Japan and South-East Asia the market viewed gas as being the safe, reliable fuel and it was cleaner than coal. Gas was the obvious replacement as the world became more serious about tackling the risks of global warming and climate change. In the absence of a carbon price, the competitive issue comes back to cost. The question which must be found is how the costs of long-distance LNG be brought down? If not and even if government subsidies remain in place in developing economies how sustainable is gas as a fuel?
Today BP has reported that gas demand in Europe is 12 percent lower than it was ten years ago. Part of this is price related while the other factors are geopolitical around security of supply. Chinese and Indian demand continues to grow with dramatic gains in solar power, where costs have fallen 85 percent since 2009, are opening up the market. In both countries, the firmly entrenched position of coal – a source of millions of direct and indirect jobs – will be challenging to break and will take time.
There is still growing demand for oil
The fact remains that despite the move to gas and renewables the central demand for oil has come from the economies of China and India. Today both growing economies are ever more dependent on imports. This dependency is uncomfortable for emerging superpowers and has put energy security as a central issue for Asian governments and policymakers. However, these factors create opportunities for NOC’s primarily in the middle-east centres of Abu Dhabi and Saudi Arabia in the upstream, midstream and downstream market segments.
China demand metrics are changing
Since 2008, the economic production in Asia has been mostly static however oil consumption has grown by 8m barrels a day. The growth, led by China which in June 2017 imported 8.79m b/d is presenting a new demand spectrum for the market is not based on economic production and manufacturing but more on consumption. Chinese car ownership is likely to double over the next decade, as is air travel. What we will see is a shift in energy usage from heavy industry to more consumer-driven usage. One thing which is not factored in yet is the shift to electric vehicles and the impact that they will have on demand.
India is using both oil and renewables
Similarly, the growth of the Indian economy which is expanding at 7% per year for the last five years, has resulted in the additional demand for imports which at the end of 2017 led to the whole of Asia with a net trade deficit in oil of 25m b/d. By 2030 India will have 1.5bn people, which means it is a vast market with enormous energy demand which is set to grow and a government which is actively trying to change the energy mix.
Late in 2017, the government of India stipulated target is of 175 gigawatts (GW) of renewable generation by 2022, which includes 100 GW of solar and 60 GW of wind generation, up from the current total renewable energy generation capacity of about 59 GW (with wind already now at about 33 GW). What's more, a report last year by the International Energy Agency (IEA) said India's renewable energy capacity would more than double by 2022, which would be enough to overtake renewable expansion in the European Union for the first time. This move by the Indian government is a way to reduce dependence on oil and to secure its energy supply is similar to the Chinese investment in renewables.
Energy security is vital for economic growth
As it stands these are the significant demand and supply dynamics of the market but underlying them are the geopolitical factors which translate into energy security. For China and India security of uninterrupted supply is vital for their respective economies to continue growing. They do however have different dynamics and domestic pressures.
The Chinese ‘one belt – one road’ strategy has energy security at the centre of the geopolitical strategy. The evidence is in the placement of both refineries and petrochemical plants stretching from Beijing, Mongolia, Iran all the way to Russia. Stability is the key to ensure this strategy works. For India with Modi entering his second term energy is a highly political issue. The energy security dynamic is more focused on having a reliable and affordable energy for all of India and is one of the leading domestic topics in Goa, Mumbai and Gujarat. What is frustrating for both governments is that affordable energy while a vital domestic issue is controlled and dictated by international events in places and regions outside their control.
Three key factors in energy security
First, when we look at the supply chain for Asia, the choke points from the gulf are the straits of Malacca and Hormuz. 17m barrels a day pass through Hormuz, and most of the tankers then turn east. These routes are vulnerable to closure or disruption by conflict or terrorist action.
Second, the exporting countries on which these economies depend need stable governance. Regional geopolitical conflict in the middle-east, North Africa and South America all increase the risks to production.
The third and most significant risk to global energy security lies in how import-dependent countries behave in times of market stress. By this, it is essential to consider the energy competition between China, India, Thailand, Indonesia and the Philippines and to ask the question what would happen is supply was threatened? At present, there is no agreed framework to which these countries are signed up to which minimise the impact of instability in the oil market.
Shifting supply chain in the middle-east
Closer to the middle-east it is important to look at the Saudi intention to build its ambitious $500 billion new 10,231 square mile city called Neom in the North-West of the kingdom. This city which borders Egypt and Jordan has the potential to shift the global energy supply routes and act as a gateway to the continent of Africa which as we know is a growth market of the future. If this new urban centre is developed, the hub could influence the global energy supply chains both north and south.
In summary, as 2018 starts energy, analysts need to focus on the trends in China and India. The move to renewables has long been inevitable but oil and gas will remain important sources of the global energy mix. There needs to be a greater understanding of the importance of energy security for these growing economies. These factors will be the primary influence on the global oil market, maintain the demand that OPEC desire and create the stability the global shift to renewables requires for long-term success