- Hydrogen: A Climate Change Savior Or Merely A Green Mirage?
- Electric Vehicle Market Is Alive And Well; Maybe Just Alive
- Today’s Energy Transition: What’s Real And What’s Unreal
- Covid-19 Impact On Energy Markets Has A Long Tail
- The Tsunami Of Oil Patch Bankruptcies Continues
Musings From the Oil Patch
September 22, 2020
Allen Brooks
Managing Director
Note: Musings from the Oil Patch reflects an eclectic collection of stories and analyses dealing with issues and developments within the energy industry that I feel have potentially significant implications for executives operating oilfield service companies. The newsletter currently anticipates a semi-monthly publishing schedule, but periodically the event and news flow may dictate a more frequent schedule. As always, I welcome your comments and observations. Allen Brooks
Hydrogen: A Climate Change Savior Or Merely A Green Mirage? (Top)
Remember the Obamacare debate ads showing granny in her wheelchair being pushed over the cliff? They could rerun those now, only they would change the pusher to be climate change. At one point, the climate change’s savior (then known as global warming) was natural gas. Environmentalists embraced the fuel for its lower CO2 emissions quality. They argued we should switch from burning coal to burning natural gas for our power and our carbon emissions would drop. According to data from the U.S. Energy Information Administration (EIA), natural gas emits 117 pounds of CO2 per million British thermal units (Btu) of energy. That is 50% to 60% of the amount of CO2 emitted from burning anthracite or bituminous coal in a typical new coal plant.
The United States and Western Europe have led the charge to reduce the burning of coal for generating electricity and use natural gas instead. According to the U.S. Environmental Protection Agency (EPA), the energy generation sector – electrical power and heat – is the largest source of greenhouse gas emissions (GHG), accounting for more than 60% of all GHG emissions from burning fossil fuels for energy. Electricity production represents 28.4% of the GHG emissions, while industry heat accounts for 22% and commercial and residential is 11%.
The impact of the coal to natural gas fuel switch is that CO2 emissions declined where it was done. The long-term trend shows a decline beginning in 2019. This would follow a nearly 50-year trend of rising emissions, albeit with brief periods of declines or stable emissions. Exhibit 1 shows how emissions flattened beginning in 2010, but then jumped up in 2017, before beginning a slow decline the next year, which is projected to continue into 2020. The projected emissions decline is
Exhibit 1. Will 2020 Mark A New Emissions Future?
Source: JP Morgan Chase
associated with the global economic shutdown in response to the coronavirus. The cessation of economic activity also led to cleaner air over normally polluted cities. The net effect of Covid-19 on air quality has invigorated the clean energy movement, especially in Europe, and increasingly in the United States.
At the time natural gas was the environmental darling for ousting coal from the power sector burn mix, it was high-priced. It was selling for $8-$12 per thousand cubic feet (Mcf). Environmentalists were happy to back expensive natural gas because it helped to blunt the criticism of renewable energy’s high cost. By keeping the focus on high-cost natural gas, expensive solar and wind power looked more competitive, and it deflected from the intermittency concerns. That bubble burst when the shale revolution slashed natural gas prices, thereby significantly undercutting renewable fuels. With natural gas prices wandering in the desert of $2/Mcf prices, environmentalists’ preferred wind and solar fuels had to rely on subsidies and government mandates to grow their shares in the power supply mix.
We have progressed from global warming to climate change and now climate emergency, as fear of environmental calamity has become the environmentalists’ preferred weapon to promote renewable fuels. We are told that the world has only 12 years to avoid the end of the world. No, the world won’t end after 12 years. That is the time period within which slashing carbon emissions would keep the global average temperature from rising by more than 1.5o C (2.7o F) by 2100. Avoiding this disaster is why environmentalists are increasingly promoting carbon-free hydrogen fuel as the future for powering our economy.
It is impossible to read energy news today without coming across an article about the virtues of hydrogen, and its potential role as the latest Superman fuel to fight climate change. In fact, during the month of July, the Financial Times, which is published worldwide six days a week, contained six articles about hydrogen in the span of 24 issues. It is possible that most of these articles were designed to prime the debate within the European Union, which was starting work on economic recovery plans. Embracing clean energy as a key foundational tenet of economic stimulus measures was seized upon as a double-barreled solution. You would not only get clean energy, but you would also create millions of new jobs. This made it easy to sell to citizens. Europeans were assured that not only would hydrogen give them clean energy, it would reduce their electricity costs, because hydrogen was following the downward trend seen in wind and solar costs. Is that reality, or a myth?
Exhibit 2. The Many Uses Of Hydrogen
Source: Clean Energy Wire
Hydrogen is a versatile fuel. It can be used in both a gaseous and liquid form. Thus, it can be used in conjunction with or as a replacement for natural gas in all its fuel applications, as well as a replacement for liquid fuels such as gasoline, diesel, jet and bunker fuels for the transportation sector. This is why it is viewed as the Superman of renewable fuels. Hydrogen can also be a feedstock for various foundational chemical products. It is in this latter role that hydrogen has functioned for decades. And that use has grown over time.
Exhibit 3. The Markets For Hydrogen Are Growing
Source: FT.com
Hydrogen’s growth has occurred despite the fuel being expensive. It is costly because it requires the use of vast amounts of electricity to produce it. In addition, the cost to store and transport hydrogen is high. William Todts, executive director of campaigning group Transport & Environment, told a Financial Times reporter that there are three big problems with hydrogen: it requires expensive infrastructure, its vehicles are more costly than other green alternatives, and the fuel itself is less competitive than rivals. Despite those challenges, the EU is pushing hydrogen as an important industrial policy. At the center of this policy is the formation of a “hydrogen alliance,” to funnel public money to businesses developing the “green” fuel. Thierry Breton, commissioner in charge of industry, told the Financial Times that hydrogen technology “will be strategically important for energy independence and the future of Europe.”
It is important to understand why hydrogen is being promoted by the EU and its various member states, but it is also beginning to be pushed by China. Why? It goes to industrial policy. In Europe, the hydrogen push is an admission that its clean energy policies have created serious issues for the continent’s and the UK’s energy markets due to intermittency. With wind and solar power producing only 35%-40% of generating capacity, countries are forced to build 2-3 times the capacity necessary to generate the power needed. In other words, the power industry must over-invest in generating assets in order to meet demand needs. That is a huge misallocation of resources and investment.
As more renewable power capacity has been built, various country utilities must pay renewable energy producers to not produce power when it is not needed, as the surplus power disrupts the grid. In the United Kingdom, National Grid ESO, the country’s system operator, expects to spend £826 ($1.1) billion in payments to wind farms in order to balance the grid during May to August. Germany is experiencing a similar surplus renewable power payments problem.
To balance electric grids that are disrupted by renewable power, utilities will need to invest in batteries, pumped storage, or other power storage systems. One system being tested is using the surplus renewable power from solar and wind farms to create hydrogen and store it until the power is needed. This system is thought to be more flexible than conventional battery storage, which has limited supply (usually four hours) and then adds demand to the grid as they need to be recharged in order to be of value in the future.
The way to produce “green” hydrogen, which is carbon-free, is via electrolysis, which uses substantial amounts of electricity to separate the hydrogen and oxygen molecules that make up water. That is why it is the most expensive option. The idea for reducing the cost is to use surplus renewable power that is currently going to waste. There have been several experimental projects announced that will use offshore wind facilities to produce hydrogen when the power output is not needed, store it and then retrieve it to generate power when it is needed.
Exhibit 4. How An Electrolysis Unit Works
Source: U.S. Department of Energy
Recent research published in Nature Communications showed that capturing hydrogen by splitting it from oxygen in water can be achieved by using low-cost metals like iron and nickel as catalysts, which speed up the chemical reaction while reducing the amount of electricity required. Additionally, iron and nickel are found in abundance on Earth, which allows them to replace precious metals ruthenium, platinum, and iridium that are regarded as the preferred catalysts in the ‘water-splitting’ process.
According to Professor Chuan Zhao of the University of New South Wales School of Chemistry and the lead author of the study, “What we do is coat the electrodes with our catalyst to reduce energy consumption. The key to the process he explained was that “On this catalyst there is a tiny nano-scale interface where the iron and nickel meet at the atomic level, which becomes an active site for splitting water. This is where hydrogen can be split from oxygen and captured as fuel, and the oxygen can be released as an environmentally-friendly waste.” So maybe the electrolysis process can produce hydrogen cheaper by using less electricity. This is where European industrial policy, and especially the policy in Germany, may dictate the future success of green hydrogen.
Exhibit 5 (next page) shows Germany having the largest market share of electrolysis equipment in 2016. According to reports, it still leads with a 20% market share in 2020. Most reports of the global water electrolysis market show German companies dominating the market. The top companies with their geographical location include ThyssenKrupp Ag (Germany), Linde AG (Germany), Air Products and Chemicals, Inc. (U.S.), Siemens AG (Germany), ProtonOnsite (U.S.), Teledyne Energy System Inc. (U.S.), Areva H2Gen (France), Hydrogenics Corporation (Canada), Erre Due s.p.a (Italy) and Peak Scientific (Scotland).
Exhibit 5. 2016 Electrolysis Market Share By Country
Source: Frontier Economics
China, shown with the fourth largest market share in 2016 is investing heavily in the technology. Two weeks ago, five Chinese auto manufacturers teamed up with Toyota Motor Corporation to fund a venture to develop fuel cells for commercial vehicles. With Toyota owning 65% of the venture and providing the largest investment, it will be a vehicle to allow the company to push deeper into the China transportation market, while continuing to develop the business of alternate energy sources.
Toyota has been one of the biggest backers of fuel cells among global automakers, betting that they can become a source of energy for electric vehicles (EV) on par or even better than batteries. EV companies and proponents scoff at the idea of fuel cells competing with batteries. Toyota’s fuel cell interest is especially focused on commercial applications such as buses and trucks. That interest is supported by estimates from Bloomberg NEF that annual sales of fuel cells are on track to reach one million vehicles by 2035, largely driven by growth in buses and commercial vehicles mainly in China, Korea, Japan and Europe.
The cost of hydrogen remains a major hurdle for commercialization. Optimistic projections for major cost reductions abound, but the Hydrogen Council report (Exhibit 6, next page) shows how hydrogen costs compare competitively in specific markets, along with other low-carbon competitive fuels. Outside of existing hydrogen applications in refining and specific commodities, only the forklift market seems to be even remotely competitive.
Europe is betting heavily on hydrogen – both to foster its industry and because it sees hydrogen as a way to use its natural gas distribution system that will be increasingly challenged as North Sea and Netherlands gas fields play out. At the same time new hydrogen test projects are underway, companies are striking deals to use surplus, or extremely cheap solar power in the Middle East and North Africa to produce hydrogen that would be piped into
Exhibit 6. Hydrogen’s Cost Competitive Challenge
Source: Hydrogen Council
Europe. The backbone of the continent’s pipeline network, and where it links to Africa and the Middle East are shown in orange on the map in Exhibit 7. A potentially fatal flaw in this scenario is assuming those Middle East and African hydrogen suppliers would agree to sell their output at marginal prices. If they saw their hydrogen becoming the primary energy supply for Europe, why wouldn’t they strive to price their product as high as possible? (We remember when solar thermal projects in those regions were going to produce electricity that would be shipped via cables laid through the Mediterranean Sea.)
Exhibit 7. Backbone Gas Pipeline System In Europe
Source: Power for USA
This push by European companies, especially those based in Germany, reflects the concern they have about their competitive lead over Chinese companies. A study by Agora Energiewende, an energy consulting firm based in Berlin, Germany, shows what might happen to the cost of alkaline electrolysers by 2030. Under such a scenario, Germany has to be worried about losing its technology and its market position, just as happened with solar panels.
Exhibit 8. How China Could Upend Europe’s Strategy
Source: Agora Energiewende
Two charts dealing with the solar panel market show why Germany is concerned for its industry. Exhibit 9 shows the market share for leading solar panel manufacturers from 1995 to 2013. At the start of the solar panel business, the United States and Japan dominated the market. In 2000, Germany’s market share was 8%, compared to 1% for China. By 2007, both countries were at 20% market shares, but Germany’s share was heading down, while China’s was soaring. China’s industrial policy to dominate the global solar panel market, even with a lower-quality product, has destroyed the market for other producers.
Exhibit 9. How Germany Lost The Solar Market
Source: Wikipedia
The outcome of China’s solar panel policy is demonstrated in Exhibit 10 showing what happened to solar jobs in Germany during 2007-2015. The German government and its allies in Brussels fear a similar loss of electrolysis technology and market share to China, as it appears the Chinese government may be targeting this clean energy technology. The solar panel experience cannot be underestimated when considering China’s economic policy. They already are leading the world in EV implementation, and we fully expect it wants to dominate the EV market, as well as batteries, where it already has a dominant position in rare earth minerals. The new electrolysis technology could be a competitive weapon against China. As an aside, we would point out the latest comment from Tesla CEO Elon Musk that he plans to sell his China cars in Europe cheaper than German-produced EV models.
Exhibit 10. Lost Solar Market Cost German Jobs
Source: Wikipedia
Hydrogen faces two significant challenges: i) cost, and, ii) storage and transportation. In the Hydrogen Council report, low-carbon baseload supply hydrogen will only be “relevant in regions constrained in renewables potential and situations where alternatives like fossil fuels with direct CCS [carbon capture and sequestration] or biomass (wood chips or biogas) are not an option.” The study suggested that in those markets, “companies could import hydrogen and use it to power hydrogen turbines.” The economics becomes a serious issue. Assuming an import price of $3 per kilogram (kg) of hydrogen, power produced from hydrogen turbines could cost about $140 per megawatt-hour (MWh). In comparison, a 2019 estimate of the levelized cost of energy suggests the unsubsidized cost of natural gas combined cycle electricity generation today is between $44/MWh and $68/MWh, a current 50%-70% cost advantage compared to a hypothetical cost estimate for hydrogen.
Storing the hydrogen at scale is another question. A key issue is the physical properties of hydrogen compared with natural gas. Hydrogen molecules are smaller than those of natural gas, thus they may slip through the walls of plastic pipe, and potentially allow it to escape from some forms of gas storage.
There are three methods for underground storage of natural gas. The European hydrogen strategy assumes that existing natural gas storage facilities will prove adequate for storing hydrogen. Those facilities are: salt domes, aquifers and depleted oil/gas reservoirs.
A study by the U.S. Department of Energy (DOE) suggests that salt domes are probably a secure way to store hydrogen. However, there remains the possibility of hydrogen attacking steel fixtures (the piping connected to the salt dome) with hydrogen embrittlement.
In the case of aquifers, the DOE reports that while they are similar in geology to depleted reservoirs, they have not been proven capable of trapping hydrogen. Thus, aquifers will need further study before being proven to be able to store hydrogen safely.
With depleted oil/gas reservoirs, a study by TU Clausthal, Department of Hydrogeology, Institute of Disposal Research, Leibnizstrasse 10, 38678 Clausthal-Zellerfeld, Germany, concluded that underground storage of hydrogen in depleted gas fields (and aquifers) entails the risk of hydrogen loss (and related energy loss) by bacterial conversion to CH4 and H2S and gas–water–rock interactions, which in turn lead to changes in the porosity of the reservoir rock.
At the present time, the European hydrogen strategy has not distinguished between these storage types. Therefore, it is unclear whether there is sufficient existing salt dome storage, or if new storage capacity needs to be built. This may not be an issue if the economic challenge can be overcome, and based on the current information, that may not be clear for years. Only then will storage capacity become an issue.
There is little doubt that energy planners are assuming hydrogen will play a significant role in Europe’s carbonless future. The GHG characteristics of hydrogen are compelling. The cost issue is a huge hurdle that must be overcome, or the public must be convinced of their moral obligation to accept expensive energy. What Europe cannot accept is seeing China dominate hydrogen technology and destroy the economics necessary to propel the long-term growth of the continent’s economy. Germany is already watching with concern as its automobile industry’s investment in EVs is being directed elsewhere. Losing the hydrogen race could be cataclysmic. China could end up controlling all clean energy technologies in the world.
Electric Vehicle Market Is Alive And Well; Maybe Just Alive (Top)
The global pandemic has certainly upset everyone’s life. From a buoyant economy, the world shifted into ‘lockdown mode’ to appropriately address the virus. Economic lockdowns were proclaimed as the optimal strategy for “flattening the curve” – the way to slow the virus spread so health facilities and workers would not be over-whelmed. When people couldn’t leave their homes other than to purchase food or medicine, and only essential workers could visit their workplaces, economies were crushed. That meant people lost their jobs and their incomes. Unemployment soared, spending cratered, savings jumped, travel ceased, and economic pain and suffering was widespread. This transition was from free economies to ones where people totally depended on government.
One fallout has been motor vehicle sales. From 91.2 million units last year, vehicle sales for 2020 are projected to only reach slightly over 70 million. This forecast was made in July by Lee Bo-sung, the head of Hyundai Motor Group’s global business R&D center, at a seminar held by the Korea Automobile Journalists Association. Hyundai’s assumption is that global economic activity will slowly increase during the second half of 2020, even so, the economic contraction will be greater than experienced during the 2008-2009 financial crisis and recession. Hyundai does not foresee global vehicle sales reaching 2019’s level before 2023. Mr. Lee noted that Covid-19 disrupted both supply and demand, unlike in 2008-2009 and the 2011 Japan earthquake and tsunami. This downturn impacted all markets – developed and emerging economies.
Global auto sales in the 1H2020 fell 29.5% from the previous year, according to Hyundai. Monthly sales fell to 3.56 million in April amid the lockdowns and lockouts. Not a single car was sold in India, the world’s second most populated country. For India, two-wheeled vehicles dominate the transportation market. According to Mr. Lee, monthly global vehicle sales will exceed 20% throughout the balance of the year unless demand recovers in emerging markets.
The lone bright spot in the global vehicle market has been the sale of electric vehicles (EV). This is highlighted by the data for passenger vehicle sales for the first half of 2020, as reported by Bloomberg Green based on data from Bloomberg New Energy Finance (NEF). According to Exhibit 11 (next page), worldwide passenger EV sales declined 15%, while world internal combustion engine (ICE) passenger vehicle sales fell 26%. As Bloomberg NEF highlighted, Europe was the world’s EV bright spot, as sales rose 45.6%, at the same time ICE sales fell nearly 56%.
Exhibit 11. EVs Are The Stars Of 2020 Auto Sales
Source: Bloomberg
Looked at from a different perspective (possibly different data totals, too), we see on a monthly basis that global EV sales declined every month, except for February. July sales jumped 77% ahead of 2019 sales. We know the EV market is helped significantly by subsidies and government mandates for clean energy and bans on ICE vehicles, and governments have continued to expand both.
Exhibit 12. Global Monthly EV Sales Struggle in 2020
Source: EVvolumes.com
Europe was the clear 1H2020 regional winner due to its generous incentives and a better supply of new and improved EV models. Europe is likely to lead the regional growth race for the entirety of 2020. EV sales in Europe grew 57%, reaching a 6.7% light vehicle market share. This compares to a 2.9% market share in 1H2019. Europe’s share of global battery electric vehicles (BEV) and plug-in hybrid electric vehicles (PHEV) increased from 23% to 42%. More EVs were sold in Europe than in China for the first time since 2015. All of the larger European EV markets experienced sales increases, with the exception of Norway that fell 6%. The largest EV sales growth occurred in Germany, France, and the U.K.
Six European countries introduced additional green recovery incentives to promote higher EV sales, starting in June and July. These incentives are part of stimulus programs designed to help speed the economic recovery. The auto industry also geared up to meet the EU’s new 95 grams of CO2 per kilometer emissions target for 2020-2021. Over 30 new and improved BEV and PHEV models were introduced in 2H2019, and production was ramped up sharply. July’s preliminary results suggest that sales increased by over 200%. Estimates are that sales remain strong through the balance of the second half and that total sales for the year surpass one million units, with market shares running in the range of 7%-10%.
The Chinese market has struggled since July 2019 after the government made changes in EV subsidies and boosted incentives for purchasing ICE vehicles to stimulate its auto industry and the overall economy. EVvolumes.com hammered on the fact that China’s six-month sales performance was being compared against the pre-subsidy reduction period. The outcome was that 2020 sales fell 42% compared to 1H2019 volumes. China’s market share plummeted from 57% in 1H2019 to only 39% for the first half of 2020. Preliminary July sales data indicate a recovery of New Energy Vehicles (NEV), with a 40% increase over July 2019.
Exhibit 13. EV Unit Sales By Country And Region
Source: EVvolumes.com
Global BEV and PHEV sales for 1H2020 totaled 989,000 units, down from the 1.149 million units sold in 1H2019. The global EV market share was 3%. For all of 2019, the EV market share was 2.5%, up from 2.1% in 2018. Estimates are that 2.9 million EVs will be sold globally this year, assuming the strong July sales are reflective of the pace for the balance of the year. That suggests the global market share could rise to 4%, up 1.5 percentage points.
Market shares are jumping as total new vehicle sales have collapsed. The small markets continue to lead, as 68% of 1H2020 sales in Norway were EVs. Iceland was second with 49% and Sweden was third with 26%. Among the large markets, France leads with 9.1%, the U.K. with 7.7%, Germany with 7.6%, China at 4.4%, Canada at 3.3%, and Spain at 3.2%. All other vehicle markets with over one million total sales showed 3% or less in market share for 1H2020 sales. The preliminary car registration data for August for Western European markets shows a -15.5% decline versus last year, but year-to-date, the decline is -33.1%. The data does show that monthly sales volumes are slowly improving offering hope for a better last part of 2020. It should be noted that U.K. EV sales collapsed in July as incomes fell and people could not even afford the heavily-subsidized vehicles. Moreover, a recent survey showed that nearly half of potential EV buyers are reluctant to purchase one prior to the 2035 ban of ICE vehicles. The survey results show that with increased tax subsidies, U.K. buyers may be enticed to purchase an EV sooner.
Assuming the 2020 EV sales projection is attained, the global EV fleet will reach 10.5 million units by the end of 2020. If we add in medium- and heavy-duty commercial EVs, which adds another 800,000 units, the total fleet reaches 11.3 million units. Based on the estimated global vehicle fleet of 1.2 billion units, EVs would have a market share of just under 1%. This is where perception becomes an issue for the EV business. The recent Carbon Commentary Newsletter, published in the U.K. by environmentalist Chris Goodall, noted the 2020 energy transition report by DNV. Mr. Goodall thought they were too conservative in their EV forecast. He wrote:
“Personally, I think DNV is too pessimistic about the third of these blockages; the world is seeing very rapidly increasing emphasis on the electrification of even the heaviest vehicles. I thought that its assumption that about half of all cars sold in 2032 will be electric also looks too downbeat. Almost 5% of all cars sold in Europe this year will be purely battery powered, almost double last year’s level. At the current rate of change – and assuming successful large-scale entry by Chinese manufacturers into the market – a 50% share may be achieved at least six years earlier than this in Europe.”
Recently, during a presentation on energy minerals by Rystad Energy analysts, they threw out an estimate that 32 million EVs would be sold in 2030. In our model, which we discussed in the last Musings issue, that sales estimate is reached in 2032. As we showed in the article, our forecast for EV sales in 2030 closely matched the latest projection by Bloomberg NEF, but was widely exceeded by the forecast from the International Energy Agency (IEA). So, while DNV may be more aggressive than Bloomberg NEF, it falls short of the IEA’s forecast. Is any model right?
Mr. Goodall’s view is based on the latest EV sales data, especially from Europe where he lives. The market share and sales percentage performance this year are distorted by the Covid-19 impact on the overall automobile market. EV market shares are higher, but to a large degree, their gains are attributable to smaller overall vehicle markets, after acknowledging that EV sales have increased due to subsidies, etc.
Given these conditions, we were intrigued by a special email from Gary Burnison, the CEO of executive recruiting firm Korn Ferry. It was titled, “What Do You See?” He opened with the following question: “Has the world gotten smaller, or have our minds become narrower?” He asked people to examine the photo in Exhibit 14.
Exhibit 14. An Elderly Gentleman Walking?
Source: Korn Ferry
He questioned: “Do you notice an elderly man, walking slowly, carrying something in his right hand—a cane, perhaps? Narrow
perceptions, though, can be far from reality.” This was an astute observation, as he showed the same picture with additional scope.
Exhibit 15. The Man Doesn’t Have A Cane
Source: Korn Ferry
What you see from the larger perspective is that the elderly gentleman wasn’t just walking down the street, rather, he was a jazz saxophonist making music to entertain people as he walked. The point Mr. Burnison was making was that we need to pull back and avoid making quick judgements, especially about people. The same could be said about markets influenced by people. We would further suggest people hesitate, when dealing with numbers, about jumping to conclusions too quickly. Yes, EV market shares are up. Increased tax subsidies and other incentives, combined with government anti-fossil fuel mandates and increased EV model selection, are having an impact on EV sales. However, the decline in global auto sales is also having an impact on EV market share – potentially a more significant impact. We’d like more than one data point before embracing a new trend. We understand how proponents of any cause are likely to jump on the latest datapoint that supports their vision. We will not rush to judgement, but rather try to take the wider perspective.
Today’s Energy Transition: What’s Real And What’s Unreal (Top)
Last week, BP plc hosted a three-day webinar in which its executives laid out their strategy to transform the company from “an international oil company (IOC) into an international energy company (IEC).” Their tag line is that BP will be providing solutions for people’s energy needs. This transformation is designed to enable BP to shift from being a leading global oil and gas producer to a company with a more balanced energy portfolio including oil and gas resources, as well as wind, solar and biofuel energy. This is in keeping with the transitions other European-based oil and gas companies are making, largely in response to government and societal pressures to foster a net-zero carbon emissions world. Whether BP can make such a transition, while sustaining traditional oil and gas company superior financial returns, remains to be seen. BP’s CEO Bernard Looney has warned investors about that very challenge, as returns from wind and solar projects are substantially below those of traditional oil and gas projects. A tradeoff, however, is that the lower returns may provide greater stability, eliminating much of the volatility associated with the commodity cycle.
The energy transition environment is dense with topics for investigation, yet all are highly uncertain as to their eventuality, let alone their timing. Thus, logical and well-thought out structural presentations on how an energy transition might unfold can lead to materially different conclusions about the pace and the ultimate destination. There is no right or wrong answer. The process of arriving at the destination, however, is of greater value, as it allows for assessing possible alternative paths. The BP roadmap is based on its economists’ assessment of the probabilities of differing scenarios about social behavioral patterns and economic development unfolding. During Spencer Dale’s presentation, he often noted that there were conflicting scenarios about the uptake on issues such as mobility and the fuel mix of the global vehicle fleet. In effect, while the BP Energy Outlook focused on two scenarios that addressed carbon emissions more aggressively than in its business-as-usual outlook, Mr. Dale suggested his staff had considered other scenarios. He did acknowledge that all the models will be wrong.
There were several key points from the BP Economics presentation that should be considered when thinking about the energy transition. They should be considered because they are driving BP’s new business strategy.
-
- Energy growth in all three scenarios only occurs in developing economies. That is the result of demographics, increased energy efficiency in mature economies, the shift of manufacturing out of mature economies and into developing ones, government policies restricting certain fuels while favoring others that restrict consumption in developed economies, and increasing levels of prosperity in developing economies.
- For much of our energy history, a single fuel has dominated the total energy mix. Going forward, the rapid growth in renewable fuels will help provide a more diverse fuel mix. That increased fuel diversity will be driven by customer choice, rather than fuel availability. This comes as the wider
range of fuel choices, as well as their greater abundance, means the fuels will compete more aggressively for market share, reducing the pricing power of suppliers.
-
-
- In the company’s three scenarios, consumption of coal, oil, and natural gas drop while renewable’s share soars. Fossil fuels accounted for 85% of primary energy demand in 2018, but by 2050 they may represent between 20% and 65% of the share. “This would be entirely unprecedented. In the modern history of energy, there has never been a sustained decline in the consumption of any traded fuel,” said Spencer Dale, the chief economist at BP.
- Renewables’ share of the 2018 energy mix was 5%, but it could represent between 20% and 60% by 2050. If this happens, renewables would penetrate the global energy system faster than any fuel in modern history.
- There will be a long-term fallout from the Covid-19 virus that will limit economic growth and energy consumption throughout all of the next decade. The assumption is based on the belief there will be permanent changes in economic activity and behavioral adjustments reducing energy use.
- Previously, BP assumed that only in the scenario depicting the most aggressive policy actions to address climate change, would peak oil use be pulled forward. Now, BP believes peak oil may have occurred in 2019.
- Those scenarios (Rapid and Net Zero) describing an acceleration in decarbonizing and electrifying the economy ensure that wind and solar energy become the fastest growing energy sources. This will result in the need for between 300 gigawatts (GW) and 550 GW of wind and solar generating capacity, respectively, to be added yearly, at an annual investment of $500-$750 billion per year. That investment will exceed the amount of all upstream spending in the oil and gas industry.
- The importance of hydrogen as a fuel carrier will grow during the second half of the 30-year forecast period. As a result, by 2050, hydrogen will supply 6% of the Rapid and15% of the Net Zero scenario fuel mixes. Hydrogen does not play a role in the business-as-usual scenario. Blue and green hydrogen will provide roughly equal shares of supply by the later portion of the forecast period.
-
A chart Mr. Dale spent time discussing focused on how the evolving energy future is impacting the shares of primary energy source in the Rapid scenario. From 1900 to 1960, coal was the dominant source of energy. In 1960, oil surpassed coal’s share, and four fuels – coal, oil, natural gas and nuclear – supplied all our energy. Going forward, coal’s share is in a strong downward trend, while renewables’ share is soaring. The one aspect about the future energy scene is that renewables growth is not driven primarily by economics and superior fuel performance, but rather by edict and policy. That is a key difference, as the energy output, space use and employment requirements of these renewable fuels mark a reversal from the historical evolution of energy sources.
Exhibit 16. How BP Sees The Energy Transition Happening
Source: BP
While Rapid’s energy mix chart is interesting, another BP chart shows primary energy consumption by fuel source for all three scenarios compared to 2018’s fuel mix. Coal and oil see their market shares shrink in all three scenarios, which is not a big surprise. The natural gas share remains stable in the Rapid scenario, but declines in Net Zero, but increases meaningfully in the Business-as-usual case. We were surprised to see hydro and nuclear growing in all three scenarios, given that we are tearing out dams and shutting down nuclear plants. We need to pay greater attention to the evolving energy markets in Asia, India and Africa. Again, no one should be surprised that BP sees the share of energy from renewables growing in all scenarios, and becoming the dominant share in Net Zero. That growth speaks to the magnitude of new wind and solar power capacity BP says needs to be added to the world’s energy supply, as well as the huge investment requirement.
Exhibit 17. Fuel Mix Will Shift In Each Scenario
Source: BP
JP Morgan Asset Management’s annual energy report produced a chart based on data from Professor Vacal Smil and BP covering the last three energy transitions. It shows each transition needing roughly 40 years to attain a 15%-20% share of the world’s primary energy consumption. Environmentalists will claim that the renewables revolution has required less time to reach the 15%-20% target. They will say that it wasn’t until 2010 that renewables became the new fuel. With that start date, it will look like the target penetration level was attained in around 21-22 years, assuming the target share is reached in 2031-2032, as suggested in BP’s Rapid scenario. On the other hand, if we mark the start of the political push to use renewables to NASA scientist James Hansen’s 1988 Congressional presentation. BP predicts the 15% share should be reached about 2025 and 20% in 2031-2032, a 37- to 44-year time frame. However, one might say that renewables have taken 130+ years to reach the target range based on the orange line in BP’s chart in Exhibit 18.
Exhibit 18. Energy Transitions Are Not Quick Affairs
Source: JP Morgan Chase
JP Morgan sees several similar energy trends as BP. These trends help explain how primary energy use will change as electricity and hydrogen become energy transit agents. A substantial portion of primary energy is wasted in the form of heat when fossil fuels are burned. This is how BP is able to project that under its Net Zero scenario, where renewables account for more than half the energy consumed, total energy use declines.
Exhibit 19. How Much Energy Is Lost In Combustion
Source: JP Morgan Chase
When we see which of the fuels powers key economic sectors, the challenges of the energy transition become clearer. For example, in the transportation sector, petroleum is the primary energy source because of its energy density and its liquid form, facilitating mobility.
Exhibit 20. Which Fuel Is Used Where In The World
Source: JP Morgan Chase
What these fuel mixes will look like in 2050 will be quite different, as electricity will account for much larger shares in the industry and residential/commercial markets, and most of the transportation sector demand.
Two other charts that support BP’s forecast show how energy-intensive manufacturing is moving from developed economies to developing (emerging) ones. This shift is one reason why carbon emissions in the developed economies, such as the United States and Europe, have been falling. This has been helped by the shift from coal to cleaner natural gas to power economies.
Exhibit 21. Global Manufacturing Shift Impacts Energy
Source: JP Morgan Chase
As a result, BP predicts that all the energy growth will be in the developing economies, which is also supported by the International Energy Agency (IEA) forecast by regions. As we have pointed out in the past, this shift will actually impact the pace of the global energy transition, as many of these countries will focus on using their domestic natural energy resources. In many cases, that means the increased use of coal. Coal energy is more labor intensive, helping governments address jobs for their rapidly growing populations. Secondly, renewables require the importation of equipment and hardware – wind turbines, solar panels and the like – that are not manufactured in-country. It requires that they have foreign currency, or they have to go into debt. Developing mines and clean-burning coal-fired power plants helps keep the money inside the country and the economy growing. This reality is why the climate change movement is aggressively targeting the financial community. It needs to block financing of fossil fuel energy projects to be successful, regardless of harm to local economies.
Exhibit 22. Energy Demand Will Be Primarily In Asia
Source: JP Morgan Chase
As Dr. Smil has forecast many times, energy transitions require decades to unfold. Today’s climate change push is designed to scare the world into action, by predicting that we have only a handful of years to address carbon, thereby we need aggressive via government actions. As Mr. Looney of BP stated in his concluding comments at the company’s strategy presentation, “people want cleaner, reliable and affordable energy.” This is what BP is striving to deliver. To truly be successful, it needs policymakers to incentivize carbon choices, i.e., overturn energy market dynamics, so investing in lower-return investments can be justified.
Covid-19 Impact On Energy Markets Has A Long Tail (Top)
During the BP 2020 Outlook presentation last week, the company’s chief economist Spencer Dale discussed their assessment of the long-term impact on economic activity, and thus on energy consumption, from the Covid-19 virus. The company’s focus scenario when explaining future energy changes in response to events is its Rapid Transition Scenario. That scenario assumes government policies significantly increase carbon prices, along with taking sector-specific steps to cause carbon emissions to fall by about 70% by 2050. This scenario is consistent with actions designed to limit the rise in global temperatures by 2100 to well below 2o C above preindustrial levels.
In Rapid, Covid-19 is projected to reduce economic activity (GDP) by 2.5% in 2025 and by 3.5% in 2050 from what it would have been otherwise. The reductions will be disproportionately borne by India, Brazil and Africa. A portion of the reduction reflects anticipated behavioral changes such as reduced air flights, mobility, trade and manufacturing. The fallout on energy calls for a 2.5% reduction in 2025 and 3% less in 2050, meaning that oil demand would be three million barrels per day (mmb/d) below expectations in 2025 and 2 mmb/d below 2050. That outcome is shown in Exhibit 23.
Exhibit 23. How BP Sees Covid-19
Source: BP
BP also presented a scenario reflecting a greater economic impact, largely due to a second wave of the virus and longer-lasting and deeper behavioral changes as a result. The impact is for global GDP to be 4% below expectations in 2025 and almost 10% below its 2050 target. The fallout on energy and oil demand in 2050 could be -8% and -5 mmb/d, respectively.
Exhibit 24. How Bad Covid-19 Could Be For Oil
Source: BP
These negative assessments come at the same time both the International Energy Agency (IEA) and the Organization of Petroleum Exporting Countries (OPEC) are revising down their oil demand estimates for the balance of 2020 and their preliminary recovery forecasts for 2021. The lower oil demand, which is marginal (a few hundred thousand barrels per day) is the result of lowered economic growth projections. We found it interesting that both organizations reduced their economic growth forecasts, while at the same time, the Organization for Economic Cooperation and Development (OECD) raised its September forecast from its June prediction. Fitch Solutions, a global credit rating organization, has also increased its economic projections.
In the case of Fitch Solutions, it now predicts a -4.4% decline in global GDP in 2020, 0.2% better than its earlier forecast. This is because the recovery has happened faster than anticipated, even though the pace of the recovery is slowing. It is interesting that its 2021 and 2022 GDP forecasts call for growth well above the 2015-2019 average annual growth rate of 3.0%. In 2021, Fitch Solutions sees world GDP rising by 5.2%, followed by 3.6% growth in 2022. Those growth rates should help boost global energy demand, as well as oil demand. Shortfalls in oil demand from normal would likely reflect behavioral changes such as BP is suggesting. It is hard to believe there will not be changes, but predicting what they will be, and how much they will impact oil demand, remains difficult to call.
The OECD forecasts are interesting, and are shown in Exhibit 25. The blue and black dashed lines represent the OECD’s June 2020 forecasts, while the light red lines are its recently released September forecasts. Like Fitch Solutions, the OECD anticipates a smaller economic decline in 2Q2020 and a sharper rebound. It appears that the shape of their recovery mirrors their June recovery pace (black dashed line).
Exhibit 25. OECD Sees Global Economy Healthier
Source: OECD
The single message we take away from all the forecasts and guestimates is that oil demand will be below what it would have been absent Covid-19, and that will likely be for years. The magnitude of the shortfall can be debated endlessly. Our assumption is that we are looking at something close to BP’s estimates of -2 to -3 mmb/d shortfall. In a world of 100 mmb/d oil demand pre-virus, this is not a catastrophe for the oil industry. It will, however, force managements to begin assessing the shape of the long-term oil demand curve and what strategy adjustments may be necessary.
The Tsunami Of Oil Patch Bankruptcies Continues (Top)
If you haven’t seen your favorite lawyer recently, it’s probably because he has been pressed into service assisting his bankruptcy compatriots deal with the fallout in the oil patch from extremely low oil prices and the Covid-19 destruction of oil demand. The first contributed to the latter, which was then exacerbated by Russia and Saudi Arabia launching a market share war at precisely the wrong time. To appreciate how dramatically the energy world has changed over the past few years, who would have ever envisioned the President of the United States brokering a truce in an oil war that was driving oil prices down? Traditionally, the U.S. economy benefited from low oil prices by boosting consumer budgets as gasoline and heating oil prices dropped. Now, the harm to the energy sector’s economic contribution outweighs consumer pocketbook benefits.
The energy world, unfortunately, is unfolding just as the bankruptcy lawyers at Haynes and Boone suggested it would earlier this year. They predicted that 2020 would see a tsunami of oil service and E&P companies forced into bankruptcy, as their cash flows dried up in the current industry environment and their balance sheets could no longer support their high debt loads. Substantiating that view, Haynes and Boone just released its August accounting of the sectors’ bankruptcy filings. We have updated our charts showing the number of companies and amount of debt involved in these filings.
Exhibit 26. Will A Slow August Be Followed By A Flood?
Source: Haynes and Boone, PPHB
August was a slow month for the E&P sector, as only four companies filed for bankruptcy, throwing $6.7 billion of secured and unsecured debt into the restructuring process. August’s debt represents 13% of the $51 billion of total E&P debt involved in bankruptcies. After the first eight months of 2020, we have nearly half the number of E&P companies in bankruptcies as filed in the record year of 2016. The debt involved so far this year is nearly 90% of the 2016 total. With one-third of the year remaining, we may not reach the 2016 record number of E&P companies, but we will clearly surpass that year’s debt total, which reflects how much more financially levered this sector had become. In a world of low oil and gas prices, debt has proven to be the proverbial “kiss of death.”
Exhibit 27. Oilfield Services Debt Tsunami Gains Speed
Source: Haynes and Boone, PPHB
The month of August proved more onerous for the oilfield services company bankruptcies, as 12 filed for court protection. That monthly total exceeded the number of bankruptcies filed in 2Q2020.
Surprisingly, the August bankruptcies only involved $1.3 billion in debt, as most of the companies were small. Through the first eight months of 2020, the 37 companies that have filed for protection represent 71% of the total number that filed in 2017. With respect to the amount of debt involved, the sector is about 3.5% away from matching the 2017 record bankruptcy debt. It is hard to imagine 2020’s final debt total not surpassing 2017’s record, and potentially by a wide margin.
It is no fun tallying these bankruptcy filings, as they reflect the hopes and dreams of many employees, bankers and investors that have landed in the trash heap. Unfortunately, the data reflects managements, in many cases, failing to understand the seismic shift the industry underwent in 2014. They did not appreciate the drastic actions that were necessary, and the speed with which they needed to happen, in order to survive. At some point, historians will write the industry’s history, but given the macro issues overhanging its future, we wonder if anyone will be around to benefit from the lessons learned.
Contact PPHB:
1900 St. James Place, Suite 125
Houston, Texas 77056
Main Tel: (713) 621-8100
Main Fax: (713) 621-8166
www.pphb.com
Parks Paton Hoepfl & Brown is an independent investment banking firm providing financial advisory services, including merger and acquisition and capital raising assistance, exclusively to clients in the energy service industry.
