National Post (National Edition)
BURNING QUESTIONS ABOUT THE FUTURE OF OUR ECONOMY.
The pandemic has left a multitude of unknowns in its wake. In a yearend series, the Financial Post explores some of the most intriguing.
Around this time last year I made some predictions for 2020. Like many crystal ball gazers, I was made to look like a fool. Then again, who could have predicted the pandemic, save Dr. Anthony Fauci?
I'll give it another try this year, offering my energy-related thoughts for 2021. But this time, I'll make foolproof predictions and reflect on why they are so.
Here are three themes I see in my crystal ball: First, more green policies will be forthcoming, including more corporate investment into decarbonization initiatives. Second, oil and gas companies will continue to consolidate. And third, the world's primary energy demand will rebound quickly in the latter half of 2021.
Before we look forward, let's go back a few years, starting around 2017. That's when the first serious “end of oil” narratives began.
Tesla Inc. introduced its mid-range Model 3 to penetrate the broader light-duty vehicle market, and electric vehicles began to feel like a legitimate alternative rather than a luxury novelty. France and a handful of other countries announced bans on internal combustion engine sales by 2040. Mainstream media championed the notion that the end of the 160-year petroleum era was nigh. At the same time, wind and solar costs continued to plummet and “grid parity,” the point of cost competitiveness with fossil-powered utilities, advanced closer to reality.
By 2018, the prospect of breaking the energy dominance of fossil fuels, combined with more aggressive climate change targets, led to investor retreat from North American oil and gas companies. Accelerating the capital migration were low oil prices, which had been cut in half in 2015 by price wars and gluts caused by the U.S. shale revolution.
Investors gave oil companies a blunt assessment. They asked: “You don't make money and you're going to go out of business. So, tell me, why should I invest in you?” The argument was simple enough and was amplified by divestment movements vilifying the industry for lack of action on climate change.
To be fair, investors have been complicit in the oil companies' predicament. Since the early 1970s, investment was driven by a belief in ongoing, long-term resource scarcity — the peak oil-supply argument. Prior to 2018, the first question an investor asked a CEO was, “What's your outlook for production growth and reserve additions?” Costs and profitability were afterthoughts. The mindset was, why bother with MBA 101, when investing in a portfolio of oil stocks was mostly considered a torqued-up call on forever rising global oil prices?
By 2019, investor sentiment had decidedly shifted. The prime narrative was that technology and the environment were driving the oil industry into the ditch, followed quickly by the view that there's no shortage of oil in the world and oil companies were drilling themselves out of business. But investors didn't close the door entirely, advising the oilpatch to give them a call when they clean up their business, and start to make money and steady payouts.
The investment shift in the five-decade-old oil paradigm, the sudden swing in expectations from growth in oil production at all costs to growth in profitability with the lowest costs, is a major factor affecting the pace of energy transition.
Then the pandemic amplified everything.
Mobility was paralyzed. The sudden drop in petroleum consumption slashed the price of oil again, momentarily down to zero. For much of the year, capital markets reinforced both the end-of-oil and the future-istech sentiments. Tesla's stock soared along with clean technology indexes. Oil and gas equities sank to historically low valuations.
That's why my first prediction is clear. The market returns of clean energy technology companies are a self-perpetuating mechanism for attracting investor capital. Government policies will skew toward more encouragement, but increasingly it will be corporations and their investors that fund the next wave of decarbonization.
Superficially, that prediction should cause my crystal ball to conjure a rapid demise of the oil and gas business. But it shows otherwise. Lower commodity prices and reduced access to investment capital remain as accelerants to greater ingenuity and efficiency, not oblivion.
Here's where my second prediction comes in, and for this I'll turn to Charles Babbage to explain. In 1832, Babbage, father of the modern computer and the field of operations research, penned On the Economy of Machinery and Manufactures. What he noted a couple of centuries ago still holds true. In response to “every reduction in price of the commodity,” the producer will cut costs “and his ingenuity will be sharpened in this inquiry by the hope of being able in his turn to undersell his rivals.”
Babbage also spoke of the difference between “making” and “manufacturing,” which is a matter of scale. In Canada and the U.S., there are many oil companies in the business of `making' — in other words, small boutique operators. The “making” paradigm survives only when prices are robust. Now, with prices deflating and capital scarce, scale matters. That's the domain of “manufacturing.” And that's why the oil and gas industry will continue to consolidate in the pursuit of lower costs.
The irony of it all is that — contrary to end-of-the-industry narratives — the new investor directives and divestment are rapidly creating a far more resilient oil and gas industry, one that's able to make money and compete at progressively lower commodity prices. In the span of three short years, US$45a-barrel has become the new US$60 for profitability. The bar is likely to go lower.
This discussion leads to an important mega trend: The cost of bringing a joule of energy to market, from whichever source (oil, gas, wind, solar or nuclear), is getting cheaper. In other words, primary energy is now a deflating commodity.
And that brings us to my third outlook. We already have a glimpse into the post-pandemic energy world. Clean energy investments are continuing at a robust pace. Yet traffic congestion in Beijing and other Asian cities is rebounding and, in some instances, exceeding pre-pandemic levels. Remarkably, China's draw on petroleum in 2020, including gasoline and diesel, will close higher than in 2019. Heading into 2021, I predict the rest of the world won't be far behind.
The simple law of economics prevails: When things become cheaper, people buy more of everything. And that's the easiest, most pandemic-proof prediction of all.
A FAR MORE RESILIENT OIL AND GAS INDUSTRY, ONE THAT'S ABLE TO MAKE MONEY.