Power Surge! The Third Energy Super-Cycle Of Our Lifetime

Power Surge!

In last week’s “Long-Takes From The Road” video podcast (here), we teased our view that the third energy super-cycle of our lifetime is underway, with this one focused on the power sector. We back date the start of this super-cycle to 2023 following the late 2022 viral launch of ChatGPT and market recognition that power demand was set to take a step change upwards. While the rise of artificial intelligence (AI) and broader digital transformation rightfully capture significant mindshare, aging OECD grids, the need to incorporate a rising share of intermittent resources like solar and wind, and billion-person-scale economic/wealth gains in the developing world are all similarly important drivers. While electricity is not a primary energy source like crude oil, coal, natural gas, nuclear, hydro, solar, or wind, we still think referring to the current environment as the third major energy super-cycle of our lifetime is appropriate.

Our career has been focused on the “other” side of energy—i.e., oil & gas and its related value chains such as E&P, pipelines, refining, and oil services as well as its alternatives like biofuels. “Oil and gas” and “power” have historically had their own macro analyses, corporate strategies/outlooks, and analyst coverage. Today, the lines are blurring. Oil service pressure pumping companies are seeing stock price gains from power sector announcements. Natural gas E&Ps and midstream executives increasingly discuss the prospect for rising power demand on their opportunity set. Power demand growth in developing markets such as Africa we think is directly driving unexpected improvements in crude oil and refined product demand as overall economic activity is lifted.

Importantly, Big Tech and Big Industrial consumers of energy are helping the broader world recognize that it is energy’s natural hierarchy of needs that drive why we use energy in the first place (Exhibit 1). It is the aspect of the energy narrative that gives us the most optimism and energy producers should now recognize the criticality of ensuring high-profile leaders from trillion dollar companies vocally advocate for sensible energy policies around the world. We are moving away from a world that labeled some forms of energy as “pollution” and sought to place limits on future energy use, well before everyone on Earth was energy rich. This mindset shift benefits both the power value chain and traditional oil and gas.

Independent power producers (IPPs) and power infrastructure companies in the U.S. are giving leading technology companies a run for their money in terms of stock price performance (Exhibit 2). It is to be determined whether pre-revenue, new technology areas like nuclear SMR companies will deliver commercial growth and avoid the round-trip flame-out of other recent speculative energy technologies such as green hydrogen and most EV start-ups. We keep an open mind as always and would contrast the need to meet massive global power demand needs with the failed “energy transition” ideology that drove areas like green hydrogen.

We are not looking to write a treatise this week so will stick with the popular Q&A format in this post, with additional video podcasts and written posts to follow.

Exhibit 1: Energy’s natural hierarchy of needs

Source: Veriten.

Exhibit 2: Power equities have been rock stars since 2023

Source: Bloomberg.

Can you briefly characterize the prior two energy super-cycles?

The first energy super-cycle of our lifetime was the Arab Oil Embargo era of 1973-1986. The second was the China/BRICs expansion of 2004-2014. The Arab Oil Embargo era was at its core a geopolitical event and the weaponization of crude oil by major Middle East producers against the rich, developed world. Without secure oil flows, life ground to a stagflationary halt—at least on the days your odd- or even-numbered license plate wasn’t allowed to fill up with gasoline. The geopolitical and economic ramifications of that era have left an enduring scar on energy importers everywhere, even those that were not directly impacted by that 1970s experience.

The China/BRICs expansion was a more positive expression of what it means to lift a billion people out of poverty. It was about turbocharged global GDP growth and the strain that put on energy supplies after an extended period of more modest demand growth and the waning benefits of the oil supply investment wave that followed the 1970s. In other words, a major new energy supply CAPEX cycle was required, with a 5X increase in oil prices ($20/bbl to $100/bbl) proving motivational to upstream companies.

What were the biggest surprises to come out of those prior 2 energy super-cycles?

The 10-fold increase in oil prices from the Arab Oil Embargo era drove a major power generation mix shift where the OECD replaced oil-fired power generation with coal, nuclear, and natural gas. Global oil demand fell for four straight years from 1979 to 1983. The 1980s are also the only extended period where the U.S. saw a step-change improvement in fuel economy gains as inexpensive, smaller Japanese imports took significant market share from the gas guzzlers Americans had preferred (and now again prefer).

China’s massive increase in oil imports—and the prospect of major additional import needs—has sparked its all-of-government approach to “new energies” value chains (Exhibit 3). This came at the same time US shale oil and shale gas surprisingly all but eliminated the U.S.’s previously major oil import dependence (at least on a “net” basis). The U.S. in a short decade also became the world’s top LNG exporter in 2023. The relative energy geopolitical security of the U.S. stands in sharp contrast to China’s relative energy insecurity at a time China is still in need of lifting the living standards of large swaths of its population.

Exhibit 3: China’s surge in oil imports has sparked its focus on new energies alternatives

Source: Energy Institute, Veriten.

What can be gleaned from those episodes as it relates to the current power super-cycle?

Technology will surprise in unexpected ways. As oil prices rose from $20/bbl in 2002 to over $100/bbl by 2008, upstream oil & gas companies were focused on various deepwater exploration provinces, Canada’s oil sands region, Russia/Arctic, and West Africa among other areas. In fact, U.S. shale oil proved to be the dominant oil supply area of the 2010s, something almost no one anticipated for at least the first 6-8 years of the super-cycle! U.S. shale oil growth proved to be a wrecking ball for many other investment regions.

What will be the surprise power sector opportunity on either the supply or demand side of the equation? Nuclear SMRs? Enhanced geothermal? Permitting reform? Chip efficiency gains? Natural gas? Solar + batteries? Something else? When will it reveal itself? Within the next 2 years? Or more like over 5 years from now?

What can be learned from the profitability cycle during the China/BRICs era?

We have previously highlighted our “quadrilateral of death” analysis of oil & gas sector profitability versus oil prices as a key lesson learned (Exhibit 4). In a nutshell, initially oil prices and sector profitability rose (the green line). The warning that profitability cycle was rolling over came between 2006 and 2008 when oil prices continued to rise sharply (reaching our $100+/bbl objective) but profitability began to stagnate (the yellow line). It was all over for traditional energy when oil prices remained around $100/bbl in the first half of the 2010s but profitability collapsed such that CROCI (cash return on gross capital invested) was no better at circa $100/bbl than it was when oil was previously in the $20s/bbl.

Given the nature of power sector CAPEX versus oil & gas, we do not anticipate a similar profitability evolution to occur. The question is what is the equivalent of the quadrilateral of death where warning signs emerge that the power sector is getting extended and the best days of the super-cycle are in the past? At this time, we are not sure what the answer is. And to be clear, we believe we are still closer to the beginning rather than even the middle let alone late stages of this super-cycle, so there is some time to figure this out.

Exhibit 4: Key lesson learned from last oil super-cycle: Quadrilateral of Death

Source: FactSet, Veriten.

Perhaps the ramp in Big Tech CAPEX is akin to what upstream players did in the 2000s?

Maybe. We shall see. The current crop of “Magnificent-7” (Mag-7) stock market leaders have enjoyed the enviable combination of leading revenue growth, low capital intensity, and superior profitability (Exhibit 5). However, CAPEX is now rising sharply due to spending on AI datacenters (Exhibit 6). It is unclear at this time—and certainly difficult to envision—whether the returns on that CAPEX can come anywhere close to historic Big Tech profitability. Unlike the energy business, technology companies regularly face existential risk from the displacement of their products with newer, better alternatives: hence the urgency to spend and stay ahead of the competition. The returns on Big Tech CAPEX are an area we will be watching closely.

Exhibit 5: The envious super profitability of Mag-7 leaders

Source: FactSet, Veriten.

Exhibit 6: But will sharply rising CAPEX impair future profitability?

Source: FactSet, Veriten.

How does the current power super-cycle differ from “The Energy Transition” era of 2020-2024?

The current power super-cycle we believe is at its core a reflection of energy’s natural hierarchy of needs in contrast to the inversion attempted by the biggest proponents of “The Energy Transition.” Whether it is AI hyper-scalers or developing economies, the current power boom is focused on investing in and having access to reliable and affordable 24/7/365 power. Ideally, reliability and affordability can be achieved with as low of an emissions profile as possible. But make no mistake, reliability and affordability trump emissions as the driver. The Energy Transition era had this backwards and pretended the economics of various low-carbon technologies were or would be competitive with traditional areas.

Bonus Questions

Should upstream oil & gas companies get into the power sector?

We believe significant ongoing investment is needed in both crude oil and natural gas supply in order to meet long-term demand growth. While we do not rule out the potential for some upstream-oriented companies to consider power opportunities, we suspect that it will make the most sense for most companies to spend the bulk of their time figuring out what will be the next low-cost upstream oil or natural gas opportunity to pursue.

What areas of the power sector look most interesting to you?

The power sector is fascinating with radically different risk/reward opportunities found in power infrastructure companies versus IPPs versus regulated utilities versus new technologies versus commodity producers of key inputs like natural gas, uranium and other important metals and minerals. All should benefit from structural demand growth. We need to do more work on each of those sub-sectors.

Is global power demand growth a risk to oil demand growth?

No, in fact just the opposite. Rising wealth in the developing world is leading to improving oil demand growth.

But won’t many developing nations prioritize electric vehicle (EV) growth in order to limit oil imports?

Yes, but overall wealth gains will lead to growth in all forms of energy including internal combustion engine (ICE) vehicles along with EVs. A key lesson learned from The Energy Transition era is that no region is choosing between energy sources and technologies; all will be needed.

How do environmental considerations fit into the power super-cycle?

Rising global wealth is positively correlated with clean air and clean water. Full stop.

What about carbon emissions? Will Big Tech and Big Industrials require power demand growth be low-carbon in nature?

In our view, Big Tech and Big Industrials will care most about ensuring access to reliable power 24/7/365 that is competitively priced. While lower emissions-power will be preferred over higher-emissions, it is reliability and cost that will drive technology choices. Emissions will be a byproduct of those choices, not the other way around.

⚡️On A Personal Note: Writing vs Video Podcasting

An unofficial poll based on incoming emails and in person comments is that there is something like a 3:1 preference for the video podcasts versus the written posts. I like doing both but have to admit that there is a discipline and forced clarity that comes from writing that I don’t think I can match in the video podcasts. With immense gratitude to the video production team at Veriten, video has become the medium that allows my being able to maintain weekly flow since joining Veriten full-time 2.5 years ago. As a result, I am now generally at a 3:1 run-rate of video podcasts versus written posts. But for the vocal minority that prefers the written word, I understand and I would prefer to be at least at a 50:50 mix.

⚖️ Disclaimer

I certify that these are my personal, strongly held views at the time of this post. My views are my own and not attributable to any affiliation, past or present. This is not an investment newsletter and there is no financial advice explicitly or implicitly provided here. My views can and will change in the future as warranted by updated analyses and developments. Some of my comments are made in jest for entertainment purposes; I sincerely mean no offense to anyone that takes issue.