Re-Centering “Energy Transition” To a Rest of World Focus

The Energy Transition Needs to Transition

Our key takeaway coming out of CERAWeek 2023 was that the “energy transition” as a concept needed to transition, a perspective we believe is slowly being recognized by policy makers, energy companies, and the financial community. We will dive into this topic with a series of follow-up posts. This week we focus on the over-arching need to re-center energy transition toward solving the energy supply needs of the Rest of the World, which contains the other 7 billion or so people that do not live in the United States, Europe, Canada, or Japan.

Energy transition will never succeed as an idea if it means we are trying to force a move to newer energy technologies within an unrealistically quick time frame. The post Russia-Ukraine concept of solving the “energy trilemma”—which gives equal weight to a mix of affordability, security, and climate—does not adequately reframe the idea. Instead, we believe “energy transition” needs to recognize that there is a hierarchy of needs, with availability coming first, followed by affordability, followed by security. It is only after all these conditions are met that the general population are likely to take into account climate considerations. A climate-first approach we believe will ultimately not solve climate concerns and is patently unjust to the other seven billion people on Earth.

We can see the hierarchy of needs most obviously in Germany of all places post the cut-off of Russian gas. Germany is now burning increasing amounts of domestic lignite coal. It is difficult to square increasing coal usage in Germany—even if it is declared to be only temporary—with strong calls from European organizations to not support the financing of new coal projects in the developing world.

Unlike years past, the Rest of the World is as well positioned as it has ever been to go forward on its own. Actions taken by Europe and the United States in recent years, especially post Russia-Ukraine, appear to be motivating major non-OECD countries to take steps that circumvent US and EU dependence. At the same time, the energy needs of the Rest of the World are surpassing those of the United States, Western Europe, and Japan. For the US, the shale revolution coupled with steady growth from Canada have enabled it to eliminate its previous import dependence. Western Europe and Japan are economies with diminished relevance to global growth and have been replaced by China, India, the rest of Southeast Asia, and in the future by Africa. Why is the greater world allowing the Euro perspective on energy & climate to dominate discourse?

There is little logic to Western Europe setting the agenda on global energy & climate policy. Germany’s retirement of its last three nuclear plants is symbolic of Europe being past the point of no return in terms of remaining a meaningful contributor to global economic health. It is not too late in the United States and Canada in no small part due to the still sizable energy resources our respective countries are blessed with. There is still time for the United States and Canada to go down a healthier path that benefits its citizens and helps support energy supply growth needed to improve the lives of the other 7 billion people.

What does re-centering energy transition to a Rest of World focus mean for decarbonization initiatives? We would argue that it is going to be up to major economies like China and India and individual countries in important regions like the rest of southeast Asia and Africa to decide for themselves. In the past we have written how the Glasgow Financial Alliance for Net Zero (GFANZ) poses a financing risk to traditional energy companies in the United States, Europe, and Canada. It, along with the International Energy Agency (IEA) and World Bank, pose a bigger risk to financing energy supply growth for the Rest of the World. Steps to limit “fossil fuel financing” will be detrimental to economic growth in the developing world. There is neither economic nor social justice in starving the Rest of the World of needed energy supplies.

A Re-Orientation to the Rest of the World

If we look at energy needs through the lens of the Rest of the World, some key considerations become apparent:

• The historic focus of energy supply was to feed import needs in the major consuming economies of the United States, Western Europe, and Japan, with the goals of availability, affordability, and security. It is now about meeting the needs of the Rest of the World, which contain the other 7 billion or so people on Earth (Exhibit 1).

• As a result, the ability for US and Europe-centric energy & climate policies to dictate global direction is diminishing relative to the history we have all lived.

• Rest of World dependence on western world financial institutions is also diminished relative to decades past. They can increasingly go it alone, with or without us.

• There are substantial energy resources outside of the United States, Canada, and Europe to meet energy demand. There is a logic to resource-long regions redirecting focus to the developing world.

The relevance of this globally re-oriented framing for US and Canadian energy companies and investors is to look past policy myopia and culture wars that plague energy & climate discussions in the US and Canada. Western Europe increasingly looks like a lost cause, so our focus is with US and Canadian companies and investors.

Exhibit 1: Rest of world population will want and need more energy supply

Source: US Census Bureau.

DEMAND/ENERGY SOURCE

• The Rest of the World will undoubtedly take an “all of the above” approach to energy supply, prioritizing availability and affordability above all else. All forms of energy supply including coal, natural gas, and crude oil will be needed and there is certainly a role for new technologies to take a piece, and maybe even a large piece, of the growth pie.

• The traditional energy commodity with the clearest demand growth outlook, surprisingly, might well be coal, as its use in the OECD is now minor and it is a large, inexpensive domestic resource in many developing areas (Exhibit 2). Domestic coal in just about every region is significantly less expensive than imported crude oil or LNG (liquefied natural gas).

• The long-term outlook for global natural gas is also favorable though there is uncertainty on the degree to which Europe will demand LNG, which might drive pricing/contracting uncertainty. Even as coal ramps up in the developing world, there will still be incremental demand for LNG in those same areas. It is, however, the direction Europe decides to take that suggests some caution is warranted as we think about long-term LNG demand.

• Internal combustion engines will remain a sizable portion of the transportation mix in the Rest of the World for the foreseeable future, even if Europe is some day “100%” EVs. Overall, we expect crude oil demand to grow at least into the 2030s (assuming trend global GDP), with the post mid-2030s outlook clouded by the pace and timing by which OECD declines could be offset by non-OECD growth.

• Finally, there is a bright outlook for new energy technologies, some of which will grow meaningfully in coming decades taking a to-be-determined portion of the growth wedge. Nothing in this post should be construed as anti-new technologies. Quite the contrary, they are badly needed. Our concern instead rests with the mis-guided belief by many that growth in new technologies can fully offset a large percentage of traditional energy by 2050, or 2060, or some future year.

Exhibit 2: Coal, surprisingly, may have the clearest growth outlook given it is now a non-OECD fuel

Source: BP Statistical Review of World Energy.

SECURITY

• Domestic resources will always trump imported supply. This is the case for coal in the developing world.

• The supply/demand balance for crude oil, natural gas, and coal can vary significantly by country and region. The Middle East is an obvious oil exporting region, with Qatar a major LNG exporter. China and India both have sizable coal resources but are less well endowed with crude oil or natural gas. Latin America and Africa supply/demand realities vary significantly by country.

• Renewables and other new energy technologies will likely be sought after by countries with import needs. The impetus will be security of supply first and foremost. Renewables and new technologies can also help with availability and affordability in some instances.

ENERGY SUPPLY

• Developing world coal is typically the domain of a state-owned company; the opportunities to invest in resource development seem unclear for US and Canadian companies.

• US shale oil will remain an important supply source, but it is unlikely to remain the only game in town as core areas mature.

• African countries in particular will likely look to revitalize dormant exploration and development programs. The outlook for Latin America is less clear given the nature of governments in the region.

• Canada’s oil sands region ought to be considered a key, dependable resource to help the world develop economically. A proposed carbon capture hub will eliminate the current Scope 1 emissions disadvantage faced by the oil sands.

• International project development of all sizes and shapes are likely to return, driven by the needs of developing countries, rather than the historic import needs of the United States and Europe. The number of western world oil and gas companies capable of pursuing international projects is greatly diminished post the shale revolution.

FINANCING

• The biggest uncertainty in financing energy supply comes from the combination of GFANZ, the IEA under its current leadership, and the World Bank. The IEA’s “Net Zero by 2050” report that declared no new oil & gas fields would be needed in a net zero by 2050 scenario has been predictably, and arguably willfully, weaponized by activists in what is an increasingly successful attempt to halt western financial institution financing of traditional energy. GFANZ is essentially calling for a managed phase down of fossil fuel financing on a highly unrealistic time scale.

• It is unclear what direction The World Bank will take under its new head, the well-regarded former Mastercard CEO Ajay Banga. However, if the forced departure of its previous head is any indication, “climate only” ideology will almost certainly remain the order of the day.

• Whereas the influence of GFANZ and related bodies pose challenges for western oil & gas companies, it could be detrimental to economic growth in developing areas, in particular those with less developed economies than say China.

• It also creates an opportunity for resource rich countries to collaborate with the developing world to figure out investment solutions that cut out European and perhaps US companies.

What about climate and decarbonization?

There is actually a lot of good news on the climate front and some obvious areas for further improvement.

• The worst case outcomes of over 3 degrees of warming, in particular the 4.5 and 6.5+ degree scenarios, by 2100 are increasingly viewed as improbable by climate scientists. The debate is now about the possible pathways to getting to the low end of the 2-3 degrees of warming range and continuing to reduce the high end of the reasonable range.

• There remains a major opportunity for improved energy efficiency to allow the developing world to grow with a less energy intensive mix than what we have seen elsewhere. India, for example, does not seem to be looking to replicate China’s heavy industry, export oriented growth model.

• While the developing world will rightfully prioritize energy availability and affordability as its core driver, there is recognition of the need for clean air, clean water, protecting biodiversity, and ultimately trying to decarbonize.

• Developing countries are motivated to add any and all sources of energy, which will include non-fossil fuel alternatives for the primary reasons of availability, affordability, and geopolitical security. It will also help countries grow with reduced carbon intensity.

• Methane is a largely solvable problem, with faster progress possible.

• There is plenty of room to reduce Scope 1 emissions from coal, natural gas, and crude oil…cleaning up our existing fuels should be as important as trying to ramp new technologies.

• Newer technologies are making progress. For example, Europe and parts of the United States could replace a significant quantity of ICE vehicles with EVs in coming decades. Heat pumps, energy efficiency, and battery storage are all areas where we expect further progress, to name a few.

• Outside of Western Europe, nuclear power is gaining mindshare as a core driver of future power sector decarbonization. If the world is to ever become serious about decarbonization, there is little doubt a “Nuclear Marshall Plan” will be needed.

• Significant capital is being deployed to find “the next Tesla.” While it’s hard to handicap the timing and likelihood of success, it’s not for want of trying.

• Putting a price on carbon emissions would help motivate additional reductions in carbon intensity.

• Carbon capture and storage will likely need to ramp meaningfully to further reduce carbon intensity.

The point of this section is to highlight the fact that decarbonization is likely to remain a global objective. It is simply unlikely to be an obsession in the Rest of the World as it is in Europe and parts of the United States. Moreover, countries in the Rest of the World will need to decide for themselves their hierarchy of needs. We suspect that available and affordable energy for all will remain the overarching objective. Environmental factors like clean air, clean water, and biodiversity can go hand-in-hand with an improving economic outlook and pressure will remain to take these factors into account.

Regarding decarbonization and newer technologies, the degree to which they can enhance availability, affordability, and geopolitical security will likely help drive growth. Unlike decades past, there will likely be a broader mix of energy supplies meeting economic growth. But countries need to solve basic needs first.

What does this mean for investors?

Western world investors appear to be caught up in the idea that traditional energy is a sunset industry, with the only debate being the exact upcoming year that fossil fuel demand will have peaked before entering terminal decline. The framing is one driven by a European and US perspective that has currently inverted the hierarchy of needs to prioritize climate concerns over the basic need for energy by everyone at all times.

We do not share this pessimistic view and would encourage investors to consider how we are going to meet the world’s energy needs without using traditional energy. The size and scale of required CAPEX to meet global energy demand growth suggests there are many ways and business models through which an investor can participate, including in both traditional and new energy markets.

The battle to improve profitability and balance sheet health is won. It’s now about holding onto the gains and looking forward. A few points:

• Without risk taking and investment, a company will not be able to sustain advantaged profitability and shareholder distributions.

• No one, including us, is calling for a return to the bad ole days of drill-baby-drill, 100%+ reinvestment rates, and rapid production CAGRs.

• For larger companies in particular, we believe production can at times grow and at times shrink; it is base shareholder distributions that should grow at a clip faster than the S&P 500.

• For smaller companies, a broader range of value creation pathways exist, but companies and investors should not expect a materially lower cost of capital to magically materialize.

What does this mean for traditional energy companies in the United States and Canada?

Implications for US and Canadian traditional energy companies:

• Ten years from now would you still want to be a US shale pure-play? Perhaps the answer is “yes” for smaller companies. Hard to think it is “yes” for larger players.

• If you don’t have it, what is the best way to (re-)gain international or offshore expertise?

• How do you extend inventory life, maintain competitive ROCE, not ruin your balance sheet, and possibly diversify without deeply upsetting your existing investors? In our view, deals that fundamentally improve a company will, ultimately, be winners. The best example from history may be Occidental Petroleum’s purchase of Altura Energy (Permian Basin) at a time investors had a bearish view of the oil macro, a bearish view of onshore US oil, despised Oxy’s management team, and followed a period of poor stock price performance and a discounted valuation. Altura follows the edict of doing deals that make your company better without worrying about your current multiple or relative popularity.

We understand that it’s not easy moving away from the pack. If you want to be with like-minded peers, join a country club (or church or temple or affinity group, etc.). If you want to outperform, blaze your own trail.

🎤 Streams of the Week

Streams of the Week include four past COBT episodes that provide unique perspectives on “energy transition” that we don’t always hear in the United States.

• Sunita Narain is an environmentalist, political activist, and author based in India.  Episode link here.

• NJ Ayuk is the CEO of a South Africa-based energy-focused law firm and author who advocates strongly for an “all of the above” approach to meeting Africa’s vast energy supply needs. Episode link here.

• Dr. Lars Schernikau is a German economist, entrepreneur, commodity trader, and author who provides a strong dose of analytics and pragmatism around the future of energy. Episode link here.

• Andrew Kamau is based in Nairobi, Kenya and is Managing Director of Internal Programs, Energy Opportunity Lab at the Center of Global Energy Policy. Episode link here.

⚡️On a Personal Note: Africa

I have had the good fortue to travel extensively in my career and on family vacations. The one region I have not spent a lot of time in is Africa. I have been to the Algerian desert to visit Anadarko Petroleum’s major discoveries in the mid 1990s. That is it for me in the continent. The history of Africa is also something I don’t remember spending much time learning about growing up in the 1970s-1980s. I remember American history, European history, and even studying the history of China, Japan, India, and other countries. But Africa? Just can’t remember it being a subject we spent any time on. I previously mentioned I had recently read Siddharth Kara’s new book Cobalt Red: How the Blood of the Congo Powers Our Lives. It's a tough read, but one I would highly recommend. Along with India and Southeast Asia, the future of Africa is going to be an important future region. I need to do more homework...and travel.

⚖️ 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.