Insights — October 2021
Dramatic increases in energy prices world-wide has implications for inflation, economic growth, and future energy policy
We are closely monitoring world energy markets following recent dramatic increases in energy prices. We are alert to the risk that the situation escalates into a more serious global crisis with implications for inflation, economic growth, and future energy policy. So far (prices as at end-September), we observe:
- The oil price is +95% YoY, achieving multi-year highs and US gasoline prices are up 80% YoY;
- In Europe and Asia (the key regions dependent on imported energy), coal and natural gas (transported as LNG) prices have hit record levels, up 270% and over 500% YoY respectively;
- There have been signs of panic in the UK with long queues at petrol stations; and
- In emerging markets, there are reports of Chinese provinces rationing electricity; Indian power stations being on the verge of running out of coal; and electricity prices spiking in Brazil.
What is causing this?
We assess the root cause as a confluence of factors:
- Rapid energy demand recovery as the world economy recovers from the COVID-19 pandemic;
- Lingering pandemic-related constraints in the energy supply chain;
- Long-term trends of curtailing emissions-intensive (coal and natural gas) and nuclear electricity generation capacity driven by asset age, emissions reduction initiatives and economics;
- Drought-impacted hydroelectric supply in many parts of the world (for example, c.60% of electricity in Brazil is hydroelectric and the country has had its driest summer in 91 years). Hydropower supplies c.16% of global electricity;
- The biggest hurricane disruption to US oil and gas supply since Hurricane Katrina, 16 years ago. While the Gulf of Mexico supplies c.15% of US crude oil and 5% of its natural gas, c.50% of US oil refining and natural gas processing capacity is located on the Gulf coast; and
- Mild weather in Europe impacting wind power output. According to specialist wind data provider, Vortex, this year the strength of the wind in northern Europe has fallen by up to 15% on average in places. In 2020, wind power supplied c.15% of Europe’s electricity.
Importing seaborn coal and LNG are the short-term solution for many economies to plug the gap, driving prices sharply higher.
What does it mean in the short term?
The potential for more panic.
Predictions from long-range weather forecasters for a colder than average northern hemisphere winter is amplifying the tension and may drive further panic buying and even higher prices.
The issue is causing some to blame the general policy of developed-market governments shifting from emissions-intensive energy to renewables. This issue is likely to become a subject of debate at the upcoming 26th United Nations Climate Change Conference (known as COP26) to be held in Glasgow, Scotland, between 31 October and 12 November 2021.
What does it mean for clean energy?
In our view, notwithstanding the fact that some will blame renewable energy in part (or wholly) for the crisis, the direction of travel towards renewables driven by the economics, government policy and public opinion will be hard to change (even if a cold winter tests the patience of the voting public in parts of the world).
‘Net zero’ emissions targets, backed by strengthening government policy and an investment-friendly backdrop is likely to see the private sector direct an enormous amount of capital towards wind, solar and energy storage infrastructure in the coming years.
Our analysis indicates that renewables have economics on their side, and this is structural. The key fact is that renewables are now the cheapest form of new electricity generation capacity in almost every part of the world – increasingly without any subsidies. This is creating an incentive price for considerable investment in energy storage as well as smarter grids to accommodate the changing supply dynamics. Within transportation, electric vehicles are well on their way to cost parity with internal-combustion engine transportation (this month Volkswagen estimated it will achieve margin parity within 2-3 years).
According to McKinsey, the electric vehicle industry has attracted more than US$100 billion in investment since the beginning of 2020. According to management consultants AlixPartners, major automakers have announced a total of c.US$330 billion of investment into electric vehicle and battery technology over the next five years, a number which continues to grow.
We translate all of this to mean that the clean energy boom is just getting started.
How big do we think the prize is?
The world’s super-major and state-owned energy companies were the most valuable companies on earth before the big technology companies (the FAANGs: Facebook, Apple, Amazon, Netflix and Google) changed our lives. Our view is that the most valuable companies of our future, and the solution to sustainably powering our world, are those companies which sit at the intersection of clean energy and consumer technology. Identifying and investing in these opportunities is our top priority.