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The Geopolitics of Energy

“The Geopolitics of Energy”:  that was the title of a talk given at the Opportunity Crudes conference in Houston last week by Guy Caruso of the Center for Strategic and International Studies.  It’s an endlessly fascinating and urgent topic, as very few sectors of the economy shape the world in which we live as much as energy — and particularly, oil — does.

Highlights of Caruso’s presentation — many of which are not novel or unique, but are worth restating:

Oil is currently inseparable with transportation:  virtually 100% of mobility — whether by car, truck, rail, boat or plane — is fueled by petroleum-based products.  Demand is flat or even shrinking in the U.S. and Europe, but this is more than offset by explosive demand growth in the developing world — especially China, but also India, and the Middle East.  “The center of gravity of the oil industry is moving East.”

Most of the lowest-cost endowment of oil resources on the planet are concentrated in the Middle East, subject to great political instability.  A scary thought:  many leaders, especially in the lynchpin Saudi Arabia, are over 80 years old — what happens when they die?

Reliability of delivery is threatened by geogrpahic chokepoints.  For instance, over 15 million barrels per day — nearly 20% of world oil supply — passes through the Strait of Hormuz.  Although most of the oil passing through goes to Asia, the U.S. military remains the key protector of this vital trade route.

Meeting global demand growth in the face of declining conventional resources means two things:  a shift towards unconventional resources (which are more expensive to produce, and face significant environmental/technical challenges) and an almost insatiable need for ongoing additional capital investment.

Although technological leadership may remain with the “supermajors”,15 of the 20 biggest oil companies in the world (i.e., the ones with the most reserves/resources) are now state-owned enterprises, such as Saudi Aramco and PDVSA.  While some of these companies like Lukoil (LSE:  LKOD), PetroChina (NYSE: PTR) and Petrobras (NYSE: PBR) do have minority stakes that float on stock exchanges, make no mistake:  they are not being managed for the purposes of shareholder value maximization.  These companies trade on stock exchanges solely to access global capital markets so as to finance immense expansion programs.  Otherwise, their motivations are far different than profit-maximization as expressed so effectively by the supermajors:  these organizations are arms of nationalistic pursuits.  In other words, the oil game of the future will be driven less by money and more by geopolitical moves on the global chessboard.

There are more upward pressures on oil prices than downward pressures.  Note that the oil industry is running at over 95% of capacity — there’s almost no spare or excess capacity to cope with any perturbations.  Even so, most companies are using $60-80/bbl as the reference price in determining long-term capital investments:  big bets require conservative assumptions. 

Shale gas is a game-changer — not just in the U.S., but in many parts of the world.  More gas will be used for power generation, which will displace coal.  Indeed, without carbon capture and sequestration, coal will be under threat for both economic and environmental reasons in most places of the world.  (Exception:  China, which is growing so fast that it will build as much as possible in a true “all-of-the-above” energy strategy.)

Caruso closed by noting, humbly, that in his 40 years in forecasting the energy sector, there was a consistent tendency to underestimate the impact of technological advancement, which in turn renders long-term predictions subject to big errors.  Not only will the finer points of his analysis be inaccurate, but some of the overarching conclusions — which seem so obvious today — will no doubt be wildly off a few decades from now.  The key is figuring out which ones will be right and which ones will be wrong.  Black swans are hard to see when they haven’t yet flown to the horizon.

Banking on a Low-Carbon Energy Future

One of the world’s largest banks, London-based HSBC (NYSE: HBC) issued last September a very interesting research report entitled “Sizing the Climate Economy”.

At less than 60 pages, it’s an excellent read for those interested in the future growth of the advanced energy economy.  There are really too many highlights to capture all of them in this blog post, but here are a few snippets.

HSBC pegs the global low-carbon energy market — comprising low-carbon energy supply (renewables, nuclear, and carbon capture/sequestration) and energy efficiency (vehicles, buildings, industrial, energy storage, and “smart-grid”) — at $740 billion in 2009.

The HSBC authors characterize four potential scenarios between now and 2020:  ranging from a “Backlash” scenario where most world economies retrench from commitments to reduce or limit carbon emissions, to a “Green Growth” scenario in which many nations commit (and actually follow through on those commitments) to clamp down on emissions to an even greater degree than in earlier headier days of 2009. 

Even in the most-pessimistic (in my view, most realistic) scenario, the global low-carbon energy market is projected by HSBC to more than double by 2020, to about $1.5 trillion, representing an annual growth of over 6%.  By any account, and even under this uninspiring scenario, the low-carbon energy market is a solid growth market of the next decade.  If the dominoes fall right and we get a result similar to HSBC’s most optimistic scenario, then the low-carbon energy market would nearly quadruple to $2.7 trillion by 2020, for a 12.5% compounded annual growth rate.

The numbers in the HSBC report need to be taken with a grain of salt.  Any system or market as complex and multi-faceted as the global energy sector cannot be modeled with any great degree of precision.  If HSBC’s forecasts for 2020 end up within +/- 50%, I’d say they would be doing well.  What’s more valuable, in my opinion, about studies of this type are the qualitative conclusions that can be drawn.

In general, the energy efficiency side of the ledger fares better in HSBC’s analysis than low-carbon energy supply.  No doubt, this is because many effiicency options are lower cost (certainly, lower cost per ton of emissions reduced) than new low-carbon supply options — and because the demand for new energy supply options will inevitably be depressed as more efficiency is implemented.  HSBC is particularly bullish on electric vehicles, especially in the second half of the decade — an optimism that I’d like to share, but can’t at present based on the decidedly mixed results of 2011 for electric vehicles (as discussed in my last post here).

For most of the report, HSBC uses their “Conviction” scenario as “the most likely pathway to 2020″, in which Europe meets their renewable energy targets but not their energy efficiency targets, China more than meets their clean energy targets and becomes the largest market for low-carbon energy in the world, and the U.S. (disappointingly, but predictably) experiences relatively limited clean energy growth.  So, for those of you in the clean energy marketplace, the place to be is….NOT the U.S.

This report was written by a team of HSBC analysts based in Europe — and it shows in many places. 

The text refers several times to human-driven climate change as a phenomenon that’s commonly-known and understood to be a real issue, and the need for public sector intervention to address the issue — if not cap-and-trade or carbon taxes (which seems unlikely for the foreseeable future), then command-and-control regulation.   Alas, much of corporate America and most of one of the two major political parties in the U.S. (lots of overlap here) contends that climate change is unproven at best or a hoax at worst — and therefore undeserving of any policy initiatives.   

This study could never have been issued by a U.S. bank, or even a U.S. based team of a global bank, or else they would be disavowed.  It certainly won’t help HSBC grow market share for U.S. corporate banking services.

Notwithstanding the lack of political will and leadership (especially in the U.S.), HSBC is more hopeful about progress in lowering carbon intensity, because other co-aligned forces will be powerful in the coming years.  In particular, austerity will squeeze out inefficiencies.  Furthermore, the authors note that many countries are pursuing low-carbon strategies because such an emphasis fosters industrial innovation or offers the prospect of creating many “green jobs”.

As HSBC notes, “a low-carbon economy will be a capital-intensive economy”.  This makes intuitive sense, as the use of carbon-based fuels implies an ongoing set of economic activities to continually extract and consume the resource.  Put another way, low-carbon energy will be more about capital expenditures and less about operating expenditures.  And, a LOT of capital will be required:  HSBC estimates about $10 trillion of capital cumulatively through 2020, tripling from 2009 levels to reach an annualized rate of $1.5 trillion per year — “a large but manageable sum in our view”. 

Where will this investment capital come from?  “It will be private capital from corporations and consumers that will finance the climate economy — with governments setting the framework and providing capital at the margin.”  In typical understatement, HSBC notes that “the challenge for investors, however, is the lack of certainty over both policy intentions and actual implementation.”

That’s a polite way of saying the world will likely muddle through, somehow.