In the analysis below ACF takes a short form look at the data within the most recent McKinsey Quarterly report and overlays some of its own interpretation.
When I try to reduce the whole of economics to one idea to make it a more accessible subject at the theory level, sometimes I like to use the following idea – energy must be injected into a system that contains things we dug out of the ground in order to make the things we want. This principle applies to agricultural commodities as much as it does to making metals and composites for motor vehicles.
The McKinsey Quarterly April 2019 analysis… ‘The decoupling of GDP and Energy Growth’ does not change anything about our primary statement above.
The report makes, amongst others, the following points:
‘It is axiomatic (to date) that economic growth and energy demand are linked’. Which is to say that If energy is constrained, so is GDP growth.
‘The world will not become less “energy hungry” but technological innovation and behavioural trends should cause the energy demand curve to flatten’ – i.e. energy pricing will decline (supply) as energy demand rises, which is akin to an oversupply of energy, that will be important for Oil & Gas and mining.
‘Wealth creation has depended on a society’s proficiency at burning things’.
Until fossil fuels almost all the energy we created through burning ‘things’ was lost (wood burning originally lost nearly 100% of its embodied energy in the burning process). Fossil fuels in stark contrast loose about 40-70% of their embodied energy in the burning process. What this tells us is that although modern economies require ever more energy, the energy we burn from oil and gas goes far further than it did when burning wood was the primary energy supply.
The decoupling of energy demand from economic growth is driven by four changes:
- Aggressive decline in energy intensity of GDP – essentially due to the shift from manufacturing to services in rapidly growing economies such as China and India.
- Climb in energy efficiency – technological innovation stimulated by actual or perceived high future energy prices is improving energy efficiency.
- Increase of electrification – electricity is more efficient in many applications.
- Growth in the use of renewables – energy resources that don’t require a skill at burning. And if we think about photons (solar) combined with increased electrification, this won’t just flatten the demand curve, it will change energy to a constant, C, in the equation. Energy will become essentially irrelevant as any sort of constriction to economic growth.
Energy costs are a significant proportion of total costs in many businesses; therefore, energy savings have a disproportionately large and positive effect on Net Income generation.
Energy needs (globally) per capita will fall 10% by 2050 vs. 2016 – this is in spite of the emerging economy households entering the middle classes and so the high energy demand “refrigerator/aircon/car” economy.
The transport sector will deliver some of the most dramatic improvements in energy efficiency.
Electrification – the rise of electrification will also contribute to the likely plateau in energy demand. ICE vehicles hit a ceiling at about 40% energy efficiency, electric motors reach their limits at a little above 90% efficiency. Electric battery costs are anticipated to continue to decline.
Oil (currently the dominant but declining transport fuel of choice) is therefore becoming significantly more price elastic. Put another way, Cartels will have increasingly less effect on price setting for the price of oil (and gas) and every time they exercise their remaining influence, so they will hasten their own demise.
- By 2020 renewable electricity will be cheaper than most new build (the most advanced) coal and natural gas power stations, almost everywhere.
- By 2025 renewables are probably going to be a cheaper way of producing electricity even when compared to the marginal cost of running existing power stations in many parts of the world.
- By 2035 renewables (wind, solar, hydro etc.), will provide over 50% of global electricity supply.
- Over the next 15 years only natural gas of the non-renewable energy sources is likely to maintain its market share.
- By 2050 demand for coal and then oil will level off and then begin to decline.
- Emissions – the McKinsey analysis suggests that emissions will contract by 20% from 2016 levels by 2050.
Energy Transition watch list – three we think particularly relevant:
- Transformation of businesses – a retailer becomes an energy producer – solar panels on store roofs
- New market dynamics – Consumer preferences change increasingly to green products and so-called circular solutions
- Government policy/regulation – Bans e.g. on plastics or diesel, in turn constraining business operations.
ACF Equity Research’s view (read through) of what McKinsey’s Quarterly April 2019 means for:
Oil & Gas E&P – The changes are a risk and opportunity for oil and gas E&P in the lifetime of current managements, remembering that markets will come to recognise these changes way before the growth of oil and gas consumption is expected to plateau, which in the McKinsey analysis is within the next 10-15 years.
Miners – (i.e. other minerals) should benefit tremendously as the energy to make things from what they dig out of the ground becomes a Constant in the equation or for now at least tends to marginal cost zero (just like the impact of the cost of sending data down a telco pipe – a change that took just two decades).