In part I of this blog https://acfequityresearch.com/decoupling-of-gdp-and-energy-growth/ We discussed some of the fundamental changes in macro-economic relationships happening now and revolving around energy and GDP growth.
In part II we consider some of the implications for extractives (basic resources – Oil & Gas, E&P and Mining). The conclusions our ours, the forecasts are from McKinsey (ACF neither endorses nor takes issue with these forecasts or their likely accuracy, but they are interesting).
The nature of the relationship between energy and economic growth is changing, picking up speed, and will end with a flip. The end result is great for miners and requires thought from Oil & Gas exploration companies.
Think about the generational change in the use of mobile phones and photography. Tech innovation plus behavioural change. 20 years ago there was no mass-market in mobile communications except perhaps within the world’s military organisations.
Today, just 20 years on, no-one can contemplate business without mobile communications. In the last 10 years this truth has also come to apply to smartphones and business.
Where there is change there is opportunity and when the change is so potentially vast, then axiomatically, so are the opportunities.
Key demand trends:
- Coal demand – to decline due to rapid rise of renewables. China is key, today 70% of China’s power is derived from coal.
- Oil demand – to grow over the next 10-15 years to around 110m barrels per day, i.e. 10% above today’s demand, and then to decline on an accelerating trajectory. The main driver is road transport vehicle electrification. This means E&P companies will still need to find around 40m barrels per day given field average decline rates.
Oil prices – 2007 over 80% of demand was insulated from oil price changes where government policy that had been introduced after 1973 globally served to insulate economies from cartel driven supply side shocks. 2019 over 66% of oil demand is exposed to oil prices (dramatic price falls in 2014 in the oil price were used by many governments to abandon oil price subsidies and the shock absorber strategies by for example reducing the scale of their strategic petroleum reserves. This means oil will become more price elastic and more expensive in all likelihood.
- Natural gas demand – 20% growth to 2035 or 700bn more cubic metres (which is equivalent to the total gas demand for Europe, Japan and Korea today). Key driver is China, which is expected to account for half of the total demand growth for natural gas. Other regions will see a slowing of natural gas demand thanks to renewables.
The markets seem to be indicating that there are businesses out there ready to create opportunities for value generation from energy efficiency, electrification and decarbonisation. The market also appears to be signalling that everyone in energy needs to be thinking about these issues, mega and large cap companies are already desperately taking note. Smaller caps are more nimble, the opportunity is there, with imagination, for them to outrun their bigger brethren.
The intimate linkage between primary energy demand/supply and economic growth is decoupling. We are at the beginning, but it is such an attractive scenario that its momentum is unstoppable. Populations continue to soar, economies continue to develop (grow), global energy demand is rising but the trajectory is flatter and the relationship less and less straight forward.
Energy intensity is decreasing, renewables (unlimited and ubiquitous in the case of photons) are new sources of power with remarkable energy and distribution differences from biomass, fossil fuels and nuclear).
ACF Equity Research’s view (read through):
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 plateaus in 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 a cost of zero (just like the impact of the cost of sending data down a telco pipe – a change that took just two decades).