The Road to Hell is Paved with Coal…?

BP plc recently published its 65th annual statistical review of world energy (http://www.bp.com/content/dam/bp/pdf/energy-economics/statistical-review-2016/bp-statistical-review-of-world-energy-2016-full-report.pdf), commonly considered a treasure trove of data about all aspects of the industry, as well as trends within it.

As our readers will know, at Awbury, we like to keep ourselves as informed as possible about potential trends and risks across the financial and economic spectrum, because that helps us identify potential opportunities, as well as minimize the chances of errors of judgement in our risk acceptance and management.

So, what struck us as interesting in terms of themes or trends?

Clearly, much of the world constantly obsesses about oil, with some signs of recovery beginning to appear only now after almost 2 years of price declines; yet coupled with uncertainty about sources of demand, and whether a new “normal” pricing range will appear. The advent and growth of US “tight” oil and gas from shale formations has changed the balance of supply and demand, because it can respond to pricing signals much more quickly than “traditional” sources or those with large, long-term project horizons. Secondly, energy intensity (the average amount of energy required to produce a unit of GDP) continued in its longer term trend of declining at a rate of 2% per annum, meaning that, although’ the price of most hydrocarbons declined significantly, there was no offsetting behavioural change causing more flexibility in the use of energy inputs.

Another significant trend was that natural gas gained increasing market share as a source of energy vs. coal, while the rising availability of liquid natural gas (LNG) is likely to lead to a more globally integrated natural gas market, with pricing responding much more quickly, in the same way as in the oil market. As for coal, in presenting the review, Spencer Dale, BP’s Chief Economist, described 2015 as its “annus horribilis”, as consumption, production and pricing all fell. The effect of this was clearly visible in the US, when natural gas supplanted coal as the largest single source of fuel for power generation; while, one after another, the largest coal producers filed for Chapter 11 bankruptcy protection. Similarly, the question arises as to whether declining demand in the PRC will be offset by an increase in India (which is now the world’s second largest coal user after the US.)

The third clear theme is the continuing rapid growth (albeit from a relatively small base) in wind and solar power as energy sources. In particular, solar power production has increased 6o times (sic) in 10 years, including by 33% in 2015, driven by ever-declining costs per unit of output. Of course, for each source, the real test will come when and if it can (or is allowed to) compete on a comparable, non-subsidized basis with “traditional” hydrocarbon fuel sources (taking into account the significant costs for hydrocarbons which are usually not factored into standard accounting.)

We have written before about the risk of hydrocarbon assets becoming “stranded” and, therefore, economically non-recoverable. That risk would certainly seem to be rising in a number of sub-sectors; but, even so, the impact and likely timeframe are not consistent across all jurisdictions. As always, one has to look beyond the “headlines” and to analyze the actual risk being presented; because, in doing so, one may find opportunities that the “market” has overlooked or ignored; and those are the situations on which Awbury and its partners focus.

The Awbury Team

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