Three predictable surprises for the energy industry
Energy academic and author Professor Dieter Helm took the stage at Flame 2016 with an energetic analysis of the future fossil fuel market and the likely impact on gas. Professor Helm’s thesis is built on the impact of three “predictable surprises” that are being experienced by the wider industry, alongside other factors impacting countries, regions and large-scale industry players.
The current situation is set against a historical context of the late 20th century, post-war growth when energy was delivered primarily by coal and gas. Until 1990 it was actually illegal to burn gas in a power station; gas is a recent entry into the energy mix, whilst renewables were hardly in the picture at all. Into this framework, says Professor Helm, the EU has tried to introduce the internal market, onto which was grafted the renewables story.
“The renewable story is not a story about the internal market; it’s a story about government-backed contracts that are largely fixed price.” Professor Helm says the energy industry is coming out of that historical context and is now facing a series of substantive changes.
The end of the commodities super-cycle
The first of the predictable surprises impacting the industry is the end of the commodities super-cycle. “If you look back over the last 150 years of the oil industry, the story is 100 years of gradually falling oil prices followed by two episodes punctuating that trend,” Professor Helm told the audience. It is abnormal for the price to go up, even when demand is expanding.
What has been the response to that ongoing fall in commodity pricing? asks Helm. The obvious thing has happened – as happened after the last big price shock in the 1970s - essentially the large producers responded by producing more. That might seem counterintuitive, but for many of the producers the price is still higher than the marginal cost of production. Saudi Arabia, for instance, has said they still want to increase their production further.
If you look into the medium term, it’s possible to imagine a world where the five main producers alone are able to produce 50 million barrels a day – assuming Iran and Iraq join Saudi Arabia, Russia and the US. “Even if world demand moves to 100 million barrels a day that’s half the total demand covered by five of the main producing countries.”
“The question is, are there other constraints on oil that may play to gas’s strengths and point towards not just lower for longer but, in the oil market, lower forever.” There are further predictable surprises, according to Professor Helm, that will bear down on these prices and would lend some support to the proposition of lower forever.
Carbon constraint won’t bite
Professor Helm says that all of the larger energy companies and industry players predict that we will continue to burn substantial amounts of fossil fuels well into this century and companies will continue to produce them.
If the carbon constraint does have an impact, then Helm says it will be bad news for oil, bad news for coal and “moderately” bad news for gas. Gas, he argued, would still have a role to play in the transition from fossil fuels to low carbon energy.
But Professor Helm’s belief is that COP21 will have very little impact on the fossil fuel industry as the carbon constraint is still weak. Instead of legally-binding targets and an enforcement mechanism to apply those, the agreement produced a series of non-legally enforceable pledges with a target that has reduced from 2 to 1.5%.
Emissions have continued to grow since 1990, says Professor Helm, and there’s no good reason for thinking that will change. “It’s a story of achieving nothing in reducing emissions since the start date of the Kyoto framework.”
Impact of new technologies
In the background to today’s industry is a ‘revolution’ in the nature and structure of modern economies, says Professor Helm. This has been driven by digital and connectivity.
“That technology is now rolling forward into new domains that will change the demand for energy, the structure of the demand for energy and therefore your industries and your outlooks,” he explained.
For Professor Helm, digitisation is “an electricity game”. In energy terms, the future is electric; every other player must think about where they sit in relation to those energy market developments. Oil will suffer in this world, says Professor Helm, as it has little part to play in this electricity-dominated world, but there is an opportunity for gas to gain ground in areas such as hybrid vehicles, petro-chemical projects and small-scale LNG projects.
Who will be the winners?
In terms of key winners and losers, Professor Helm believes Russia and the Middle East will struggle because they do not have an entrepreneurial culture and the capacity to build a substantial technology base. China, he says, has a mixed future as it may struggle with handling new technologies but has the benefit of lower energy prices.
“Curiously, Europe could be a winner in this world. For a continent without much energy suddenly to find it’s abundant in supply, and cheap, especially gas is quite a relief,” says Professor Helm.
The oil companies are still struggling with next steps – Professor Helm, for one, is not confident that companies like Total can diversify into renewables and other energy sources.