INSIGHTS FROM AMPHORA

Peak oil demand predictions still fall wide of the mark

In light of President Biden’s announcement to a 50% cut in US Greenhouse gas emissions by 2030 in comparison to 2005 levels, it is timely to explore once again an article Amphora published earlier last year where we asked whether the transition from fossil fuels is indeed accelerating at the rate many were predicting. Here we revisit that article and examine some of the observations this past year.

The US recently announced a package of nearly $3 trillion dollars as part of a series of efforts to boost the domestic economy. A central theme of this economic boost is to counteract the likely effect of job losses from the traditional high carbon economy.

The measures announced here will come in the form of a series of bills which, if passed, Biden can use to add diplomatic pressure to other significant economies who have been less ambitious with their climate action plan.

Biden faces significant opposition from a highly polarised political landscape at home and the measures – although on the right path towards the US transition goals – are likely to be watered down in time for the COP 26 in November. Given that the US legislative and executive branches will have difficulty in an agreement, what about the rest of the world?

Significant takeaways of the Biden infrastructure bill include :

Installing thousands of new electric vehicle charging stations

Funds to build energy-efficient homes

Constructing new electric power lines

Funding a global approach

The funds necessary to truly kickstart a global climate transition away from fossil fuels is difficult to pinpoint. Christiana Figueres, the former UN climate chief who oversaw the Paris agreement, said poor countries urgently needed help: “So many are still struggling with Covid-19 hardship. There has to be a big push for the G7 now, and the G20, on a finance package.”

The UN itself has estimated the figure to be in the region of $90 tn over the next thirty years for poorer countries to become carbon neutral by 2050. This is a vast sum by any measure, but in context of energy commodities, it is the equivalent to 50% of the total spend by poorest countries in their entire mix! In practical terms either price of energy needs to be raised appreciably to fund a global transition programme or legislation needs to have a more profound impact on carbon-intensive supplies.

The EU is still at the forefront of the push for a faster transition to a low carbon economy. In addition to funding, the EU recognizes that new legislation is needed (the stick to the carrot). Most notable is the EU ETS legislation entering a Phase 4: The EU is legislating a mass balance approach to capturing the total carbon emissions in a supply chain. With carbon trading at over EUR40/tonne, we will begin to see a faster transition curve than would otherwise be possible from straightforward market economics.

Elsewhere in the world, market economics rule. In India, for example, a population of 1.4 billion will see a Covid recovery plan that relies on existing energy infrastructure. This nation simply cannot afford the investment which will be multiples of the Biden plan. Here the transition will be much longer than predictions will have you believe: But not without significant steps in the right direction - In 2020 India burned less coal and more natural gas – the country could afford to do so in light of the collapse of global LNG prices.

‘We believe commodity markets pose a specific set of material challenges because they straddle the regulatory perimeter’

Funding in oil

We hear a lot from oil majors talking up their transition from oil to other energy sources. In fact, these companies represent a very small proportion of the market – about 10%. And even these standard bearers for the transition to renewables are doing it incredibly slowly.

There are a few significant projects – including Dogger Bank Wind Farm, Danish ‘energy islands’ and flare off reduction in Saudi Aramco. However, these projects pale into insignificance in a market that last year alone, in terms of the swaps value of the energy industry, was worth $3 trillion. Private companies who are not recognized by the average journalist are only too willing to take over the capacity left by the ‘High Street’ Majors. Most of these private companies don't have investor relations to worry about.

Although Big Oil may have an investment portfolio of $60-80 billion for renewables projects the numbers, just don't stack up in the context of a sector worth an annual $3 trillion transaction value. It seems we are not heading into a new golden (or Green) era anytime soon.

The rise of the NOCS and INOCS

Last year, we predicted that National and International Oil Companies (NOCs and INOCs) would be able to dictate supplies and prices. This is beginning to materialise – Saudi Aramco’s announcement that it is lowering production caused a bounce in oil prices to more than $50 in January 2021.

Even assuming that demand stays still and does not increase, NOCs and INOCs are set to expand their influence. In a long run of low oil prices – around $40 or less – NOCs and INOCs will effectively govern and rule the oil production portfolio.

Saudi Aramco can wind up and wind down production in a matter of days. In contrast, it is not possible to switch off an oil rig in the Gulf of Mexico, or a liquefaction plant in the Arctic Circle. These are stranded cost assets.

Many of these assets were built for a lifespan of 10 to 20 years, based upon a predicted bullish pre-COVID Ford forecast of prices ranging between $60 to $90. But that won't materialise. Oil prices are likely to be between $20 and $30 less, as much as 50% less than predicted, over the next 10 years.

In response, some companies have written down assets. BP wrote down assets some time ago, protecting it from the sudden market shock Exxon Mobil experienced recently. Exxon Mobil wrote down – through share price depreciation and its own voluntary reduction on its books – $110 billion-worth of assets last year.

Supply shocks

Oil price is now all about supply infrastructure shocks. Demand is inelastic. It’s not like alternatives exist today or indeed tomorrow outside the very richest countries. None of this really exists on any kind of commercial scale. Yet, on the supply side, NOCs, INOCs and large private companies can switch the taps on and off at will.

We predict oil prices will remain in a long-run equilibrium of around $40-$60. But the backdrop to that is an extremely volatile market with price swings greater than we have ever seen before. Opportunities abound, and the NOCs, INOCs and private companies are best placed to exploit them.

In a market with price fluctuations and oversupply, it is challenging to maintain revenues and manage credit risk management. A single view of the commodity supply chain is vital.

Amphora is a unique provider in today's LNG marketplace. We offer CTRM and Shipping services under one roof, allowing LNG clients to go to market quicker and for significantly lower cost. In October 2020 Amphora set up a strategic partnership with nGenue, the market leader in Natural Gas ETRM and retail operations software. For more information, please visit amphora.net.

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