Q&A: why conventional energy companies still matter
As global leaders gather to discuss the climate crisis, portfolio manager Mark Lacey tells us why conventional energy companies still have an important role to play.
Energy markets are back in focus again as global leaders meet at the COP26 conference in Glasgow to discuss the climate crisis. The world is also currently experiencing an energy shortage, with oil, gas, coal and power prices around the world reaching all-time highs.
And despite an urgent need for the energy sector to decarbonise, traditional energy companies are still very much an important part of the global energy mix. This was recently highlighted by Ben van Beurden, chief executive of oil giant Shell, who said it would need the cash from its oil and gas business to fund the transition to net zero.
Moreover, as traditional energy companies switch their asset bases towards renewable power, they could be part of the solution rather than part of the problem. We spoke to portfolio manager Mark Lacey to find out more.
Why is conventional energy still so important?
Mark Lacey said: “As investors in the energy transition, we strongly believe that the energy sector needs to decarbonise, through the increased use of low-cost technologies such as solar, wind, hydrogen and battery storage. Over time, the use of coal, oil and eventually natural gas will all be phased out of the energy mix.
“However, it is important to note that fossil fuels still account for 85% of the global energy mix. Hydro and nuclear account for a further 11% and solar energy accounts for 4%. The shift towards more sustainable forms of energy is a transition and this transition needs to be managed. And not just managed by consumers switching to greener energy sources, or governments using fiscal policies to discourage investment in fossil fuels or providing subsidies to encourage investment in emerging technologies. This also has to be managed by the big oil companies and balanced investments will be still required over the next few years.”
Is demand for oil still rising?
Mark Lacey said: “Although we believe that the take up of electric vehicles (EVs) will be incredibly strong over the next few decades, global oil demand (from passenger vehicles alone) is still expected to rise until 2024/2025. Our forecasts assume that EVs reach 90% of global sales by 2040. This is higher than the forecasts by the International Energy Agency (IEA) and Bloomberg New Energy Finance (BNEF).
“The IEA and Energy Information Administration (EIA) forecast that the oil market will grow from the current level of around 100mb/day to around 107mb/day in 2025. This increase will be driven by higher demand in emerging markets, which will be partially offset by a decline in demand in developed markets."
How are the big oil companies dealing with the energy transition?
Mark Lacey said: “Although the major integrated oil companies continue to be very important suppliers into the oil market (accounting for about 15% of global supply), their capital allocation is changing. These companies have significantly reduced capital expenditure over the last few years as both oil and gas prices had weakened significantly. They have now focused on reducing their debts, maintaining dividend payments to investors and redirecting capital towards renewable power capacity, hydrogen and energy transition infrastructure. They are in no rush to spend more oil or gas projects.
“With current decline rates in the oil industry running at between 3% and 6% per year, it is estimated that this is not sufficient to hold production flat, let alone provide incremental volume growth.
“Put simply, as a result of many years of under-investment, the number of new oil projects (non-OPEC) are at their lowest level since 2002. The global oil market, meanwhile, has grown by 30% over the same period.”
What about the gas markets?
Mark Lacey said: “Gas prices have risen dramatically in all regions, driven by low inventory levels in three key regions (Europe, North America and Asia) as we head into winter in the northern hemisphere. Along with oil, natural gas also plays an important role within power generation as a transition fuel, as gas emits 50% less CO2 for the same amount of energy as coal.
“As demand rises in emerging markets such as China and India, the gas market has moved from being a relatively local market to being a truly global market with the introduction of transportable volume through liquified natural gas (LNG). Since 2015, this market has been growing at around 8% per year.
“Two things stand out. Firstly, in a little over 10 years China has become the largest importer of LNG. And secondly, as much as Europe is reliant on natural gas from Russia, it is now very reliant on imported volumes of LNG to meet its energy needs.
“It is also important to note that although we expect the wind market to grow by at least 150% in the next 10 years and the solar market to grow by at lest 200% in the next decade, this does not mean that demand for gas will fall in the same period. And this is probably one of the most underappreciated parts of the energy transition period ahead of us.”
So, what does this mean for investors?
Mark Lacey said: “Sentiment is improving towards selected energy companies. The heavily discounted and once disliked conventional energy companies are starting to be very much part of the energy transition solution – not part of the problem.
“The recent supply shocks and rising electricity prices will accelerate the pace of divestment in coal and accelerate the pace of investment pace in the key energy transition markets such as wind, solar and batteries. The recent supply crunch, coupled with the much more transparent growth plans towards renewable power generation, hydrogen and carbon capture has started to swing sentiment towards selected energy companies.
“Conventional energy companies currently provide a critical link in the energy mix and their investment rates will have a huge amount influence on the stability and speed of the energy transition. The recent events in global oil and gas markets, has started to shift sentiment away from one that thinks these companies un-investable, to one that accepts these companies have a critical role to play going forward.”