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Why conventional energy companies still matter?



Mark Herlihy
Investment Writer
Mark Lacey
Head of Global Resource Equities

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. 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.

Why is conventional energy still so important?

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, 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?

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?

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.

So, what does this mean for investors?

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.

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Mark Herlihy
Investment Writer
Mark Lacey
Head of Global Resource Equities


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