Scale and Scalability: A One-Chart Guide to the Global Energy Transition

An era of unbalanced, unproductive energy supply is coming to an end – and a new age of scalable, efficient energy is rapidly emerging.

In previous posts (eg here and here) we outlined the main features of the current energy transition: the move from the dominance of extracted oil and gas, toward manufactured energy via shale, solar and wind.

In this short piece we try to capture the transition in a single chart.

The main organizing principle is the idea of scale and scalability: energy leadership stems from having both large energy resources (scale) and the ability to provide them efficiently, quickly and flexibly (scalability).

Shale, solar and wind have an abundance of both scale and scalability, which is why they are growing so rapidly, and absorbing most of the globe’s incremental energy demand growth.

At the same time, the incumbent energy industry is split between two extremes: OPEC and Russia have vast scale and production scalability, capable of  adjusting supply to demand. However, their high–cost twin, the international energy industry, has limited scale, and low scalability. Rigid and inflexible it has only one strategy: growth via complex, longer-term investments and projects.

The 21st century energy dynamic will be the story of how the tension between the two-paced incumbent industry, and the high speed new entrants, gets resolved. How the use of energy changes when it’s available at various scales, and how a deeply-entrenched industry attempts to reconfigure itself.

As a start-point, the chart below attempts to put a number of these key issues together in one place, using scale and scalability as a frame. The main sources are highlighted below it, and a summary of the key issues follows.

But for those happy enough with just the picture, the post ends here.

main sources:

main graph, Goldman Sachs, production, reserves, R/P ratios and CAGR,  BP ,  and EIA AEO . Capex IEA World Energy Investment 2016, break-even data, Rystad, and Lazard for wind/solar LCOE, dollarsperbbl estimates, graphics

Scale and Scalability

A key to world energy leadership is the possession of two great strengths: scale (the size of energy resource) and scalability (the ability to produce it efficiently, rapidly and flexibly),

Historically, in oil and gas, this powerful combination has been the domain of the large Middle Eastern producers, and some big national players, notably Russia. These nations have vast energy resources (scale), and relatively simple production facilities plus centralised governmental control that allows production and decisions on investments to be made quickly (scalability).

Competition from the international oil and gas industry has been relatively weak, as they tend to possess neither scale nor scalability.

The resources of even the largest independent energy companies, such as Exxon or Shell, are a small fraction of the size of OPEC, and more importantly their assets and organizations are inflexible. These firms have to use vast, complex engineering work-arounds in difficult locations to produce oil and gas, combined with elaborate organizational partnerships to manage funding.

As a result their projects take a very long time, and offer up energy only in a single expensive tranche when eventually completed.

Even though the international industry invests hundreds of billions of dollars per year, it has already hit a wall in terms of future efficiency.

The limits of the industry’s modest scale and low scalability are now being exposed by a persistent low oil price: most exploration and projects have been cancelled, debts have increased, and financial metrics are declining.

Meanwhile, two new energy technologies: US shale and global solar and wind have reached economic parity with the incumbent oil and gas industry leaders.

These are a different form of competitor, and both have the potential for global energy leadership: shale as the largest scalable hydrocarbon producer, and wind/solar as the largest source of global energy.

The two have access to huge energy resources, and more importantly, they have high, or potentially higher, scalability characteristics than the current oil and gas behemoths.

In terms of size, US shale has access to several hundred billion barrels of potentially recoverable reserves of oil and gas. By some estimates this resource size is greater than that of Saudi Arabia.

Global wind and solar have access to limitless, infinite energy – their only critical constraint being the efficiency of the conversion technologies employed.

More crucially, shale and wind/solar have very high scalability – they are flexible and rapid, providing energy in multiple quick phases, and they quickly improve on unit costs via the benefits of manufacturing experience curves. In addition, they both have fast decision-making organizational structures: decentralized, and market-based, with investments distributed among a wide range of firms and stakeholders.

This would be complex if each investment were an immense undertaking like oil and gas mega-projects, but these projects come in a wide range of sizes from very small to large, lasting from weeks, to months or at most a couple of years – and they are based on increasingly mature and standardized engineering designs.

Economics: Manufactured Energy Catches Up with Fuel Extraction
All these technical developments have brought the energy industry to an economic cross-roads.

The growth rates of shale and solar/wind, at over 20%pa in the last five years, have provided enough new energy output, at over 10 million barrels/ day to absorb most of the industry’s marginal growth. In absolute investment levels, annual capex of shale and wind/solar is now on a par with that of the international oil industry at over $300bn pa.

Along with the decline in demand from China post its hyper-intense growth phase, this enhanced supply has caused global energy prices to fall – benchmark oil prices have dropped below $50/bbl, 60% below their 2014 levels.

OPEC and Russia have attempted to force prices higher by restraining output, and international oil and gas firms have responded by asserting they can be profitable at $50/bbl, and by divesting high-cost assets, investing more heavily in shale.

However, the wider oil and gas industry is becoming increasingly marginalized, with assets likely stranded, as prices continue to fall.

Meanwhile, shale and especially  wind/solar continue to extend output, and relentlessly reduce costs.

A new world begins to emerge.

21st century energy generation will now be a clash between two groups of technologies with vast scale and high scalability: the incumbent leaders of OPEC and Russia and the new entrants of US shale and global wind/solar.

This will force the exit of high-cost incumbents – a very disruptive process as low-scalability producers will be unable to unwind and withdraw positions efficiently or easily, adding to an energy over-hang as un-needed production is prolonged. A sharp cycle of declining prices will follow, unless, for example, OPEC agrees to a formal long-term production cap.

The longer-term outcome should be positive however. Scalable technologies will force energy pricing down, and technical innovation will allow energy generation and consumption to become far more dispersed and evenly distributed.

An era of unbalanced, unproductive energy supply is coming to an end – and a new age of scalable, efficient energy is rapidly emerging.