Gradually, then Suddenly: The Two Ways Oil and Gas Will Go Bankrupt

“How did you go bankrupt?”
Two ways. Gradually, then suddenly.”

Ernest Hemingway, The Sun Also Rises 

The oil and gas industry believes itself immortal – we’re about to see

Latest scenario planning from an oil industry leader, Shell, suggests that fossil fuels will dominate the primary energy landscape up to 2060 and perhaps to 2080 and well beyond, to add to its hundred years of energy dominance.

This echoes forecasts from valued analysts such as Vaclav Smil and Daniel Yergin, who cannot foresee that energy – by which they mean fossil-fuel based energy – can move in anything other than vast century-long cycles.

The immortality assumption creates a deep confidence: counter-arguments or initiatives or even business context that challenges this longevity are quickly downplayed or discounted.

The Stranded Asset and Unburnable Carbon concepts, the Paris climate change agreement, investment fund withdrawals, and explicit targets by governments to limit or ban fossil fuel development and fuels, continue to have limited impact.

Even with an oil price collapse of over 60% since 2014, and a primary energy demand drop of almost 50%, the oil and gas industry still spends far more on exploring than on field retirements: in 2016 it spent $60bn on exploration for new oil reserves, and only $3bn on decommissioning of late-life assets, a 20:1 ratio in favour of eternal growth.

Last year, even in mature, technically-expensive basins such as the UK North Sea, Oil and Gas companies spent over $10bn in capex, $4bn in mergers and acquisitions, and increased the number of exploration, development and appraisal wells,  all in line with the basin’s Maximising Economic Recovery (MER) program driven by OK Oil and Gas, a regulatory body.

Expectations are for eight new greenfield projects next year with associated capital of over $7bn – a figure about four times the level of expected decommissioning.

And UK production levels are now over 200,000 b/d higher than 2014 as projects from that age of over $100/bbl start to come through.

But rather than being seen as a negative issue, as yet more supply arrives as demand slows, the local industry looks upon this as a renaissance.

In oil and gas mythology this is the “cycle” returning; by which is meant the price will move up again through some restorative interplay between OPEC, geo-politics, technology and unyielding demand.

Structural concerns, and existential anxieties are fleeing once more.

The industry-wide vocabulary is also shifting to reinforce it’s belief in indestructability: jargon such as “baseload” is being co-opted from aged power utilities by OPEC to suggest only fossil fuels are reliable, long-term energy options.

Competitor technologies such as solar and wind are always referred to as “intermittent”, a more fey form of energy, not as steadfast and reliable as the traditional (CO2-emitting, polluting, cartel-controlled ?) sources that we will need for our energy future.

To see this ideology at work, take the US EIA latest update to the long-term (2040) projection for coal demand. Although the new forecast is 40% lower than before, the EIA can’t bring itself to predict that this clearly declining industry can contract before 2040: so coal will “grow” smoothly at 0.04% pa for the next 23 years. Closing in on, but never, ever, quite touching zero.

source: Ed Crooks, FT after EIA

All the analytical and conceptual tools are now in place to reinforce the incumbent oil and gas industry’s muscular instincts toward endless investment and endless growth, and dismissal of any competitor threat.

As long as we require energy – which is always – we will require oil and gas (plus coal) as the dominant, baseload fuels.

This way of thinking is an illusion.

Energy may be immortal – but oil and gas is certainly not.

The gradual phase of oil and gas bankruptcy is over – the sudden era has begun

The technical break-even price for new oil and gas fields is about $50/bbl, and for national oil company producers in the Middle East, the fiscal break-even is $100/bbl. 

These are likely the best numbers the industry will ever achieve.

Technical extraction costs outside the Middle East have risen over time as oil fields become more complex and depleted, and in the Middle East the cheaper, large oil fields have fallen victim to expensive fiscal dependency structures that will take many decades to undo.

The chart below shows how major oil economies such as Saudi Arabia, Mexico, Russia and Nigeria, with technically cheap oil fields,  are now in major shortfalls to cover sovereign debt.

source: EY

As Chris Goodall notes in this excellent blog post, the most dangerous time for an incumbent industry leader is when overall demand is growing (but slowing), and its main competitor is growing much more quickly.

The global energy industry is now poised at this point.

Primary energy demand is still growing – at about 1% pa – but over 60% of marginal growth is now being swallowed up by scalable and capture and conversion technologies, able to offer innovative energy solutions whose costs are fast-declining.

Wind, solar and the new energy platform of battery-powered electric vehicles (EVs) are the disruptive new energy forms.

Their growth rates are in the range of 20-40% per year, and they have now breached the critical barrier of over 1-2% primary energy market share that moves them in to the region of high-impact growth.

As Goodall points out, humans and industries are particularly poor at dealing with exponential growth.

But the basic premise is straightforward; right now, after an incubation phase of the past ten years in which they were ignored, wind and solar and EV batteries have managed to reduce their costs by over 90%.

As a result their technologies have become very deployable: wind and solar and have taken over 7% of the global electricity market, and battery EVs well over 1% of the new car sales market.

At today’s growth rates that will make wind and solar the number one global generator of electricity, with about 35% market share, in less than 8 years.

Similarly battery EVs, on this trajectory, will capture over 25% of the car sales market by 2025, and 100% of car sales annual growth by 2020-21.

Such average growth rates are not assured of course. Equally, because the changes will not happen smoothly they will happen disruptively as various countries observe various important milestones achieved at different times: the doubling of solar capacity or charge points and so on.

And as soon as the technology is seen as feasible at some important scale, other regions or firms  will adopt them more confidently.

This is very dangerous territory for an incumbent, especially one insouciant about future competition, and structurally unable, because of asset-intensity and fiscal regimes, to react quickly.

It puts them on a direct collision course with a high-growth, technically diverse energy alternative, increasingly backed by high-growth markets such as China and India who wish to extract themselves quickly from the existing fossil-fuel system.

There are many reasons the incumbent industry will provide to explain why all this will not happen; policy reversals, infrastructure delays, low margins, consumer indifference – even the century-long cycles required.

But this is looking more like advocacy than economic argument, with projections, like the EIA one above, increasingly at odds with actual developments (and common sense).

Major technology disruptions follow a sudden path, because as soon as events move in a clear direction, supportive elements such as investment, media coverage and sentiment quickly reinforce and accelerate the up-and-coming trend.

So, despite incumbent skepticism, China will deploy more solar energy in 2017 (45GW) than existed on the planet in 2010.

A recent report by consultants DNV show how this could dramatically play out in the country’s power sector:

Similarly, wind power in the large UK offshore market is now lower in cost than gas and nuclear at £57/MWh, which is over 50% lower than the UK government estimated it would cost in 2030.

And once more in China (the world’s largest car market) a total ban on fossil fuel engines is proposed, perhaps in line with its aim to put a cap on emissions, by  2030.

And no wonder, China is increasingly dominant in global EV design and manufacturing – with the US big three GM, Ford and Chrysler now looking to spend much of their EV R&D dollars there.

In fact, with over 200 EV models projected to be available globally in 2017-18, this Bloomberg analysis shows that by the end of next year the term EV may be outdated.

By then they may just be known as – cars.

And that is how the fossil fuel era ends, suddenly.

World is Suddener than we Fancy It

Energy is much grander and more complex than the familiar oil and gas structures we assume will always be here.

The growth of wind, solar and EVs is shifting our understanding of energy from being one-sized, asset-heavy, based on pipes and various fuels toward being centered around scalable, capture and conversion technology platforms, globally manufactured and fuel-free.

As DNV forecasts, wind and solar dominated energy does not have to follow the trajectory of the past centuries: it can grow more far more efficiently than GDP and population, and vastly reduce emissions at the same time.

Utopian?

Or the unemotional consequence of learning curves applied to  scalable energy technologies rather than eternal reliance on extracted fuels.

source: DNV

If any energy form has the right to declare eternity, solar and wind have the strongest claim.

And the exponential growth of these new technologies has huge consequences: in a giant global rebalancing, the decline in fossil fuel demand has to fall exponentially too.

The sudden era of oil and gas bankruptcy has begun.

And the immortal companies of the incumbent industry are determinedly unprepared.

————-    ————