Welcome back to Energy Source — and to the second half of what has been a tumultuous 2020 for energy (and everything else). From the Soleimani assassination and the Saudi-Russia price war to coronavirus lockdowns and WTI’s negative plunge, it’s been a busy six months.
The next six could be as seismic. The key event will be November’s US elections, which offer starkly contrasting visions of the energy sector — between the status quo-oriented Republican Party and a Democratic Party proposing sweeping changes.
Our first item today looks at what the Democrats’ new climate plan will do to clean up shale emissions. Next up, we ask if a coronavirus vaccine is a blessing in disguise for biofuels and talk to IEA director Fatih Birol. Elsewhere, a surprisingly positive second quarter for energy stocks and a Q&A with Ben Dell of Kimmeridge, a private equity investor, who predicts an acceleration in shale M&A.
Thanks for reading. Let us know your thoughts and ideas at email@example.com. Please sign up for the newsletter here. — Myles
Democrats target oil sector’s environmental record
Nancy Pelosi, the Democratic Speaker of the House of Representatives, stood on the steps of the Capitol on Tuesday and set out her party’s proposals for slashing US emissions to net zero by 2050. It’s a plan, she said, that “honours our obligation to address the climate crisis”.
The proposals — described over 547 pages — are sweeping (if aspirational), covering everything from electric vehicles to power production. The package is a blueprint for a radical shift in the US energy sector and its approach to climate. We looked at the big picture here.
Oil and gas companies, especially the worst polluters, would be compelled to clean up their act.
If they are translated into law, the Democrats’ proposals would force oil and gas producers to dial back greenhouse gas emissions quicker than many other industries. The targets for EVs and the power sector, for example, are relatively less ambitious, analysts said.
Two areas are worth particular attention.
Routine flaring of natural gas in shale oil production would be ended by 2030. Flaring is a wasteful and carbon-intensive practice which sees producers burn off the natural gas they produce alongside oil. Natural gas prices have been too low to justify installing infrastructure to process and deliver it to consumers.
Natural gas that is not flared can leak into the atmosphere as methane — a more potent greenhouse gas than CO2. The proposals would cut methane emissions by up to 70 per cent by 2025 and 90 per cent by 2030. That would require significant investment into plugging leaky infrastructure, from well pads to pipelines.
For shale oil operators that have largely been able to ignore the externalities of flaring and releasing methane, production costs would rise because of the need for new gas infrastructure. The pace of output growth would fall. On the other hand, fixing shale’s methane and flaring problems may give shale some more staying power, especially among ESG-focused investors. This is why even some large oil companies have sought tighter regulations.
Environmental groups welcomed the proposals. Elgie Holstein a director at the Environmental Defense Fund told ES it pointed Congress “in the right direction”.
“Given that methane is over 80 times more potent than carbon dioxide as a warming agent in the atmosphere, it is both appropriate and welcome that the Democratic climate plan includes recommendations for reducing methane emissions from the oil and gas sector — the largest manmade source of that gas.”
The politics are intriguing. At November’s election, Joe Biden wants to hold oil- and gas-drilling states like Colorado, recapture states with fracking heartlands like Pennsylvania and grab Texas from the Republicans. But he also needs to keep his base happy. Biden’s energy plan proposes “aggressive” limits to curb methane from oil and gas producers — probably somewhat like the Obama administration’s limits, which the Trump administration has weakened. But the Biden plan makes no mention of flaring. (Myles McCormick)
How a coronavirus vaccine could help biofuels
Will coronavirus boost the biofuels sector? It may sound far-fetched, but here’s how it could work. As labs race to find a vaccine for Covid-19, algae and genetically engineered plants could be used to produce a vaccine (once it is discovered) in large quantities. This could benefit biofuels by bringing about advances in genetic engineering or new ways to extract products like oil from biomass feedstock.
But don’t take it from us — take it from the International Energy Agency, whose new report catalogues emerging clean energy technologies.
One of its takeaways is that tech breakthroughs emerge in unexpected ways, as the vaccine and biofuel example suggests. The IEA worries, however, that spending on research and development might slow down because of the pandemic, which has put budgetary pressure on governments and companies alike.
Another key takeaway is that new energy technologies take a very, very long time to reach maturity — typically 20 to 70 years. One example is solar photovoltaics in Germany: the first panels were developed in 1954, but it was more than 50 years later that solar PV reached the early adoption threshold of 1 per cent of the national market.
That may sound like bad news for emerging clean energy tech. But the IEA says this is precisely why spending on R&D is so important. “My message is clear, in the absence of much faster energy innovation, achieving net zero goals in 2050 will be all but impossible,” Fatih Birol, head of the IEA, told Energy Source. “Of the 400 different technologies we analysed [in this report], the big chunk we need to reach net zero goals, are not mature today,” he added.
There is slightly more optimism in a chart showing how long certain new technologies will take to reach 1 per cent of the market. Ships powered by hydrogen fuel? 2038, says the IEA. What about battery-powered trucks? 2032, it says. But all of this is in a scenario in which governments spend big to reach climate goals, and limit global warming to 1.8C. How likely that this scenario becomes reality in a post-Covid world is a question the report does not address. (Leslie Hook)
You might think the second quarter was oil’s most hellish ever. Global demand was 18m b/d — or about 20 per cent — less than a year earlier, according to the IEA. Stockpiles bulged. WTI crashed below zero for the first time ever.
Canny investors might tell a different tale. US oil and gas stocks outperformed the S&P 500 on a relative basis through the quarter. So did WTI, despite its horror-show in April. An exception was USO, the ETF for retail investors that tracks the US oil price. But one quarter does not a recovery make. Energy stocks are still down by almost half in the past five years, versus a 50 per cent rise for the broader market. (Derek Brower)
A green economy can’t be turned on at “the flip of a switch” and the US will need to help oil-dependent countries in any transition from petroleum, argues Amos Hochstein in the Atlantic. It’s significant because Mr Hochstein, who now works for LNG developer Tellurian, previously worked in the Obama administration and advised Joe Biden on global energy markets.
Wind farm developers are pushing ahead with plans to get projects up and running despite the pandemic, the New York Times reports.
Private equity will be involved in the US shale shake-out. We asked Ben Dell, a managing partner at Kimmeridge, a private-equity company active in the sector, for his market take.
What will happen to the oil price?
They’ll be rangebound between $30 and $40 a barrel this year. Covid-19’s re-acceleration and restrictions in some states will remain the wild card. In early 2021 the market will be oversupplied, as demand, especially jet fuel, remains impaired. But the lack of upstream investment, coupled with Opec cuts, should reduce the overhang and drive prices higher.
Will US crude production recover?
It depends on capital. The industry’s have-money-will-spend motto led to a flood of uneconomic growth over the past decade. We’d like to believe a new model takes hold with reinvestment rates closer to 70 per cent. If so, US production may not recover 2020 levels, but instead will grow at 1-2 per cent a year, in line with global demand, similar to the 1990s.
How do you see energy M&A activity changing?
It should accelerate dramatically. There are too many subscale companies. To be relevant, they need to produce around 500,000 or even 1m barrels a day, drive down costs and deliver free cash flow. Consolidation will happen in all major basins but especially the Niobrara, Bakken, Appalachians and Permian.
What is at stake for shale in the election?
A Democratic sweep would make permitting and drilling on federal land more difficult, while potentially adjusting taxes to be less favourable. This would limit activity and supply, and may raise prices. If the current administration remains, we’d see more rules relaxed, but as capital to drill will still be limited, the impact on activity would be minimal.
Energy Source is a twice-weekly energy newsletter from the Financial Times. Its editors are Derek Brower and Myles McCormick, with contributions from David Sheppard, Anjli Raval and Leslie Hook in London, and Gregory Meyer in New York.