The Arrogance of the West
September 22, 2020
“The future shape of oil demand remains unclear . . . . But the beginning of the end is here.”
This. This is what we’re talking about. These two bookend sentences in the last paragraph of a Financial Times article titled “The slow death of Big Oil.” Just look at that last line from FT’s article about BP’s decision to shift its business model from producing oil and gas to green energy. It’s so certain about what’s to come, and it’s based on BP’s rational for reducing oil and gas production by 40% over the coming decade based on forecasts that we’ll have reached peak oil demand in the next few years. Europe with its aggressive push into ESG and climate change has lauded the company . . . wait lauded isn’t quite right . . . feted is more appropriate . . . for its “forward looking” stance. That is frankly just ludicrous.
BP’s Energy Outlook for 2020 is an 82 page slide deck discussing why their new strategy makes sense for its investors and for the public. It’s a tour de force of a presentation, replete with data and figures about the coming green energy revolution and why BP will be at the forefront of that change, but let’s just pause a moment and look at two charts pulled from the deck and discuss why we think those two slides will prove why the entire forecast will prove wildly inaccurate. The first chart illustrates the universal, inescapable truth. As your country becomes wealthier (as measured by GPD), your energy consumption increases.
Now BP is using this chart to illustrate that economic prosperity and development depends on the quantity and quality of the electricity provision, but the chart effectively illustrates per capita energy consumption.
Upper middle/High income countries are middle to right, and they consume multiples more energy than the Lower middle/Low income countries on the left. BP notes “In 2018, average energy consumption per capita in the developed world was more than three times that in emerging economies, with an average person in the US consuming 12 times more energy than an average person in India.” Intuitively this makes sense, energy consumption rises commensurate with wealth because of lifestyle changes. In general, with more money comes more leisure and business travel, more electronics, and a higher energy consumption lifestyle. This isn’t a controversial take. What’s a bit more controversial in BP’s slide deck is this other chart . . . what happens in the future.
In the next three decades? Energy consumption per head in BP’s scenario will not only decline for developed countries, but more importantly, and this is the key, in emerging markets they will have barely increased? China will have stayed flat, and India will have budged higher but still well below China. Frankly that is fanciful. Why? Poverty. We’ve written before about this clash of priorities between the developed countries and emerging countries
“On one side you’re battered by the climate/environmental/peak demand narrative and on the other side the financial one. As investors, we’re making no moral judgments on the use of petroleum products. We’re simply saying people use them and they’ll continue to use them until it costs too much financially and/or socially and a suitable substitute is found. For now, neither has happened, which means demand for oil and petroleum products will increase because global living standards continue to rise. We have a situation where well intentioned people in industrialized countries with per capita GDP >$50,000/year telling 1.4B people in China living on $9,800/year or 1.3B people in India surviving on $2,000/year that they should decrease energy consumption and slow their rate of growth. Good luck with that. Why would anyone expect demand growth to stop when most of the world’s consumers are trying to claw their way up from poverty? You don’t think they want what you have? Betterment has always been relative, and in an interconnected global economy, those without will look at your Instagram account and think hmm maybe it’s time for me to “live my best life,” which translates to higher energy consumption.”
Here’s the reality of energy consumption for the developing countries, more specifically the two largest: China and India.
As China and India develop, urbanization, GDP and energy consumption will rise dramatically. We fully expect the “S” curve of energy demand to continue in the coming decades. When 2.7B people climb the economic ladder and further urbanize, their energy consumption will leap upwards. If you’re forecasting little growth in the consumption curve for the next 30 years, it flies in the face of what’s happened before. If we read further, we also find that BP has made two assumptions that help offset the increase in energy consumption. First, BP anticipates that energy efficiency improvements will increase by 50%, versus what we’ve been able to achieve in the past two decades. Second, BP’s forecast also assumes that the COVID pandemic will reduce energy demand by 2.5% in 2025 and 3% in 2050, close to 3M bpd in 2050 because of behavioral changes (i.e., work from home, etc.). We believe these assumptions are . . . aggressive.
Now we understand the point of the slide deck is to make a case to BP’s stakeholders that the strategic shift makes sense; that this pivot away from their core business holds water despite the reality that the new business will earn half the returns of the current E&P business. Fair enough, but at least make your forecasts plausible.
The Big Assumption
Forecasts aside, there’s this general assumption that the developing countries will join hands with the developed world to help subsidize the shift to global decarbonization when in fact just the opposite will happen. Energy in the form of oil, natural gas, etc. is a global commodity. You pay what I pay, and unless you have significant reserves in your backyard, which India and China do not, then their marginal energy costs are effectively your energy costs. Yet, we make much much more. Think about this for a moment. India’s per capita GDP is $2,000 a year; it’s poverty level.
What’s missing entirely is the understanding of human nature; the behavioral dynamics of what’s to come. So now that we’ve summited Maslow’s pyramid of needs, the collective “we” must collaborate and shift to more expensive green/renewable energy? How does that translate for a poorer developing country? It doesn’t because it can’t. Those in poverty are concerned with survival. As JK Rowlings has said “[p]overty, entails fear, and stress and sometimes depression. It means a thousand petty humiliations and hardships . . . . Poverty . . . is romanticized only by fools.”
Economically we can’t expect governments to subsidize our way into this greener world because there simply isn’t enough money, which leaves the dilemma to the market, and there’s little room for altruism in the market. Over time the market expects returns, so the development and operation of green energy resources must generate a sufficient return (one that’s at least on par with today’s fossil fuel endeavors). As for consumption, the economic benefits of the new energy source must outweigh the cost of the one being replaced (i.e., what you propose must be better and cheaper than current energy sources, or the existing energy sources must become more expensive). Cajoling and castigating emerging markets to adopt renewable won’t work, or at least not anywhere near the scale of what’s needed.
So the only way this works is if we eventually, collectively, pay the price to shift, and it’s a shift we’re beginning to see. We believe we’re in a lull, and that lull will clear once the pandemic recedes, and we return to our regularly scheduled program. There’s a massive divergence occurring these days. Customers in the developed world see climate change as an issue, and is politically and economically forcing an underinvestment in fossil fuel development. In turn, producers are also shunning investments, curtailing spending and in BP’s case even strategically pivoting away from their core business. Everyone’s practically assuming that world demand for fossil fuels will not recover, or anywhere near what we consumed earlier this year, and we’re thinking, no we’re pretty sure people will return to their daily activities/habits once the pandemic sirens abate. Moreover, if the emerging markets want to continue their climb out of poverty, they will employ the cheapest and most readily available source of energy they can to achieve that growth, fossil fuels. While most analysts are living in the future, we see the present, and the tension between what’s occurring on the supply side is disconnecting with what will occur on the demand side. As for our developing countries? Yeah they see the same thing.
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