Published on November 17th, 2016 | by Joshua S Hill0
Renewables & Natural Gas Win Out In World Energy Outlook, But Investors Must Not Misread Oil Demand
November 17th, 2016 by Joshua S Hill
The International Energy Agency published its annual World Energy Outlook report this week at the United Nations COP22 climate change talks being held in Marrakech, and hailed renewable energy and natural gas as the biggest winners in the race to meet energy demand growth through to 2040.
However, in response to the report, independent financial think tank Carbon Tracker Initiative has warned investors of the potential to be misled by the report’s outcomes, and the possibility of the oil industry misreading future demand, thus creating even more stranded fossil fuel assets.
The report provides a detailed analysis of the pledges made for the Paris Agreement on climate change, and reveals “that the era of fossil fuels appears far from over and underscores the challenge of reaching more ambitious climate goals.” Nevertheless, the challenge is within reach, and a combination of government policies and cost reductions across the energy sector allow for the doubling of both renewables and improvements in energy efficiency over the next 25 years.
The report also includes a special feature dedicated to renewable energy, and the role that they can and will take over the next 25 years. This is the result of a special gathering held back in May by the International Energy Agency (IEA), which invited 100 experts from around the world representing governments, industry, academia, financial institutions, and civil groups, to advise “on how best to leverage renewable energy to fight against climate change, improve energy security, and reduce local air pollution.”
Renewables & Natural Gas
“We see clear winners for the next 25 years — natural gas but especially wind and solar — replacing the champion of the previous 25 years, coal,” said Dr Fatih Birol, the IEA’s executive director. “But there is no single story about the future of global energy: in practice, government policies will determine where we go from here.”
Across all the Paris pledges, 60% of all new power generation capacity through to 2040 outlined in the IEA’s main scenario comes from renewables, and “by 2040, the majority of renewables-based generation is competitive without any subsidies.”
Of concern, to this author at least, is the hidden-assumption that renewables-based generation is so far away from being cost competitive without any subsidies, when in actual fact, renewable energy generation such as solar and onshore wind is already nearing cost competitive status with most traditional fossil fuel generation technologies, often in spite of failing policy and financial subsidies. The authors of the report do state that “Subsidies per unit of new solar PV in China drop by three-quarters by 2025 and solar projects in India are competitive without any support well before 2030,” but this still seems somewhat pessimistic, given recent events and reports of ever-smaller solar and wind costs.
The report also expects the rapid deployment of renewable energy to continue to further lower costs. Solar PV is expected to see its average costs cut by a further 40% to 70%, and onshore wind by an additional 10% to 25%.
The IEA’s 450 Scenario — an energy pathway consistent with the goal of limiting the global increase in temperature to 2°C by limiting concentration of greenhouse gases in the atmosphere to around 450 parts per million of CO2 — has nearly 60% of the power generated in 2040 sourced from renewables, almost half of which is from wind and solar PV.
The 450 Scenario is a big win for groups such as the Carbon Tracker Initiative (CTI), which has long lobbied hard against the IEA for pessimistic outlooks and low-ball estimates. “Big steps have been made in the transition to a low-carbon economy over the past 12 months,” the CTI noted in a blog post Wednesday. “The IEA have acknowledged this progress and have adjusted the 2016 450 scenario accordingly. Although the scenario still achieves a 2°C outcome on the balance of probability, this is now achieved through more renewable energy technologies, less coal and CCS in the power sector and greater electrification in the transport sector.”
As CTI point out, solar PV is the big winner as a result of these revisions, growing by 44% more than in the 2015 450 scenario by 2040 published by the IEA. Wind power also receives a boost from these revisions, both coming largely at the expense of coal-fired power, which according to CTI “makes a far smaller contribution to this 2°C scenario than in the previous year.
The IEA’s 2016 450 scenario sees significant changes in power generation on last year
“Renewables make very large strides in coming decades but their gains remain largely confined to electricity generation,” said Dr Birol. “The next frontier for the renewable story is to expand their use in the industrial, building and transportation sectors where enormous potential for growth exists.”
Oil & Gas
Despite the increasing role of renewable energy, the IEA still believes that investment in oil and gas remains essential if we are to meet demand and replace declining production — however it does note that the growth in renewables and energy efficiency lessens the need for oil and gas imports in many countries, mitigating the potential harm increasing oil and gas demand might have. The IEA also predicts we are about to reach a period of increasing price volatility for the oil sector.
“We are entering a period of greater oil price volatility,” said Dr Birol. “If oil prices rise in the short term, then shale producers can react quite quickly to put more oil on the market, producing a see-saw movement. And if we continue to see subdued investments in new conventional oil projects, this could have profound consequences in the longer term.”
Sadly, the IEA believes that “the collective signal sent by governments in their climate pledges … is that fossil fuels, in particular natural gas and oil, will continue to be a bedrock of the global energy system for many decades to come, but the fossil-fuel industry cannot afford to ignore the risks that might arise from a sharper transition.” The report concludes that in the main scenario, natural gas will see consumption rise by 50%, while growth in oil demand will slow over the projection period, but will still top out at 103 million barrels per day by 2040. In the 450 Scenario, oil demand falls back to levels of the late 1990s of under 75 million barrels per day.
The Climate Tracker Initiative highlight the use of two new scenarios in the IEA’s report — the ‘well below 2°C’ scenario (WB2°C) (equivalent to 1.84°C of warming) and the ‘1.5°C scenario’. With each successive scenario, the carbon budget decreases, subsequently impacting fossil fuel demand, as seen below.
Carbon budgets across climate scenarios and the impact on fossil fuel demand in 2040
As such, the demand for oil in the WB2°C scenario is 63 million barrels per day, down almost a third on today’s levels. This falls to 40 million barrels per day in the 1.5°C.
This leads the CTI to warn of oil demand misread — simply put, the potential to misread the accurate global demand for oil — and the resulting potential for stranded assets. The IEA links the likelihood of stranded assets to the manner in which we transition to a low-carbon economy — be it either orderly or disorderly. “In the case of oil, we find no reason to assume widespread stranding of upstream oil assets in the 450 Scenario, as long as governments give clear signals of their intent and pursue consistent policies to that end.” However, the IEA notes that “the risks would increase sharply in the event of sudden policy shifts, stop-and-go policy cycles or other circumstances that lead companies to invest for demand that does not materialise.”
The Carbon Tracker Initiative note that the IEA is on board with its assumption that a more disorderly or “disjointed” low-carbon transition, “based around overly optimistic readings of future demand, could be highly damaging to the oil and gas industry.” Specifically, the World Energy Outlook’s New Policies Scenario (NPS) “comprises 190 billion barrels not needed in the 450 scenario, potentially wasting $200 [billion] in exploration costs, not to mention lost revenues. Overall, companies are worth 20% less in the 450 scenario than the NPS, largely as a result of a lower oil price assumption.”
“The 2016 WEO confirms our analysis that there is the potential for a demand misread in the oil sector,” said James Leaton, head of research at the Carbon Tracker Initiative. “Investors need to review whether it makes sense for companies to reinvest oil revenues into new high cost projects.”
For the CTI, the big concern is the often commonplace confusion between scenarios and forecasts. “The scenarios produced by the IEA, and indeed those from the US EIA, are not forecasts of what the organisations expect to happen,” they write, noting that these scenarios “have been frequently misrepresented as such.” As a result, “The selective use of scenarios which fit business as usual for the fossil fuel industry we believe is misleading for investors trying to understand the energy transition.”
As such, CTI believes that investors should rely more heavily for risk management purposes on the IEA 450 (2°C) scenario. “Using this baseline allows investors to compare variations between companies and their assumptions, and therefore perceive how aligned management is with their view of the energy system going forward,” CTI explains.
“The IEA450 scenario has evolved further to include faster uptake of renewables, a more rapid decline of coal, and a smaller contribution from CCS,” James Leaton continued. “This scenario should be the minimum the energy sector considers to understand the potential downside risk for fossil fuels.”