L to R: Gordon Bell, Barry Hawke, Mark Taylor, and Ben Potter
Author: Ben Potter, Head: Energy, Minerals and Resources, Neu Capital Africa
The COVID-19 pandemic has had a dramatic impact on the energy and renewables space. According to the International Energy Agency’s Global Energy Review (published in April 2020 based on real lockdown data), the net effect in 2020 will be:
- A 6% fall in global energy demand in 2020 (7 times the effect of the fall in the Great Recession of 2008)
- A 9% drop in global oil demand to 91 million barrels per day erasing the previous 8 years of oil growth
- A 5% drop in global power demand, the largest since the Great Depression in the 1930s, albeit with resilience in renewable energy generation within the energy mix composition
- A 5% fall in natural gas demand, the first drop in decades despite the tailwinds behind gas in the energy transition, and 8% in coal demand
Oil and gas markets are battle-hardened by regular crises, but the magnitude and depth of this shock is astonishing. Global oil and gas markets entered 2020 already facing a supply glut. The demand shock of COVID-19 has caught many global producers off guard, with geopolitical ramifications in the stability of the OPEC “Plus” alliance led by Saudi Arabia and Russia, and the US tight oil market pushed to the brink.
The most significant implication is an acceleration of the trend of capital allocation away from hydrocarbons and towards assets better positioned for the energy transition. Capital markets and investor decisions are now pricing in the “peak demand” narrative of a world with surplus hydrocarbons and the risk of stranded assets, with a terminal demand decline as consumers and technology shift to low carbon.
The immediate effect will be sluggish prices which place projects with a breakeven above US$35 at risk of becoming unviable assets, with both temporary and permanent production shut-ins from upstream wells to downstream refineries. National Oil Companies are likely to fight for market share by flooding markets to monetise their resources whilst they still can. Gas assets which enjoy economies of scale, or which are close to markets with strong liquidity and price signals, will increasingly displace oil in the energy mix as a cheap, clean and reliable fuel that is compatible with renewable energy intermittency.
In this environment only the most strategic or competitive hydrocarbon assets will attract capital (e.g. Mozambique LNG, Guyana oil), whereas higher cost basins such as Angola, Brazil, Canada and Australia will be under pressure. In the face of this onslaught, industry consolidation is expected with the disappearance of many Independent E&P producers, a wave of mergers and acquisitions (especially in the US tight oil market), and global fire-sales of exploration blocks, operating fields and refineries as operators dispose of assets to shore up their cash position.
In the power space, falling wholesale power prices, and deteriorating credit worthiness of corporate offtakers, will have a negative impact on the growth of the corporate power purchase market for both utility and small-scale power projects. Weakened public finances will stall large projects that are procured by state owned utilities. Nevertheless, the renewable energy industry is future-proofed for COVID-19 and will emerge out of the crisis in a stronger position relative to hydrocarbons. This is underlined by both existing open-ended capital vehicles available for clean energy (especially from DFIs in emerging markets), as well as funds from institutional investors that seek long-term, predictable yields from utility assets, whilst safeguarding against climate change.
Solar photovoltaic power, in particular, will continue to attract financing as the competitiveness of the technology inexorably improves, albeit with the challenge of balancing the cost of capital, investor return hurdles, and the compression in realised returns occurring in mature markets. Battery storage technology will become cheaper in a much quicker horizon, as China ramps up its large-scale manufacturing in order to gain dominance in this new frontier and stimulate its post-pandemic economy. The advent of cost-effective storage will unlock an immense wave of investment in energy solutions, enabling customers to reduce their energy bills and partially exit the grid in markets where solar and storage is at parity with grid costs.
Energy is essential to human progress. The suffering from COVID-19 is an added complication to the trilemma of resolving tensions between affordable energy, climate change, and security of supply. As a capital-intensive industry, players need to position themselves with a robust capital strategy to bolster their resilience and emerge stronger on the other side of the pandemic.