We’re witnessing the new energy world

Do you know why?

McKinsey & Company

Global Energy Perspective 2022

·       While governments and businesses are increasingly committed to steep decarbonization targets, energy markets face extreme volatility driven by geopolitical tensions and a rebound in energy demand.

·       Going forward, the energy mix is projected to shift toward power. By 2050, electricity and enabling hydrogen and synfuels could account for 50% of the energy mix.

·       The projected peak in demand for fossil fuels continues to move forward; demand for oil is projected to peak in the next five years.

·       Even if all countries with net-zero commitments deliver on their aspirations, global warming is projected to reach 1.7°C by 2100.

·       Total investments across energy sectors are projected to grow by more than 4% per annum and are projected to be increasingly skewed towards non-fossil and decarbonization technologies, while returns remain uncertain.

While developments of the conflict in Ukraine are highly uncertain, today’s decisions could impact the long-term energy transition and path towards decarbonization.

Power supply and demand

·       Power consumption is expected to triple by 2050 as electrification and living standards grow.

·       Renewables are expected to become the new baseload, accounting for 50% of the power mix by 2030 and 85% by 2050.

·       Flexible assets like gas plants, batteries, and hydrogen electrolyzes are key for grid stability and decarbonization.

·       Technologies like Carbon capture, utilization, and storage and nuclear will likely see additional growth if renewables build-out remains constrained.

Oil demand

·       Global liquids demand is expected to peak around 102 MMb/d in the next two to five years, despite a near-term recovery of liquids demand from the impacts of the COVID-19 pandemic.

·       A decline in liquids demand in road transport will likely drive a peak across markets, while growth in chemicals and aviation may slow down.

·       Crude oil demand is expected to decline rapidly after 2030, while remaining liquids demand growth may mostly be seen in non-energy use of oil and bio- and synfuels.

Crescat Capital

Given the macro and fundamental backdrop, we continue to be buyers of oil and gas businesses. These energy companies are currently generating more free-cash-flow than any other time in history. Meanwhile, political efforts towards ESG policies are still preventing them from performing at full capacity which remains very bullish for commodity prices. In fact, oil production still is almost 10% lower than it was at its prior peak in February 2020.

A reminder that the energy sector makes up less than 4% of the S&P 500 weight today, which remains to be one of the lowest levels ever.

The performance by sector in the US equity market since the pandemic lows has been astonishing. The disconnect in energy stocks simply reflects the macro regime we just entered.

Brazil: Geopolitically Neutral & Commodity-Driven Economy

Brazil is one of the few economies in the world that could do exceptionally well in today’s macro environment. It is a commodity-driven economy with a long history of dealing with inflationary problems and political shifts. From a value perspective, Brazilian equities are just as undervalued as they were at the early stages of a multi-year bull market in early 2000s.

The upcoming elections add a degree of uncertainty and fear, but at such attractive prices we think the risks are mostly priced in. Historically, the Brazilian economy has an incredibly strong correlation to commodity markets. We view this opportunity as a high-beta version of our long positions in natural resources. Different than the Fed, the Brazilian central bank has gone long ways to proactively tighten financial conditions as inflation gained momentum. Short-term interest rates, also known as Selic rates, went from 2% to 11.75% in the last 13 months. Inflation remains elevated but slightly below interest rates. Brazil is one of the few economies in the world running a positive real interest policy.

Goldman Sachs Asset Management

Energy & Equity Market Backdrop

We believe that a combination of fundamental and technical factors has created a very constructive landscape for commodity prices and energy equities over the next decade.

1.     Due to the Russia/Ukraine crisis, policy makers are increasingly focused on securing reliable long-term energy with North America uniquely positioned as the key supplier.

2.     Years of under investment led to tight supply and demand prior to Russia/Ukraine conflict; replacing lost Russian supply could result in years of elevated commodity prices.

3.     Inflationary periods are historically constructive for energy equities; during the 2003-2008 inflationary cycle, the energy sector outperformed the S&P 500 by 130%.

4.     Investor interest has picked up and the sector may continue to benefit from a growth to value shift, in addition to a rationalization of energy underexposure across portfolios.

5.     Management teams have transformed balance sheets by cutting capital spending and focusing on maximizing free-cash-flow, reducing leverage, and driving shareholder value.

6.     The European energy crisis highlights that fossil fuels and renewables need to co-exist to maintain reliable/secure supply with reasonable consumer prices amid growing demand.

Renewables Are Not A Stand-Alone Solution

Renewables alone can’t satisfy the world’s energy needs due to intermittency issues, hidden costs, and potential geopolitical considerations.

Intermittency Issue

·       Output from renewable sources, such as wind and solar, is dictated by weather.

·       Utility scale battery economics are currently prohibitively expensive to be solely relied upon.

·       Fossil fuels are required as a back-up source to maintain reliable and consistent energy supply.

Hidden Costs

·       Levelized cost of energy, a common measure of renewables cost, does not account for high associated costs of transmission and back-up generation.

·       Intermittency increases the associated costs of integration into the grid.

·       This cost is generally assumed by households in the form of levies and taxes on energy bills.

Geopolitical Concerns

·       Select countries control significant material/resources needed to scale renewables.

·       China is the top producer of Rare Earth elements and is also the leading processor of all key mineral inputs.

·       The majority of Cobalt production is controlled by DR Congo & Russia.

·       Concentration may result in unintended environmental, cost, labor and geopolitical implications

My conclusions and considerations

How will be the energy sector over the next years?

We’ve tried to answer to that question with 3 interesting and well written international papers.

Although very slowly, but we’re witnessing to a big change of the energy sector, and below you can read some highlights that I found remarkable.

• By 2050, electricity and enabling hydrogen and synfuels could account for 50% of the energy mix.
• Total investments across energy sectors are projected to grow by more than 4% per year and are projected to be increasingly skewed towards non-fossil and decarbonization technologies, while returns remain uncertain.
• Power consumption is expected to triple by 2050 as electrification and living standards grow.
• Crude oil demand is expected to decline rapidly after 2030.
• Brazil is one of the few economies in the world that could do exceptionally well in today’s macro environment.

Join the conversation with your own take on these topics in the comments below.

About the Author

Alessandro is a Financial Markets enthusiastic and he loves learning from articles/papers on many financial topics and in doing so he shares with you the most interesting charts and comments.

Disclosure

This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. This material has been prepared for informational purposes only. Any forecasts contained herein are for illustrative purposes only and are not to be relied upon as advice or interpreted as a recommendation.