TITLE: The Future of Energy Security in Europe
Louise Bennetts: Welcome to the first in our series of Director Advisory Services Podcasts. My name is Louise Bennetts, I'm the Head of Director Advisory Services for Europe, The Middle East and Africa and we are very pleased to welcome you to the first in what we hope will be a very interesting series of discussions. The purpose of our podcast series is really to look at a series of topical issues that are front and center of people's minds. I think to that end, there is no topic that is more front and center of the mind certainly of people living in Europe and possibly across the globe than the topic of energy security and energy prices, particularly in the short-term.
To that end, I am very, very pleased to welcome Christyan Malek. Christyan is a Managing Director and the Global Head of Energy Strategy. He's also the Head of the EMEA Oil and Gas research team, and his team has been front and center on some of these topics. They have won a number of awards. They are ranked number one in Europe and Christyan himself is ranked number one in the individual category of the top research analysts by the Institutional investor. We are very grateful for him to be here today and give us his insights and thoughts about this topic. So welcome, Christyan. Thank you.
Christyan Malek: Thank you Louise. It's great to be here and is a privilege to be part of this series.
Louise: So I'll jump right in with the elephant in the room. Coming out of COP26, we saw a number of countries making commitments to reduce their fossil fuel usage, quite aggressive commitments and yet here we are nine months later and we are talking about reopening coal mines in Germany. Is the Ukraine war a blip on the radar, or are we seeing a fundamental shift in the approach of these countries?
Christyan: It's a great first question. Thank you for that. I think the war in Ukraine has up lifted the veil on what was already a very stretched energy ecosystem. It's already been tight in terms of energy availability and all this war has done is effectively just exposed it. For example, this year we published our global energy outlook, assessing the outlook for global energy demand supplies 2030. It's the first edition for JP Morgan, and I think it's a believe it's a first to cross any bank to present a wholesale energy view.
In the report, we explained our view that you cannot have a real safe and sustainable energy transition without also having energy security. To us, energy security is the necessary condition and the building blocks for the energy transition. I think this was perhaps underappreciated previously, and there's a risk that an outsized focus on the E and ESG comes at the cost of the S. In our view, the rate of energy transition will prove codependent on both the E and the S in ESG.
It's very tempting too difficult to resist to say that actually this year I'm going to COP27. You know energy representation in COP which is a microcosm itself, but a huge data point in term s of the evolution of coming together of minds. Interestingly, just to add, in a recent event of help, put the spotlight on that and giving us a clear understanding of supply and demand. For example, it's clear now that no one wants the energy transition where electricity prices can peak up to a thousand (unintelligible) of mega hour and US gasoline over $5 a gallon.
This is not just a problem for developed economies, Louise, but also EM nations where citizens need to access the fuels they need at an affordable price. They too can grow and develop. In summary, the war has forced to rethink the implications of the war in Ukraine on the energy markets are in large part, a symptom of critical underinvestment in the fossil fuels industry and has shown that to meet demand. We need more investment across all fuels including oil and gas.
Louise: Okay, thank you for that. We know also that we've had a lot of focus on how the energy crisis is really affecting households.
Louise: Of course, it's also affecting the real economy and in particular, obviously industry across Europe. Taking a step back and recognizing that we have a lot of people listening to this from various different sectors. How do the different sectors in Europe utilise energy today? How interlinked are those energy sources and how interchangeable are they?
Christyan: I'm glad you asked that. Because that's very much how we're approaching it. Looking at joules, which is a unit of energy as opposed to particular fuels, who's stepping away from barrels and megawatts and keeping it simple. Joules is just a reflection of energy. It's like calories for food. The starting point in our global energy outlook is that we estimate the total global energy demand across all fuels in 2019 stood at 606 Exajoules, that's one to the 18 joules. Now, if Exajoules are the unit of energy, as I said, then the 606 Exajoules used in 2019 is roughly equivalent to 300 million barrels of oil equivalent per day.
Now of this, developed economies account for one-third of all energy demand. When I ask people, they tend to think it's actually way higher than that. In reality, by sector, the main energy users are industry about 30% of all energy use with a similar figure for transport demand and residential demand accounts for around 21% of the total.
Now that said, there isn't a single type of energy that can meet all demand.An investment will need to be inclusive of all fuels including oil and gas, renewables, nuclear, and other forms of energy. The report basically highlighted that all fuels are not made equal. I often have to explain to people that you can't use solar energy to produce tires. That there are things you just cannot replace in terms of the energy that we need.
For the most part, at least for 2030, different sources of energy are not fully fungible. Solar panels cannot replace oil, for example, needed for in industrial production of petrochemicals. That said, on a very long scale, Louise, all of the current sources of energy will be viewed as transitional to a safer cleaner and cheaper source of energy.
But the key is time, generation of energy and distribution of energy. Those are three conflicts that we often have that we don't appreciate. Longer term, this may only be provided by nuclear fusion. Until then, scalable, reliable, clean, and affordable technologies are available in both emerging and developed countries.
The world will just need to work with all the current sources of energy fossil and non-fossil and their respective drawbacks. If you don't we're going to end up with a huge deficit which what we'll talk about a bit later.
Louise: In the developed world it's focused on that because that's a bit of a simpler discussion. Even though we have a globalized energy market oil prices are essentially said, we are seeing quite marked differences in energy prices across different countries. I would ask you is there any country that is doing this if not well then certainly better than others? Is there any lessons to be learned from that?
Christyan: Sure. I think the best way to answer this is really what not to do. Here, while global energy prices have increased this year, do you impart to underinvestment in energy production across multiple years? We've highlighted this when we turned bullish in our Super-cycle thesis over two years ago. The issue is that it's the delivery to the consumer throughout the last five years which is always going to be a challenge, particularly with infrastructure.
So Europe, as a region, has seen some of the highest price rises to date, particularly given they're very dependent on energy, particularly the EU and they’re a significant net import of energy i.e consuming more than the region produces. Europe isn't alone in this regard, for example, China also imports a lot of energy. However, for Europe, the issue is supplies from one of the key suppliers, Russia and that has clearly fundamentally reduced. Beyond this, Europe is also ahead versus other developed economies in installed wind and solo capacity.
So while all this is a positive reducing emissions, these sources of generation are variable leaving the region susceptible in periods of lower than average wind and solar output. It's interesting when you look at how much wind and solar will represent global energy demand by 2030, it's about 5%. People think it's 50.
Louise: Relatively small.
Christyan: People say why can't it be 50? I said because physically, to install this stuff and we've looked across the entire supply chain, the metals, the carbon, the resource with all the money in the world, you cannot speed it up because you have huge inflation. So key learnings from this are that, to underpin energy security and lower prices from a supply perspective, countries should either produce the majority of energy consumed or failing that, have strong relationships with those supply nations and critically, they’re national champions of energy, the majors, particularly now with all this windfall tax. Maybe there needs to be repositioning how to approach these companies rather than the evil co or the bad co more like the white Knight in terms of being able to help on that point.
Louise: Let's look now at the impact of energy crisis on social and political instability - you set it up really nicely at the beginning, as the trade-off between the E and the S in ESG.
Louise: Talk a little bit and I know you've done some research in this area that's had some quite interesting fun Let's talk a little bit about the link between political instability, social instability and energy prices because there seems to be quite a defined trend there.
Christyan: Yes. It's an excellent question, Louise, and I think not enough people actually ask it, which is-- I sort of touched on this topic in my first answer to you when I said that securing a safe and affordable supply of energy is critical to both the development of emerging economies and the comfort and well being of people across the globe. I did also say that one-third is developed, but two-thirds of energy demand is developing.
We have details in our research how adoption and innovation of climate technologies is clearly essential to reducing global emissions and avoiding managing physical risks. However, the scale of energy needs, along with current geopolitical tensions brings into the question whether an acceleration of the energy transition in the short term is viable, or even possible and what cost.
Again, we're back to time as a key metric in terms of the rate-determining step. In our view, in the short term, there is a very delicate balance between energy security and energy transition. Back to energy outlook in April, we saw that at the prices from back then, global energy was set to rise to around 10% of GDP this year, from an 8% average over the last six or seven years.
Now, circumstances have only become more dire since with electricity prices in Europe still multiples of what they were then. Consequently, as there just isn't enough supply to meet demand over and above that baseline to withstand this sort of geopolitical shock, any supply is better than no supply, and you referenced it in terms of now we're seeing capitulation on coal and so on. So beggars can't be choosers, if you like and as you said, nine months ago, we were talking about the energy transition, now we're talking about ramping up other fuels.
That is one side of it, but importantly, there's also the risk of societal unrest. Now, this is actually something we've done a huge amount of work on looking at our social unrest model and what we did was look at the relationship between energy prices, and food price, and social unrest going back as far as we can. Also, as far as the French Revolution, where they couldn't get bread.
Now, along with fuel prices, which have a natural link to commodity prices, these two factors have contributed in average 65% of all social unrest globally. Now it varies by region and by country, but 65% is the quantitative evidence that when you lack energy, you will see social unrest. It's a fact based on the data that we have. This, again, puts the emphasis on the need for a just transition policy that delivers energy security, but absolutely in an environmentally friendly way. It really is up to governments to work out the best way of keeping these two ideals in balance.
Louise: Thank you, Christyan, and I think you've segued quite nicely into a related topic, because I think we've seen a lot of focus on the costs of climate change, right? We've lived through probably the hottest summer on record, certainly in the UK, but then we also have this pushback against the sort of rising energy costs, so we have a little bit of what I'd like to call cognitive dissonance between-
Christyan: Yes, exactly.
Louise: -what people say they want and what they actually seem to want, or put it differently, what they're willing to pay for.
Louise: Do you actually think and you touched on increased investment in fossil fuel production. Do you think there's really the political will to invest in those sources? Or are we in a sort of no man's land at present, where people don't like paying more for fuel, but they also aren't very happy with the current energy situation?
Christyan: You touched on it, I think it's-- I love the quote from Saudi energy minister Prince Abdulaziz who said, "Everyone's an environmentalist until they have to pay." and that is clearly a constraint in terms of habit cycles. I mean, you mentioned the hottest summer, I'm actually thinking of getting air conditioning finally in my house, but then guess what? I'm going to use more energy with it. We have this sort of diversion.
Now, if you just look at the numbers, delivering energy to consumers and users sectors will always remain capital intensive. So field decline in oil and gas needs to be mitigated and increased spend on power networks is required to support this increasing electrification. To meet demand, we estimated annual investment needs to increase from around 1.9 trillion globally in 2021 to 2.3 trillion by 2025 and 2.6 trillion by 2030.
Now, we think that current commitments are on track to massively miss this. I mean, when you put a windfall tax in, when you have massive volatility on the front end of the curve, guess what? People kick the can on investment. It's just too uncertain. Our analysis suggests that annual investment is only schooled to rise to rise to around $2.5 trillion by 2030, which with underspend peaking mid-decade around $200 billion per annum. That said, closing this energy deficit requires all hands on deck, back to my point around both fossil and non-fossil fuels need to grow at a faster rate than prevailing spend implies.
Now, we see $1.3 trillion supply demand, which includes 880 billion in power generation, and $400 billion in oil. That's the deficit of $1.3 but interestingly, a third of its smaller proportions, or what actually the big majority of it is infrastructure, getting the energy is to the consumer charge stations are example of that. Renewables, we see combined solar and wind capacity, roughly quadrupling, from 19 to 2030. I remember, when we did the analysis, I said, let's find all the green jewels, we can let's go massively long, and find as much penetration within the clean energy as we can.
There is absolutely a very large influx of capital into the industry and so renewables projects are generally very well funded. However, with all the best intentions and really taking a pretty bullish view on renewables, delivering incremental growth above this level will be challenging to the middle of the decade, due to permitting constraints, supply chain bottlenecks, and inflating raw material costs, particularly post-COVID.
Hence, fossil fuels are certain to play a role in the long-term energy mix, in part, owing to the fact that oil is largely non-fungible, and other energy sources to 2030 in transportation, for example. In contrast, we look at renewables, this industry is starved of capital, but with an abundance of projects and potential supply to be tapped into.
I can't help. The irony is, is amazing you've got a huge amount of capital renewable, but it's physically difficult to deliver very low amounts of capital in fossil fuel, which is very easy to deliver. We need to find a better balance between the two. Just to come back to your question, oil really is where we see the greatest need for incremental investment, both in sustaining and existing the production place, as well as growing it.
We see 2030 demand that around 7 million barrels a day above 2019, with current spending levels, implying roughly 0.7 million barrels per day average gap to 2030. With investment, I think upstream, obviously, when it gets mentioned is one but in our CapEx survey, which was led by James Thompson, we see a 12% increase this year, the highest growth rate in a decade. Of course, that comes from a very low starting point, we're going to see project sanctioning in Norway, Middle East, US, Brazil, West Africa.
I'll finish on this point, I think we tend to understate the significance of the European majors in the world. They have a colonial legacy presence in the 1920s and 1930s, particularly in the 1970s, in the embargo they were told to go and get oil go and get energy. We underrate the fact that having pulled back from many of these countries, because of the fiscal uncertainty within Europe, what happens that has a knock-on effect in their investment, all these countries that are meant to supply oil. It's not just European energy, you're affecting industries globally, by virtue of those European majors being told to spend less. It's a long way to answer your question, but I think we've covered a lot of the points around investment.
Louise: Yes. Okay. That's interesting. Then to touch on something you've covered in a few answers. I think I know what you're saying, this is really a long game. When we look at the energy market, what is the time horizon we should really be assessing policies because it seems like we have a very short-term reactionary approach to a lot of these things, without a coherent long-term plan and we run the risk of doing neither climate nor energy transition nor energy security very well?
Christyan: You put it very, very well. To build on that, think about OPEC and what their role is in global energy demand. OPEC is now taking a bit of a Fed-like role in the energy markets. I mean, following the recent expiry of the group's longer data production agreement, which was held from 2021 to August 2022. OPEC has basically returned to setting supply agreements on a monthly basis.
As present, I think the potential for cuts in order to sort of mitigate some of the downward momentum is key. Now we tend to think about that as OPEC is just trying to put a put option, they're trying to protect the price.
Actually, it's far more than that. Because oil is so volatile on the front end, it's just exacerbating investment, really speaking to the majors, they're terrified to sanction new projects, not just because of ESG and energy diversity requirements, but also because the oil could be at 60. Could be at 120. And I think OPEC has effectively tried to create stability by saying we will make sure that we create stability through these monthly agreements. That's key in terms of building to your point, Louise, the long game. How do I know I've got a line of sight in terms of being able to invest and plan with my project sanctioning and I think this is the most important given concerns of a non-OPEC supply.
In particularly we highlight rolling US Shale activity supply chain frack constraints mount. The recounts continue to fall, we've seen revisions downward in terms of US shale production in averaging around 11.8 million barrells compared to the previous week average of 12. I think this is a signal of the lower 48 reducing price production elasticity, no matter how high prices again, you physically cannot produce more oil with logistics. Quite frankly, people don't want to work in shale anymore, it lost a lot of people. That's a real issue in terms of rebuilding the industry, from the lows of 2020, when all was negative.
I think we see continued non-OPEC, non-US CAPEX discipline, which reflects this sort of continued corporate focus on sustaining shareholder returns, dividends and buybacks, and balance sheet strength in the context of market volatility. I think the key here is for the industry to be given the green light in some ways to be recognized that they should go on and invest. Unfortunately we’re seeing more intervention, not less intervention.
I think we'll end up seeing as prices continue to rise significantly higher to a point where consumers will probably drive government to drive the majors to say, "You know what? Get on with it, do what you need, if you need to invest in oil, go for it. Otherwise, we can end up with $150 to $200 oil prices." In simple terms, this obviously is like a war of pain thresholds, which could end up dictating a greater sensibility towards actually looking at the long game properly, as opposed to these short-term fixes, which people certainly recognize or quickly recognize that isn't working.
Louise: I think to close out, I'll put you on the spot, and there's something you touched on in terms of the long-term transition. What role will nuclear play in the future? Because we've seen, as you said, I think quite correctly, it is the best answer we have currently with current technology to create a sustainable energy source. Obviously, it's something that gets an enormous amount of bad press.
Really, you've seen a lot of nuclear plants either closed down or put on hold, particularly in Europe. The question then is from your perspective, is this something that is likely to change, or are we likely to see a revisiting? This is not true across all countries say France, for example, has invested quite heavily in nuclear, but to touch on your earlier point, I thought interesting topic to close out with.
Christyan: It's interesting. It's like you've got-- We talked about bad fuels, okay, fuels in good fuels, and the bar keeps moving the goalposts has shifted significantly. To an extent that gas used to be bad, and now it's been upgraded to okay, you obviously got the clean energies in the good camp. It remains to be seen when nuclear sits in that range. I mean, you could see a world where coal stays bad, but all gets upgraded to okay. Gas gets upgraded to good and clean energies heavenly. We need to consider this range in the context of society and emissions on a serious point.
With that in mind, and just taking a step back on nuclear, I was looking at the ecosystem of joules to help balance the costs socially and economically and availability of energy in the future. While you're ensuring you've got enough oil and gas molecules, I think nuclear has a very strong place within that ability to manage short-cycle deficits. I think that's probably where we'll find the right balance, you'll see short cycle projects emerge. It's highly unlikely that we'll see major RFIDs big sanctioning of projects because obviously, you've got that not in my backyard approach.
Also with the geopolitical concerns, obviously, with Ukraine, and some of the real security issues around the nuclear power plant, is there a reminder that nuclear does come at a cost in terms of its exposure? I think in terms of just trying to sort of manage nuclear within the context of other fuels, I think, where we do see probably the most suitable fuel to manage deficits away from nuclear, and oil is gas LNG.
People talking about it as a transition fuel. I personally think unless you think transition is 100 years, gas will always be there to complement renewables. As much as we'd have to have the storage for batteries, we'll need gas to be intermittent to be able to fill that delta when we don't have enough when we'd have enough sun. LNG is definitely going to play a key role alongside nuclear in a more short cycle sense and gas, and ultimately oil for the sectors where you just can't replace it. Again, we're back to the same point, all fuels on deck as opposed to this biofication or polarization that we're seeing doesn't help anybody.
Louise: I think, on that note, energy diversification is obviously one of the best ways to ensure security and that's across the mix. Thank you, Christyan. This has been, hopefully, very interesting topic for our listeners. Thank you for your time and insights. We're living through some very interesting times in the energy markets. We look forward to chatting with you again sometime soon. Thank you.
Christyan: Great to be on. Thank you very much.
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