Since the financial crisis of 2008 we have had a bear market in fossil fuels and a bull market in almost everything else, based on cheap money, inexpensive energy, and free trade, all of which are now in the rear-view mirror. Investors lost interest in energy: cast out by the high priests of ESG into the financial wilderness, to live out the remainder of its days in penitence for its sins. Like the Israelites emerging from Sinai, with oil now back over $100 per barrel, fossil fuels are now being welcomed back from exile and look set to be the best performing asset class of the next decade.
“Hate to say it, but we need to increase oil & gas output immediately” @elonmusk March 5th, 2022
It was believed that the Coelacanth fish had been extinct for 66 million years until one was caught by a South African fisherman in 1938. The mysterious Australian Night Parrot was thought to have been extinct for 100 years until rediscovered by a twitcher in 1979. The New Guinea Singing Dog, a close relative of the Australian dingo, was rediscovered by an ecotourist in 2012. It is a commonly held view that fossil fuel companies will become extinct by the end of the decade. Like the Coelacanth, the Night Parrot and the New Guinea Singing Dog, reports of its demise have been greatly exaggerated.
We have recently been reminded of the importance of energy security. Over the past two decades the transformation of the UK power grid from being predominantly powered by coal to natural gas has been the biggest factor behind its near halving of carbon emissions. Under the malign neglect of successive UK and Scottish governments of North Sea exploration, the UK became more reliant on gas imports, which has enhanced the geopolitical status of hostile nations.
We forgot the lessons from the OPEC crises of the 1970s. The West thought it could move energy and commodity supply off balance sheet, focusing instead exclusively on technological innovation which, like most bull markets, culminated in a speculative bubble, with fund managers handing out capital like lollipops at a school fete to anyone with wacky ideas for flying taxis, solar powered tanks, or carbon free hot dogs. That bull market is now dead.
Many people think that more renewable power is the answer. They will find that the wind is no more reliable than Putin. Wind energy has already passed its optimal share of power generation. There is simply no benefit to the grid to continue to add more variable renewable power that results only in more abundant power only when the weather is favourable.
Last year there were only 7 days when the wind blew consistently enough for renewables to contribute more than 50% of UK energy generation. Adding more wind capacity might mean renewables provided more than 100% of energy on those same 7 days a year the wind blew consistently. But what would power the grid and prevent blackouts on the other 358 days in the year? Putin would simply choose to attack the UK on a cloudy day with no wind.
Renewable enthusiasts make hopeful statements about future battery or hydrogen storage technology that could potentially store wind and solar energy. A grid powered exclusively by wind and solar would need to be over-built relative to demand and the fossil fuel capacity it was replacing to account for intermittency and loss of energy during transition to and from storage. Battery technology does not currently allow for storage of power for small windfarms longer than a few hours. The laws of chemistry dictate it probably never will. Metals used in batteries such as lithium or vanadium can never be mined on a big enough scale to manufacture enough battery capacity. The cost of over-building an exclusively renewables grid, backing it up with storage would in any case amount to more than 100% of GDP.
Even if cost and technology were no issue, we would be left with a grid that was so unreliable with on average astronomic power prices, that might still need government subsidies because the power price would collapse to near zero with a glut of energy when the wind blew. If there were still any factories left in the UK, they would probably only be able to operate with power rationed by the weather forecast. Our blue-collar jobs would be outsourced to China, manufactured using coal power and in the case of solar cells, Uyghur labour.
Institutional investors – like governments – have not thought through the negative economic and social consequences of the rush to decarbonise. Jumping aboard the ESG gravy train, they have instructed the management of major oil companies not to invest for future production. Capital expenditure amongst the 12 non-OPEC+ major oil companies has fallen from $330bn in 2013 to just $140bn today.
Unsurprisingly the amount of new oil and gas discovered has also plummeted from 30m/barrels of oil/day equivalent in 2012 to just 5m in 2021, with a record low reserve replacement ratio of new volumes found to current production forecast of just 12%. Even if the West continues its rush to zero-carbon, demand for oil and gas in the rest of the world will still grow whilst supply plummets. Given that renewable energy can never replace the reliability or unsubsidised cost of fossil fuels in a free market, the result can only be a new bull market in the cost of energy.
There is a strong moral case for fossil fuels. Families in the UK have recently been hit by rising electricity and gas bills; their mortgage costs have increased because interest rates have gone up to fight inflation; and their taxes have also risen, partly because government has lavished subsidies on renewables. And what of the hopes of the 1 billon people in the world who currently have no electricity and the additional 3 billion with limited access to affordable energy?
Climate change activist claiming to be “saving future generations” from “climate change apocalypse” often seem to have profoundly anti-human, Malthusian agendas that negatively impact the world’s poorest. Even the bosses of oil major oil companies have been so cowed by the climate change apocalypticism that - like pre-Thatcherite post-war politicians in the UK – they meekly accept managed decline.
The West is heading into a period of deglobalisation, unstable energy supply threatening deindustrialisation, resulting in rising interest rates, structural inflation, and negative real returns on all asset classes apart from commodities. Full decarbonisation will never be achieved. It may not be a fashionable view, but the dawning realisation that fossil fuels are an essential part of our future will be the trade of the decade.
Barry Norris
Argonaut Capital
March 2022