Prior to 2022, the commodities oil and gas were largely regarded as fossil fuels that didn’t deserve to be anywhere near a portfolio of high-quality assets. This was largely due to the emergence of decarbonisation efforts by governments, business, and households.

It is increasingly obvious that the world is marching towards net-zero. However, does this mean that renewables replace these fossil fuels entirely by 2050? If so, then will it be a gradual transition, or an immediate one? Although it’s controversial to say, I believe fossil fuels, predominantly gas, will continue to play a role in the global energy supply for decades to come. Fossil fuels will most likely aid in the transition to an economy where renewable energy accounts for 80-90% of global energy production by 2050.

Oil and Gas from 2020 to 2022

During the depths of the pandemic in 2020, oil fetched just US$20 per barrel. In the middle of 2022, a barrel demanded over US$120. As the global economy re-emerged from the pandemic and started reopening, the subsequent surge in energy demand was higher than anticipated and ended up completely outstripping supply.

This shortage of supply was a product of chronic structural underinvestment in energy capacity globally, primarily due to environmental and social concerns surrounding fossil fuel projects. Why would companies commit billions of dollars to multi-decade long oil and gas projects when the space is so heavily regulated and scrutinised? The producers were not confident that the demand would be there in ten years’ time to justify the large expenditure. Put simply, the regulations investing in new assets were too strict, starving the producers of incentives to build out capacity. Furthermore, investment was being redirected from fossil fuels to renewables.

The chart below illustrates that prior to 2014, the investment in resource projects followed the return that those projects could yield. The new projects that were committed to once the return on those projects rose as a function of supply and demand. Post 2014, the returns on these assets have been climbing, although new production has not been following due to the constraints mentioned earlier. When you have very low supply, and very high demand, prices rise, and we have certainly seen this throughout 2022 regarding energy prices.

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Europe’s Energy Market

At the start of 2022, Europe’s energy markets were already stretched thin off the back of heightened post-pandemic demand, combined with a drop in renewable power generation due to low wind speeds, and high existing coal & gas prices. In December 2021, electricity prices were 3 times that of December 2020 prices. This sharp rise occurred before Russia had even invaded Ukraine. They are currently almost 2 times those December 2021 prices.
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Although Europe (especially Germany and Italy) has been hit particularly hard from Russia’s invasion of Ukraine, the invasion compounded pre-existing energy troubles for the entire global economy. The reason being that pre-invasion, Russia supplied over 10% of global oil and over 10% of global gas. See the chart below that reveals the impact this turmoil had on US gasoline prices.
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What this Means for Energy Producers

This undersupply and obvious strong demand for energy indicates that energy producers that have existing high quality, long-life assets, strong balance sheets, robust cashflow, and astute management teams will benefit from higher energy prices for longer.

The two main energy producers on the Australian Stock Exchange are Woodside Energy (WDS) and Santos (STO). Both companies have outperformed the local ASX200 index by 61% and 30% respectively year to date. Woodside Energy has the greatest exposure to global prices and has benefitted the most from recent global events, hence the greater advancement in its share price.

Santos and Woodside are predominantly gas producers, which is fortunate for both companies, as gas has been gradually increasing its share in the energy mix. Gas producers are expected to play a key role throughout the transition to renewables with its wide range of applications, due to its acceptance as a transition energy. Looking forward, gas could play a new role in blue hydrogen and ammonia production. Additionally, existing gas infrastructure (which WDS and STO own) could be repurposed for low-carbon fuels such as hydrogen and biogas. According to McKinsey & Company, gas demand is projected to grow by 10% in the next decade, with demand peaking by 2035.

What does the Future Hold for the Energy Landscape?

Electricity demand is projected to triple by 2050 as sectors electrify and hydrogen and hydrogen-based fuels increase their market share due to decarbonisation. Renewable energy is projected to reach 80 – 90% of the global energy mix by 2050. In 2050, oil and gas won’t be the ‘hot’ sector to be in. However, they will very likely still play a key role in the global energy market. In 2022 and over the next couple decades, the demand will still be present in a chronically undersupplied market.

According to McKinsey & Company’s Global Energy Perspective 2022 Report, demand for oil is projected to peak over the next five years, between 2024 and 2027 most likely, following the electric vehicle uptake, which will see less reliance on oil. Crude oil demand is expected to decline rapidly after 2030, driven by a reduction in its use for combustion. Towards 2035, gas demand across all scenarios is projected to grow another 10 – 20% compared to 2022. Post 2035, demand for gas will be largely driven by its interplay with hydrogen.

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Summing up

The dominant contemporary storyline is that natural gas, oil, and coal will virtually be non-existent by 2050. However, these are the fuels that will be needed to transition to a renewable driven economy sustainably and viably. Although the globe is marching towards a future powered by renewable energy, the established producers such as Woodside and Santos will still be producing large sums of cash each year and subsequently paying out a very large chunk of these profits as dividends to shareholders.
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Important information – Oracle Advisory Group makes no representation or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. The information in this document is general information only and is not based on the objectives, financial situation or needs of any particular investor. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek their own professional advice. Past performance is not a reliable indicator of future performance. The information provided in the document is current as the time of publication.
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