The World Energy Investment study released by the IEA on September 14 confirmed what analysts have been prophesying for months: the current decline in oil-and-gas investment is the biggest one in half a century. The current bout of low prices has gotten so deep and remained there for so long that capital investment in new projects, and hence new production, has taken a major hit.
But in an era of shifting energy policies, surging interest in renewables and uncertainty over the consistency of demand, what does this drop in investment really signify? And what could it mean, over the long term? There are a lot of factors to keep in mind when taking a look at this new report from the global energy watch-dog.
The IEA found that worldwide investment in energy in 2015 was $1.8 trillion, a fall in real value of 8 percent from 2014. Investment in oil and gas fields, according to IEA’s executive director, by 25 percent in 2015 to $583 billion, with a further decline of $450 billion expected for 2015. The decline in oil and gas, which has otherwise retained the largest share (46 percent) of total investment, was partially off-set by growth in renewables, electricity networks and energy efficiency (see a handy pie chart here).
The largest contributor to the decline was cost deflation, or falls in supply and equipment costs, which accounted for about two-thirds of the total fall in investment.
Other notable aspects of the IEA report: investment in energy efficiency rose by 6 percent and reached $220 billion, a further sign that increased efficiency remains a “fuel” in its own right. The IEA had estimated in October 2014 that energy efficiency could potentially be worth $310 billion worldwide.
Decline in oil and gas investment has been the big story in the US, which has contributed the most to the current slump: investment in 2015 fell by $75 billion, down to $280 billion. Investment in shale, predictably, fell a staggering 52 percent.
Outside of the U.S., however, is a different story. In the Middle East and Russia, where development and production costs remain lower, investment held steady, helping national oil companies to improve their share in upstream investment to 44 percent. In absolute terms, investment in the Middle East remains a low-cost prospect: despite accounting for one-third of global oil production, Middle East investment was only 12 percent of the global total.
Investment in renewables, another big story of the year, reached $290 billion in 2015, or 17 percent of the total. Obviously this means a lot more to natural gas than to oil: wind and solar compete with gas for markets and, Elon Musk’s enthusiasm notwithstanding, electric cars (which could be powered by wind or solar power) have yet to seriously challenge oil-powered transportation.
The IEA was also not terribly enthusiastic about the future of LNG: they predict a serious drop in investment in 2017, which will tighten prices.
As for coal, the IEA determined that despite falling use in China and the United States, where coal-firing power plants are being replaced by renewables and gas, coal remains the second largest single contributor to the energy sector. With far lower capital costs than gas (and particularly LNG, which requires massive outlays for infrastructure as well as the gas plants themselves), coal remains a cheap and attractive option in India and elsewhere in the developing world, despite a strong potential for LNG and natural gas to seize a larger share of the electricity and fuel markets.
So, the big question: how does this investment report mean for global energy, and the American economy in general? As at least one energy analyst has noted, the current shift in global energy seems likely to upset decades-old geopolitical relationships. Are we in the midst of a similarly epoch-shattering shift in energy economics?
The news from the IEA was joined by an economic revelation of similar importance: that the decline in oil prices since July 2014 has had little or no impact on the American economy. A paper by economists Christiane Baumeister and Lutz Kilian for the Brookings Institute found that in 2015 consumer spending increased by 0.61%, on account of low gas prices. This is the oft-cited surge in consumer spending that accompanies periods of low gas prices.
But Baumeister and Kilian also found that over the same period, investment in oil and gas fell by 0.62%, perfectly off-setting the rise in consumption. As Bloomberg notes, the economic dislocation experienced by massive lay-offs in the energy sector nullifies any boon the consumer enjoys from slightly lower gas prices.
Another way to interpret this: if the price had declined without the accompanying drive in new U.S. oil and gas investment (much of it linked to the shale boom), American consumers would have enjoyed low prices, thousands of American workers and dozens of businesses would not have been exposed to tougher market conditions, and the present doom-and-gloom might have been less prevalent.
As Baumeister and Klein note, the impact of the current downward trend in price (which they point out is reminiscent of the crash in 1986, only much, much worse in terms of accompanying decline in investment) is felt to differing degrees depending on whether the national economy is focused more on consumption or production.
The United States, historically the world’s major producer and consumer of oil and gas, will always be uniquely situated during crises in investment. Yet it also means that the American economy is better suited to weather the storm. Dangers that U.S. banks are overly exposed to defaults in the oil and gas sectors, for instance, seem largely over-blown: Bank of America, with the largest exposure to energy defaults, is putting aside heavy provisions in case its loans go bad. Despite potential risks, oil and gas won’t drag the U.S. into another painful recession as real estate did in 2008.
Another big question: does the drop in investment mean the price of oil will swing radically back up, as soon as new production fails to catch up with demand? It’s possible. But note that while the IEA report found investment in renewables and energy efficiency are continuing to grow, that growth has been matched by continued investment in coal, natural gas and oil. Growth in renewables has, in other words, been almost entirely off-set by increases in conventional energy sources.
Much more importantly, however, the IEA estimates that supply will continue to outstrip demand this year and next year by a significant margin. That means we’ll have to wait to mid-2017 at the earliest for markets to balance each other out. So, if the price does vault back up, it doesn’t look likely to happen for at least another year.
As much of the new production maintaining the glut comes from outside of OPEC, it puts added pressure on the oil cartel to reach an agreement when it meets this week. But why freeze production when your competitors look likely to seize market share in the short term? The new IEA bearishness on market balance puts OPEC, as others have noted, in an awkward position.
Thus, there is much to keep in mind about the new trends in falling investment. Doubts continue to surround LNG as the fuel of the future; renewables keeps the wind in its sails, but can’t quite out-run the competition; and coal remains down, but not out, particularly if you’re in an Indian state-run coal titan. Added to that, at last, is the IEA’s sudden fear that demand will stay down: how then can there be a new price spike when no one needs more gas in their cars?
By Gregory Brew for Oilprice.com
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