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Kirill Rodionov

Kirill Rodionov is a research fellow at the Financial Research Institute of the Russian Ministry of Finance. For the last ten years, he has been…

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The COVID-19 Pandemic Has Upended Global Energy Investment Trends

The pandemic has not broken but intensified global energy trends that emerged on the eve of COVID-19, whether it be the collapse of coal-fired power generation, the growing surplus of oil production, or the booming interest in renewables

The further 2020 goes into history, the clearer the extent of last year's collapse in fossil fuel demand becomes. According to the Energy Information Administration (EIA), in 2020, global crude oil demand decreased by 9%, to 92.2 million barrels per day (bpd) – the level at which it was in 2013 (92.3 million bpd). In the second quarter, which was the most painful for the world economy, oil demand (85 million bpd) fell back to the 2006 values (85.3 million bpd).

The same goes for natural gas and coal, two other key resources in the global energy mix. The drop in global gas demand reached 3% (122 billion cubic meters (bcm) in absolute terms, which is comparable to the total pre-crisis consumption in France and Italy), and for coal, that figure is 5% (384 million tons), becoming the most serious since the Second World War, as follows from the International Energy Agency.

Such a deep collapse in demand was driven by COVID-19 and by shifts in the global energy scene, which formed even before the pandemic but became more pronounced with its onset.

The Decline of Coal

One of them is a sharp reduction in coal generation (at least in OECD countries), which leads to a contraction of the thermal coal market. In 2019, global electricity generation at coal-fired plants decreased by 2.6%, while in the United States - by 15.5%, and in the European Union (EU) - by 24.1%, according to BP. In 2020, this trend did not abate: from January to November, coal generation decreased by 22.1% in the US and by 21.8% in the UK and the EU, as follows from the data provided by EIA and the Ember research center.

The reason is the high cost of coal-fired generation. In 2019, according to the latest World Energy Outlook, the value-adjusted levelized cost of electricity at coal-fired plants was one third higher in the United States than at solar-PV panels ($75 versus $55 per MWh), and almost double that of wind onshore farms ($40 per MWh). A similar difference is typical for the EU ($120 versus $60 and $55 per MWh, respectively), where ten of the 27 countries intend to abandon coal generation by 2030. Related: Oil Prices Continue To Rise As Bullish News Mounts

That's why it's hardly surprising that from 2018 to 2020, thermal coal consumption in Europe decreased by 27% (to 525 million tons), and in the USA - by 29% (to 424 million tons), as follows from the IEA data. And this trend is unlikely to be reversed, given that back in 2019, on the eve of the pandemic, the share of coal generation in the EU fell by half if compared with 2000 (15% against 30%), and in the US – to a minimum for more than forty years (23%).

Solar and Wind Energy to Replace Fossil Fuels

The growth of renewables perhaps is just as irreversible as the demise of coal. From 2010 to 2019, the share of renewables (excluding hydroelectric power plants) in total electricity generation increased from 4% to 11% in the United States and from 9% to 24% in the EU, as follows from EIA and Ember. Regarding absolute terms, the generation from renewables both in the US and in the EU has more than doubled over the same period (up to 440 TWh and 768 TWh, respectively).

As in the case of coal-fired generation, COVID-19 has strengthened the already existing trend: during the first eleven months of 2020, generation from renewables increased in the US by 13.2%, and in the UK and the EU – by 10.1%, while generation from all sources decreased by 3.3% and 4.7%, respectively.

Solar and wind energy displaces coal and natural gas in Europe. From 2010 to 2019, the share of gas generation increased in the United States from 24% to 38%, while in the EU, it has slightly fluctuated around 20%. This largely explains why during the first eleven months of 2020, gas power generation increased in the United States by 2.5%, while in the UK and the EU, it decreased by 6.1%. The reason is the already mentioned cost advantage: the value-adjusted levelized cost of electricity at gas turbine stations in the EU is higher than at solar-PV panels and wind onshore farms ($75 versus $60 and $55 per MWh, according to the latest IEA estimates).

Natural Gas: Market Uncertainty

And this is not the best news for gas suppliers to Europe, who had to face increased external and intra-industry competition. From 2010 to 2019, European natural gas imports grew by 13% (to 353 bcm), but most of this growth came from liquefied natural gas (LNG): its supplies increased by a third over this period (up to 120 bcm), while pipeline imports – only by 4% (up to 233 bcm).

A similar trend was observed in 2020: from January to September, imports of pipeline gas from Norway decreased by 1% compared to the same period of 2019 (to 74.6 bcm). Meanwhile, from Russia – by 10% (to 154.4 bcm), and from Algeria and Libya - by 20% (up to 12.6 bcm) and 21% (up to 3.4 bcm), respectively, as follows from the data provided by S&P Global Platts, Gazprom and ENTSOG. LNG imports increased by 10% over the same period (to 94.4 bcm, according to Refinitiv). Related: Russia Is The Biggest Winner In The OPEC+ Deal

However, it would be a mistake to believe the pandemic has done no harm to LNG suppliers. Due to a fall in regional demand (by 5% in 2020, according to the IEA) and average prices (by 32% in twelve months, as in the case of TTF, a leading European hub), the growth of LNG imports in Europe has slowed from 30% in the first quarter up to 6% in the second one, while in the third and fourth quarters it was replaced by a decline of 9% and 30%. This could not but affect the mood in the industry: in 2020, only one LNG project was made a final investment decision (Energia Costa Azul plant in Mexico worth $2 billion), while in 2019, there were six such projects worldwide.

In 2020, global capital investment in gas production fell by 34% (to $188 billion, according to the IEA). When the world economy recovers, investment activity is likely to return to the pre-crisis level. However, producers still cannot avoid risks – as due to a decrease in gas demand in Europe (on average by 0.5% per year over the next ten years, as follows from the IEA baseline forecast) and the rapid growth in demand for renewable energy (by 6.1% per year globally over the same period, excluding biofuels). Several months ago, this forced the Russian Ministry of Energy to warn that large-scale LNG projects must be completed by 2030 – otherwise, they will not pay off due to competition with renewables.

Crude Oil: An Elusive Balance

The oil industry has not escaped investment squeeze either: in 2020, global capital investments in crude oil production decreased by 33% (to $315 billion, according to the IEA). Perhaps this will reduce the surplus of supply in the coming years, but by the end of 2020, exceeding production capacity has become more pronounced – both because of the OPEC production cuts (by 12%, to 30.6 million bpd, according to the EIA), and the rise of supply from countries that did not join the April deal.

The first example is Libya, where production increased to 1.22 million bpd in December (versus 147 000 bpd in February 2020, according to OPEC secondary data). The second one is Norway, which increased sea oil transshipment by 17% in 2020 (to 1.33 million bpd, as follows from Refinitiv) thanks to the launch of the Johan Sverdrup field, one of the largest in the North Sea. Coupled with weak discipline among some OPEC+ countries (thus, from May to August, Iraq cut production by 82% from the baseline, and Angola by 86%, according to the IEA), it reduced the deal's effectiveness. In December, the alliance had to postpone the easing of quotas from 7.7 million to 5.8 million bpd, limiting itself to the decision to increase production from January by 500 000 bpd.

Therefore, attempts by OPEC+ to dry up the market by reducing production remain elusive. In March 2020, this dilemma was resolved by Russia's withdrawal from the deal. The same fate will most likely befall the April agreement, especially since it is far more burdensome than the previous deals.

On the Verge of the Low Prices Era

Therefore, OPEC+ efforts will not have a long-term price effect. Not least because the OECD countries have passed the peak of oil demand (the latest long-term forecasts of the IEA, BP and OPEC agreed on this), while in China its growth will inevitably slow down – from 5.5% per year in 2009-2019 years to 1.3% per year until 2030, according to the IEA baseline forecast – due to the increase in the number of electric vehicles (in 2019, China ranked first in the EV global market with a share of 47%).

Equally important is that tighter competition among oil producers will further complicate market balancing. This includes the development of both the Brazilian shelf, which will allow Brazil to increase production by 1.1 million bpd by 2025 (as follows from the IEA forecast), and Guyana's Stabroek block, where production will increase by more than 500 000 bpd over the same period. OPEC countries also can increase supply: to make it a reality, Iraq needs to overcome water shortages in the southern provinces, while Kuwait and Saudi Arabia – to increase production in the neutral border zone.

The world is already at the dawn of a low oil prices era, which could be the prologue to a low-carbon future. The COVID-19 pandemic, accompanied by a collapse in demand and production, made it possible to feel how difficult the upcoming challenge will become for oil, gas, and coal producers.

By Kirill Rodionov for Oilprice.com

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