Investment thesis: The Western environmental movement seeks to undermine hydrocarbons not only on the demand side but also on the supply side. On the demand side, it figures that more and more electrification, with renewables producing a growing share of the electricity, will eventually push hydrocarbon demand growth into permanent reverse, after a few centuries of constant expansion. Environmentalist lobbies are also pushing to have the supply-side impaired, which is where the ESG trend meant to starve the non-renewable energy sector of the needed capital comes in. The impending failure of the global energy supply system stems from the fact that flaws with feeding intermittent energy on a large scale into the grid system are emerging, due to sustained weather pattern changes. This failure led to the EU energy crisis that is currently spreading to the rest of the world. It is therefore unlikely that we will see a continued mad rush worldwide to replace oil, coal & gas with renewables because what we are seeing unfold this year in the energy markets is a reason to pause and ponder the consequences. With demand destruction for hydrocarbons through more adoption of renewables set to slow, the supply destruction trend that is in part due to ESG, supposedly starving oil & gas producers of needed capital is set to become a very dangerous combination that could shatter the global economy. Despite being starved of capital, energy stocks are set to do well going forward as energy prices may rise for a sustained period to levels we have not seen before. The global economy might not fare so well however, thus investors need to adjust accordingly.
The truth about the EU energy shortfall
When reading through MSM reports on the subject, about 90% of all articles tend to completely exclude the fact that a shortfall in renewable energy generation, due to a shift in weather patterns has occurred and it is at the root of the crisis. It is what is driving the spot price of natural gas to new records. That in turn is also causing coal demand to skyrocket, and even crude oil, as some power plants are actually looking at burning oil to generate electricity, because it is now cheaper in terms of oil-equivalent than natural gas.
It is not yet clear how much of a shortfall in renewables generation occurred this year. Piecing it together from various sources, it seems that Germany has seen a 20% decline in wind power generation compared with the previous year in the first half of 2021. Many indicators since then suggest that other countries have seen similar trends, and it seems that so far in the second half of the year there is also a wind power shortfall. It is also unclear how big of a shortfall there is in hydropower, but Scandinavian countries are reporting a substantial decline in power generation. They ordinarily tend to export electrical power to the rest of Europe.
The shortfall in renewable energy generation is the main culprit behind the massive shortfall in natural gas storage levels ahead of the impending winter of over 500 BCF compared with the five-year average.
Source: Celsius Energy.net.
Looking at the shortfall in renewables compared with the missing gas from storage, it does seem like there is a very strong correlation and proportionality between the two.
Renewable energy use in 1990 was 71 million tons of oil equivalent. By 2019 it increased to 230 million tons. A hypothetical 10% shortfall in renewable energy generation can be equivalent to 23 million tons. Translated into natural gas volumes, that is about 912 billion cubic feet of natural gas. As I pointed out already the storage gap is just over 500 billion cubic feet compared with the five-year average and almost 700 billion cubic feet compared with last year. I am guesstimating that the renewable energy shortfall is about 5%-10% YTD in Europe this year, based on everything we know.
It is not a shortfall in supplies, as it is sometimes suggested, nor is it just a matter of the global economic recovery. Russia claims that they are on track to ship a record amount of natural gas this year for export. The recovery means, recovering from the 2020 downturn, in other words to 2019 levels. This means, with all else being equal, the 2021 natural gas supply/demand balance should be very similar to 2019, if it were not for the gaping hole left by the shortfall in renewable energy generation this year.
Continuing the renewable energy expansion is no longer feasible, without remedies meant to prevent replication of the European outcome at the global scale
It is still possible that renewables will finish the year strong or at least pick up at some point this winter and thus relieve the pressure that is being put on the global natural gas supply chain. It is also possible that a combination of a milder winter and some sort of arrangement for Russia to send some extra gas supplies will make what is currently a potentially catastrophic crisis that is set to unfold this winter, into something of a non-event. Such an outcome would provide some breathing room for policymakers who seem to be committed at least in public to continue with the aggressive expansion of renewable energy as part of their energy mix, despite the worrying outcome we have seen in Europe. Privately they have to now contemplate the potential catastrophe that would be produced within a context of a world or even a region being dominated by renewable energy sources, when (not if) weather patterns will once more turn unfavorably for a sustained period of time.
It is not just Europe that needs to re-think its path in this regard. In fact, the turn away from the path of increasing dependence on unreliable weather-determined energy supplies will be more pronounced in other places like in Asia for instance, where economic pragmatism is more pronounced. All remedies meant to deal with weather-related shortfalls in renewable energy production tend to focus on daily or weekly shortfalls, not on a sustained shortfall we saw in Europe this year. It will take time for remedies to such sustained shortfalls to be put into place. In my view, we will need to limit the amount of intermittent energy we feed into the grid directly and focus more on generating another form of energy with the power that is generated from wind & solar. My bet is on the hydrogen economy, where wind & solar power will be transformed into hydrogen via water hydrolysis. Hydrogen can be stored and used as a fuel when needed in a power plant designed to do so. But this will have to happen on a massive scale in order to accommodate more renewable power generation, while such concepts are currently still in their infancy, with still many technical factors that need to be addressed. In the meantime, we will need to rely on growing supplies of oil, gas, and even perhaps coal in order to keep the lights on and the global economy moving, with nuclear power being perhaps the best immediate option in terms of reducing emissions from hydrocarbon sources.
Energy companies already faced an uphill battle to keep global oil & gas supplies from declining, without ESG pressure bearing down on them
Not long ago peak oil supply theory was considered a viable forecast of what might await us in the future. Then came the shale revolution that created about a decade of oil & gas glut not only in the US but also worldwide. Between 2010 and 2019 the shale additions to the global supply nearly equaled the entire increase in global oil & gas demand.
It was the new paradigm of peak oil demand theory that led to the concept of having to shun oil & gas investments in order to prevent the transition to renewable energy from being derailed by what seemed last decade to be the beginning of permanently low hydrocarbon prices.
The part that most people missed in the last decade was the fact that in the absence of US production growth, the global supply of oil & gas was mostly stagnated. They also missed the part where global discoveries of conventional oil & gas have been many times lower than production volumes for many years now.
While in the best of years in the past decade new discoveries of oil & gas were just over 20 billion barrels of oil equivalent, the global yearly production of oil & gas tends to be around 45 billion barrels of oil equivalent. There has not been a single year this century to my knowledge when global oil & gas discoveries surpassed production volumes. My back-of-the-envelope estimate, assuming that the real volume of viable resources discovered is in fact 50% higher, due to conservative reporting, is that so far this century we produced about 300-400 billion barrels of oil equivalent more from conventional fields than we discovered. In the past five years or so, we have been producing about 30 billion barrels of oil equivalent, in excess of discoveries adjusted for my assumption of there being about 50% more in those discovered fields than is officially being reported.
Looking at discoveries, as well as the rising costs of production, as older fields are being squeezed for everything that can be technically and economically recovered, it is hard to square these realities with the flawed perceptions by market participants that we need to squeeze oil & gas producers out of producing an excess of oil & gas. There seems to be no such problem, especially since the shale boom is now largely stagnated. In fact, the opposite is the case, where there is a very real threat of oil & gas production shortfalls, where demand is not met, which in fact threatens to derail the adoption of renewables.
This may seem counter-intuitive, given that higher oil & gas prices are in theory beneficial for renewables and EV adoption. The fact is however that we need financial resources to help with that adoption. It also takes a lot of energy as well as plastic and other resources to produce and transport those windmills. Higher energy prices will make all that a lot more expensive. An oil & gas price spike can derail the global economy, leaving us with fewer resources that can be allocated to renewables, not more. Now, with the EU crisis calling into question the viability of allowing an ever-larger role for intermittent energy in the grid systems of the world, it makes even less sense to continue with policies of financial pressure on already sorry prospects for global oil & gas production going forward.
Destroying energy supply potential even as demand continues to grow is a recipe for global economic disaster
We are not yet in the winter season, yet there are already reports of some industrial activities in Europe being reduced in response to high costs of natural gas as well as high costs of electricity. Petrochemical operations such as fertilizer plants are particularly vulnerable to higher natural gas prices, and the spot price in Europe has gone wild.
Even though the spot price market has moderated somewhat recently, there could still be much more to come going forward, especially if Russia fails to send more gas in addition to the amount already contracted for, and weather factors will continue to give Europeans a hard time in this regard.
The hope right now seems to be that the worst-case scenario, where there will be actual energy shortages this winter in Europe will not occur, and then it will all blow over and things will be back to normal in Europe as well as globally. That is not necessarily going to be the case. OPEC is forecasting record oil demand for 2022 of 100.83 mb/d. In other words, it will surpass the record levels we have seen in 2019. With US oil production still well below 2019 levels and unlikely to catch up, it is unclear where that extra oil will come from. Not to mention if we will see another robust increase in demand in 2023, at which point we will have no way of escaping a demand destruction event, in other words, prices rising to the point where a recession will be triggered.
Aside from the hypothetical possibility of another shale mini-boom starting next year, there is really very little that can be done to increase supplies or to curb demand without price-induced demand destruction having to take place in order to bring demand below supply levels. There is nothing we can do about it. Discoveries have been lacking, and investments in enhanced recovery in older fields have been partly impaired by low oil & gas prices in the past years, while efforts to starve oil & gas producers of capital most likely had some effect on their investment decisions. The ESG trend threatens to further starve the world of oil & gas supplies, even though the world is not technologically ready to switch to renewables to the extent desired by the environmental movement. In other words, we risk being caught in a perpetual energy crisis this decade and beyond, unless the oil & gas industry will be able to heavily invest in upstream activities meant to enhance recovery as well as tapping new reserves.
Just so I can clarify things, I do believe the world will need to deploy more renewable energy capacities as part of the wider efforts to meet demand growth this decade and beyond. Oil & gas as well as nuclear cannot get it done on their own, given geological limitations as well as other factors. ESG efforts meant to restrict oil & gas supplies are the wrong approach to it, given that we risk inflicting serious damage to the global economy, which will seriously limit our economic abilities to invest in capacities meant to help facilitate more use of renewable energy, such as hydrogen production and power plants that will run on it, as a way to store renewable energy for the longer term, which will be needed to stabilize the grid, given the intermittent nature of renewables.
With a growing list of financial institutions and funds refusing to invest in oil & gas producers, as well as refusing to grant them loans, the investment reality in the sector may seem bleak to some extent, even as oil & gas prices continue to rise. There is increasing pressure felt on certain companies from within their own leadership, as well as from governments and courts. Perhaps the most famous and arguably shocking situation is the one faced by Shell (RDS.A), (RDS.B), where a Dutch court ordered it to cut its emissions from its operations by 45%, by 2030. Exxon (XOM) just recently announced its intention to cancel some very large investments, mostly involving natural gas, worth tens of billions of dollars. Suncor (SU) is not faced with external pressures, it is nevertheless pledging to cut its emissions substantially as well. I do have a feeling in this regard that it will more or less follow along the lines of Canada's own history in regards to meeting such pledges in the past few decades, namely, regretfully admitting to failure.
I currently own Shell and Suncor stock. In the case of Shell, even though I like its LNG strategy as well as its long term thinking in regards to its petrochemical activities, I do feel that the environmentalist-related pressures, combined with its increasingly untenable situation in regards to upstream reserves make it a less than ideal long-term buy & hold option. It is currently benefiting from the rise in oil, gas & LNG prices and as such it will perform well in the shorter term, which is why I am yet to start the process of unloading Shell stock. The current bull run in energy is set to continue in my view, so there is no reason to act just yet, but I probably will soon.
Suncor is a far more attractive long-term buy & hold. With Canada's continued failures in meeting its climate goals, I doubt that Suncor is likely to face government pressure to sacrifice itself any time soon. It also does not suffer from a reserves shortage unlike most of its Western peers. It is sitting on ample reserves that it can profitably produce at current prices for decades to come. It is one of the few major Western integrated companies which will be able to substantially increase oil production in the coming years. I think it is one of the cheapest stocks in the oil & gas sector, among major integrated companies right now, given the fundamentals. ESG is not likely to be an issue with Suncor or most other oil & gas companies at this point, because, with oil & gas prices headed higher, they can pretty much meet their capital needs from internal resources. It will be more of an issue when oil & gas prices will crash.
In the past few years, I started buying some Russian stocks, mostly in response to the growing environmental pressures that Western companies have been experiencing. It used to be that Russian assets had a geopolitical & arguably political discount attached to them relative to their Western peers. I don't believe that is warranted anymore, because those risks pale in comparison with the environmentalist pressures that Western multinationals are facing. I currently own Gazprom (OTCPK:OGZPY) stock, as well as Lukoil (OTCPK:LUKOY) stock. I also decided to play the bullish energy prospects trend indirectly with the RSX (RSX) fund, because I believe the energy bull case is also a bullish case for the overall Russian economy.
I also bought Cameco (CCJ) stock back in 2017, because I felt then as I do now that nuclear power demand will skyrocket out of necessity. Recent trends towards smaller reactors that can be manufactured and installed far quicker, with less financial risk and commitment needed, are likely to accelerate nuclear power adoption around the world. The current energy crisis is likely to further stimulate interest in smaller-scale nuclear projects. I expect many such projects will be announced around the world in the near future.
As the price of energy will continue to rise this year and into next, with perhaps 2023 being the year when price-induced demand destruction trends will put an end to the price boom, I intend to reduce my exposure to Western oil & gas producers like Shell and move more into non-Western energy assets. It will take time for the public to start realizing the scale of the damage that the environmentalist movement is doing to the Western and global economy. In fact, there seems to be a coordinated effort by the MSM together with political elites to try to bury the roots of the crisis from the public perception of the situation, and in fact, they are using the crisis to advocate for the very policies that are at the root of the energy shortfall that has been the cause of the crisis. For this reason, I continue to regard Western oil & gas investments to be highly risky for the foreseeable future, given that they will continue to face a hostile environment.
Because it is now increasingly clear that renewable energy will have to be transformed into a form of energy that can more easily be stored and transported in order to prevent longer-term shortfalls or spikes in supply, leading to grid instability, it is worth having a look at which companies have a strong lead in hydrogen. Companies like Siemens (OTCPK:SIEGY) which produces hydrogen turbines or companies that are set to actually produce the hydrogen, such as Shell should be watched closely in this regard. Shell just opened the largest green hydrogen project, with green energy being transformed into hydrogen in Germany. That plant is set to produce 1,300 tons of hydrogen per year. This is a factor that should be increasingly taken into account when analyzing the prospects of energy companies, as well as many industrial conglomerates because it will be a growth industry this decade and beyond.
Finally, the effects that ESG will have on the global economy cannot be ignored. I expect major stock markets around the world to continue to gain in value, but it should be noted that it might not outpace inflation rates by much, if at all. The combination of energy shortfalls relative to expected demand needs for an expanding global economy and very accommodative monetary policies will result in higher inflation. The theory that it may all be just transitory is starting to look shakier by the day. There are already classical trends underway that tend to produce an inflationary environment that becomes self-sustaining. We are now at the stage where employers are starting to feel pressure to raise wage compensation in response to employees becoming more aware of the fact that the price they pay for essentials is rising at a robust pace. That, in turn, creates more inflationary pressure, because employers can only afford those higher wages by raising prices, while employees accept higher prices given that nominal wages rose, and also because once expectations of higher inflation ahead arise, consumers tend to spend the money sooner rather than later in order to lock in the lower prices. Once the trend takes root and it becomes self-reinforcing, it becomes very hard to stop it.
Perpetual inflation is not particularly good for business, but it does create upward momentum for stocks in nominal terms. In other words, revenues go up, profits may go up as well, at least in nominal terms, therefore stock prices should also be going up in nominal terms. Stocks thus become a hedge against inflation, but we should be careful not to assume that all stocks will perform that role. Some companies will be winners within the inflationary spiral, while others will find it very hard to pass on their rising costs. It is hard to discern which companies or sectors are likely to prevail and which ones are set to suffer from inflationary trends. There are many factors that can affect the determination of winners & losers, including government interventions. Overall, in real terms, once adjusted for inflation I doubt that stock market returns will greatly outperform inflation rates.
The overall long-term outlook for the economy & stock markets will be a reflection of the fact that we seem to be running out of energy growth. The simple fact is that we need energy growth in the form of energy that we can practically and reliably use, in order to produce economic growth. It is increasingly clear now that the environmental movement jumped the gun by promoting renewable energy that is reliant on weather patterns to be fed directly in the grid in large volumes. Only a small portion of our energy supply should ever be in the form of renewable, intermittent sources of electricity that are fed directly into the power grid. The rest should be transformed into hydrogen or other forms of energy or channeled into energy storage in order for us to better manage energy supply reliability. We are far from being able to do that on a very large scale at the moment, which is why we are facing an energy crisis, triggered by a shortfall in renewable energy in Europe, which came at exactly the wrong time, just as global energy demand is returning to pre-pandemic levels.
This crisis will not end with a return to favorable weather. It will continue given that ESG is helping to exacerbate an already dangerous situation in regards to the global oil & gas supply outlook, even as the green transition agenda is now proven to have gone on a flawed path, which can only translate in higher demand for hydrocarbons than anticipated. This situation is endangering the health of the global economic system. With that, it also endangers prospects of transition to a greener future. As we saw recently, it doesn't take much of a shortfall in energy supplies to push even the most environmentalist region, namely Europe to beg for more coal supplies in order to alleviate the shortfall and its effects. It turns out that governments will always feel compelled to prioritize keeping the lights and the heat on and make sure that transport chains are not broken before any environmental considerations can be contemplated. The ESG trend is a no-win situation for everyone given the current reality. Even if reality is being temporarily ignored, it cannot be escaped. The best investment strategy, therefore, is the one guided by reality. The challenge is to be able to grasp it, given a world that can only be described as progressively post-factual.