Despite a wider uptake of alternative energy, fossil fuels like natural gas, oil and coal are here to stay for the next decades and the MSCI Global Energy Composite index will outperform both renewable energy stocks and the broad equity market over the next year, JP Morgan Asset Management said in its 2022 Annual Energy Paper.
The US asset manager, handling some 2.2 trillion dollars on behalf of clients worldwide, expects persistently strong demand for oil and gas, even as renewables like wind, solar and hydrogen will become increasingly important.
“Some of the most ill-advised things I’ve ever heard about energy were said during the spike in renewable energy stocks in 2020,” said Michael Cembalest, Chairman of Market and Investment Strategy for J.P. Morgan Asset Management.
“The short version: ‘fossil fuel stocks are dead money since the renewable transition is irreversible, ready to power large economies and rapidly displacing the former. Irreversible, yes. The rest of it, not so much,” he said in the paper, titled “The Elephants in the Room”.
Consumption set to surpass pre-Covid levels
In its 2020 and 2021 energy paper, JP Morgan had argued that stars were aligning for a substantial rebound in oil and gas profitability, supported by industry cash flows and sharp increases in oil demand. It foresees further demand increases next year.
“The reason: poor oil & gas stock price performance was the result of management decisions to focus on market share and revenue rather than profits, and not because of imminent displacement by renewable energy. The big picture: global gas and coal consumption in 2021 were already above pre-Covid levels, and global oil consumption should surpass pre-Covid levels sometime next year.”
Looking further out, some forecasts of oil demand in 2030 and 2040 are not that different from today. “We also estimate that the US might need almost as much natural gas in the year 2035 as it consumes today, based on assumptions we made on wind and solar growth, EV and heat pump adoption and the decommissioning of coal and nuclear plants,” Cembalest wrote.
“With energy demand still in excess of supply, I believe the MSCI Global Energy Composite will outperform both renewable energy stocks and the broad equity market again over the next year,” he said.
Europe’s miscalculation
Addressing European energy markets, he said that Europe miscalculated by reducing its production of fossil fuels much faster than it reduced its own consumption of fossil fuels, and subsequently is caught in the vice of Russian energy reliance.
“Ramifications for Europe include: a likely recession; energy consumption displacing non-energy goods and services; a lower rate of growth and a decline in competitiveness of exported energy intensive goods; risks that ‘cold turkey’ withdrawal from Russian energy will require curtailment of industrial production (steel, fertilizer, cement etc) and related employment; higher food prices; and domestic political tensions as anti-establishment candidates take advantage of distress.”
To change course and replenish oil supplies, Europe will eventually need to arrange a deal with Iran. To replace 2.6 million barrels/day of Russian crude oil imports requires 800.000 via the US and 800.000 through increased production from Canada, Norway, UK and Denmark. “Anything else could require a deal with Iran which still exports 1.3 million barrels/day less than in 2018.
Gas substitution is a lot harder, the paper said. Europe imports 174 billion cubic meters (bcm) per year from Russia, and “our understanding is that there is not a lot of spare LNG regasification capacity”. Spanish LNG regasification utilisation rates were only 45 percent in January but it has limited pipeline connections with the rest of Europe.
Diversification
“My guess is that Europe gets part of the way this year through diversification and then has to rely on longer term adjustments. Faster wind and solar? Installations are often constrained by transmission delays and local factors. Electrification of residential heating? So far, mostly confined to Scandinavia,” Cembalest wrote.
Building more LNG regasification capacity is expensive and time consuming. Greater use of nuclear power is an unlikely option as Europe has been abandoning it, except for France.
“Europe is not the only region at risk: on a global basis, capital spending on oil and gas production is declining while oil and gas consumption is not. Many countries are now faced with three broad choices: ramp up their domestic production of fossil fuels to avoid a geopolitical and economic trap; rely on exporters; or confront the obstacles to a faster renewable transition head-on.”
The last option is not something that can be accomplished by increasing the cost of capital for fossil fuel companies, JP Morgan said. Accelerating the energy transition also requires efforts by policymakers. “Without these efforts, decarbonization will remain stuck in the slow lane despite all the corporate disclosure rules, shareholder resolutions, ESG policies, etc,” Cembalest wrote.
Click here to read the JP Morgan 2022 Annual Energy Paper.
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