This Oil Bust Will Change The Energy Industry Forever

We are in an enormous transition with sweeping implications for global financial institutions, energy demand and supply, and regulation.

As an investor in start-up companies, I am always working to test my assumptions and update my understanding of where the energy sector is now, and the direction it is moving in towards the future. Some key questions for this dynamic year: Is the current oil crisis the marking of a step change towards a cleaner energy industry or merely history repeating itself? While today’s oil price at $45-50 per barrel is probably too low to be considered the new normal, what should we expect moving forward?

One thing is for sure: change is coming. Although demand for oil and gas will continue for decades to come, it will gradually diminish as renewable energy sources rise. A lot could happen between then and now. The International Energy Agency (IEA) and many other credible parties continue to forecast that our growing world population from 7 billion people today to 9 billion by 2050 will need much more energy – in particular as most of these people will aspire a life like we have here in North America. So it is no wonder that Abdalla El-Badri, Secretary General of OPEC has recently said that if producers don’t invest in new oil and gas supply, we could see oil prices as high as $200 a barrel. On the other hand, there is Bob Dudley, CEO of BP , who believes we won’t see $100 oil again “for a long time”.

Innovation in the oil industry, particularly the North American revolution in the hydraulic fracturing of tight oil reservoirs, has changed oil supply dramatically. With smaller, more flexible capital-light projects and shorter lead times, fracking has enabled greater adaptability to volatile market conditions. The outlook for shale oil and gas could be just as strong in many places in the world. Even if the shale boom proves tough to replicate (due to factors such as regional differences in geology, regulation and incentives to land owners), in many cases bringing new technologies to mature fields will help keep supply up and dampen the increase in oil prices.

Sluggish demand is another important factor keeping oil prices from rising. Not just from disappointing growth in China, but also in North America. Car ownership in the Western world has started to drop in the past decade, especially among young people. Based on the early success of Tesla and arrival of car sharing companies like Car2Go and Uber, and the entry of Apple  and Google  in the autonomous-driving car game, there’s reason to foresee a future where not everyone has a personally owned internal combustion engine at their disposal. Change is slow however: a truck or bus and many gasoline fueled cars sold today will of course drive somewhere in the world for the next 30 to 40 years. Hence, some demand for hydrocarbons will continue.

The financial sector is a third factor inhibiting the rise of oil prices. While we already see many financial institutions divesting from hydrocarbon stocks to the tune of $2.6 trillion because of social and environmental pressure, the recent speech by Bank of England Governor Mark Carney is further going to influence the willingness of large financial institutions to continue to invest in traditional hydrocarbon projects in the future. One of the most significant risks Carney focused on in his speech is transitionary cost, the cost of write-offs for traditional hydrocarbon assets if countries are indeed getting serious about phasing out hydrocarbons. Even while the target date for a 100% carbon free society is only 2100, we expect that policies will likely start having significant implications in the next decades. The message is that “Sustainable Innovation” may become key to future energy financings and that oil and gas companies will have to innovate much more than they do today in order to survive as energy-producing Fortune 500 companies in the decades to come.

And what of Canada’s oil sands, which historically have strictly been developed by large megaprojects with long lead times, high CAPEX and strong economies of scale. With the current oil price outlook of $55 per barrel in 2016 to $65 per barrel in 2017, and the fact that oil sands production will remain challenged environmentally, many doubt that any new oil sands projects will be started in the next 5 to 10 years. Cost cutting and incremental efficiency innovation will likely ensure that existing projects will be profitable at the current low prices, but lacking some spectacular new innovations, longer term most Canadian oil sands reserves will likely remain undeveloped. What the oil sands need is new cost effective, modular, scalable and sustainable innovation with lower CAPEX and much quicker to develop to ensure greater flexibility. To make this a reality, a multiple of current investment in innovation would be necessary in the next years for deployment of breakthrough new projects 5 to 10 years from now at the earliest. It really is a case of innovate or die.

We are in an enormous transition with sweeping implications for global financial institutions, energy demand and supply, and regulation. But does anyone really care and will COP21 be a catalyst for meaningful change? Hopefully this will become much clearer in Paris this December, with firm commitments forcing an acceleration of change fuelled by innovation, very possibly the only card to play.

W.v.L. 

C.E.V.C.