(Hints: How is the end of the commodity super-cycle affecting economies, industries andmarkets? We will look specifically at commodity price trends, emerging market growth andinvestment in renewables)
Key points for intervention
- Resource recession is not necessary an economic recession. The world economy is stillgrowing at a reasonable pace and projections are pointing towards a better year for 2015.Therefore the collapse in crude oil prices should not be construed as another economicdownturn. Instead, this commodity down cycle should be seen as a transition to a morebalanced world providing inflationary relief for importing countries particularly emergingmarkets such as India.
- Unsustainably low Crude oil prices can do more harm than good in the medium term. Ifoil prices stay below the band of USD 40-50 barrel for a prolonged period, it will negateall the demand stimulus we boast of today.
- First, the shale oil led alternative oil revolution is in danger: During the lastdecade, the world made substantial progress using new technologies indiversifying from conventional oil to alternative sources such as shale oil, oil fromsands and biofuel , thus providing much needed balance to the oil market. If thecurrent trend in oil price continues, it can derail this alternative path.
- Second, it can slow down the pace towards a low carbon growth path.Unsustainably low crude oil price could not only dis-incentivise the entire energyefficiency drive but also encourage people to drive more miles emitting CO2more.
- Renewables such as Wind is mostly decoupled from oil: Contrary to the generalperception, renewable sources of energy today does not compete in the same markets asoil and moreover its revenue models are not linked with oil prices. The dynamics of therenewable market has changed altogether in the last 15 years.
- Petroleum-based fuels contributes to a meagre 4% of power generation in theworld. When we exclude the Middle East, oil is insignificant in the electricitymarket. Whereas renewables barely compete in the transportation fuel marketswhich is dominated by oil. Electric vehicles and biofuel still have a minisculepresence in this mix. Most importantly, the market drivers are different.Renewables are scalable, cost competitive, environment friendly and ensuresenergy access & security. Therefore most governments will continue to bolster deployment of renewables such as wind in the energy mix. Despite theplummeting oil prices, movement towards renewables will remain unscathed.
- Revenue models or Tariffs for renewables such as wind energy and solar are notlinked to oil. Renewables are competing with either Coal or natural gas in mostmarkets today.
- Cost of Wind and Solar approaching Grid Parity with improved Economics: Duringthe last 5 years, series of innovation and improvements in operating efficiencyhave brought down the levelized cost of energy towards close to grid parity in keyenergy markets. For instance, on shore wind power is cheaper than new powerplants using fossil fuels in Australia, Brazil and so on. There are furtheropportunities to bring down cost of energy from renewable such as wind andsolar. Even though, the gas price are somewhat linked with oil prices in somemarkets such as Europe, renewables can compete as the economics haveimproved drastically.
- Renewable energy in Europe is driven by specific target and policy initiatives. AsBloomberg studies have shown spot gas prices in Europe although often indexedto oil have not exhibited a systematic pattern. As long as Europe remainscommitted to a low carbon economy path, carbon prices will support renewablesector growth.
- In case of US, Wind Power is already competing with low Shale Gas prices (USD3/mmbtu). In fact if Shale Oil production reduces due to changed economics, itcan simultaneously affect some supply of Shale gas as well, thus supporting higherGas prices. In any case, the federal and state level commitment towardsRenewable energy will drive wind energy.
- The renewable energy growth story in China, India and Brazil is unstoppable. Wedon’t foresee any impact of crude oil price slump on the renewable targets in mostemerging markets. In fact, these markets will add a major portion of renewableenergy capacity additions in the next 20 years.
- Biofuels and electric vehicles market could suffer to some extent. However, lowprices can drive efficiency.
- Envisaging for a sustainable oil price level: Going forward, we would like to see fair pricelevels for crude oil that can justify the economics of alternative sources of oil such as shaleoil, accentuate energy efficiency drive and hasten the transition to low carbon economy.
- Oil slumped almost 60 percent during the last 6 months, the most since the 2008 financialcrisis. The slump in the Brent crude price per barrel from $112.36 on 30 June 2014 to $46 on14 Jan 2015.
- The current oil price decline is mainly driven by an increase in supply complimented by littledemand growth in China. The U.S. pumped oil (particularly Shale Oil) the fastest rate in morethan three decades and OPEC resisted calls to cut production.
- In the US, paradoxically, a lower oil price could nudge gas prices higher: shale oil productionoften produces associated gas; fewer rigs fracking for oil would have the effect of marginallyreducing supplies of natural gas. Oil at $60/barrel could mean a natural gas price as much as$0.90/MMBtu higher than if oil was at $100/barrel according to BNEF.
- BNEF research also shows that at $75/barrel, as many as 19 US shale regions would beunprofitable. However, existing wells would not be shut as long as they cover their variablecost, which is much lower, often at around $20 to $30/barrel. Thus production is removedonly as well output declines, which would take 1-2 years in the absence of new frackingactivity in those regions. Overall Shale oil needs USD 60 plus to achieve a breakeven.
1. World Electricity Generation by source (Terawatt hours)