“The energy transition has been underway for years, driven by the natural push for more energy-intensive and lower carbon fuels. Covid-19 will cause demand shifts, and government policies will influence fuel choices.”

Last week, BP plc hosted a three-day webinar in which its executives laid out their strategy to transform the company from “an international oil company (IOC) into an international energy company (IEC).” Their tag line is that BP will be providing solutions for people’s energy needs. This transformation is designed to enable BP to shift from being a leading global oil and gas producer to a company with a more balanced energy portfolio including oil and gas resources, as well as wind, solar and biofuel energy. This is in keeping with the transitions other European-based oil and gas companies are making, largely in response to government and societal pressures to foster a net-zero carbon emissions world. Whether BP can make such a transition, while sustaining traditional oil and gas company superior financial returns, remains to be seen. BP’s CEO Bernard Looney has warned investors about that very challenge, as returns from wind and solar projects are substantially below those of traditional oil and gas projects. A tradeoff, however, is that the lower returns may provide greater stability, eliminating much of the volatility associated with the commodity cycle.

The energy transition environment is dense with topics for investigation, yet all are highly uncertain as to their eventuality, let alone their timing. Thus, logical and well-thought out structural presentations on how an energy transition might unfold can lead to materially different conclusions about the pace and the ultimate destination. There is no right or wrong answer. The process of arriving at the destination, however, is of greater value, as it allows for assessing possible alternative paths. The BP roadmap is based on its economists’ assessment of the probabilities of differing scenarios about social behavioral patterns and economic development unfolding. During Spencer Dale’s presentation, he often noted that there were conflicting scenarios about the uptake on issues such as mobility and the fuel mix of the global vehicle fleet. In effect, while the BP Energy Outlook focused on two scenarios that addressed carbon emissions more aggressively than in its business-as-usual outlook, Mr. Dale suggested his staff had considered other scenarios. He did acknowledge that all the models will be wrong.

There were several key points from the BP Economics presentation that should be considered when thinking about the energy transition. They should be considered because they are driving BP’s new business strategy.

Energy growth in all three scenarios only occurs in developing economies. That is the result of demographics, increased energy efficiency in mature economies, the shift of manufacturing out of mature economies and into developing ones, government policies restricting certain fuels while favoring others that restrict consumption in developed economies, and increasing levels of prosperity in developing economies.
For much of our energy history, a single fuel has dominated the total energy mix. Going forward, the rapid growth in renewable fuels will help provide a more diverse fuel mix. That increased fuel diversity will be driven by customer choice, rather than fuel availability. This comes as the wider range of fuel choices, as well as their greater abundance, means the fuels will compete more aggressively for market share, reducing the pricing power of suppliers.
In the company’s three scenarios, consumption of coal, oil, and natural gas drop while renewable’s share soars. Fossil fuels accounted for 85% of primary energy demand in 2018, but by 2050 they may represent between 20% and 65% of the share. “This would be entirely unprecedented. In the modern history of energy, there has never been a sustained decline in the consumption of any traded fuel,” said Spencer Dale, the chief economist at BP.
Renewables’ share of the 2018 energy mix was 5%, but it could represent between 20% and 60% by 2050. If this happens, renewables would penetrate the global energy system faster than any fuel in modern history.
There will be a long-term fallout from the Covid-19 virus that will limit economic growth and energy consumption throughout all of the next decade. The assumption is based on the belief there will be permanent changes in economic activity and behavioral adjustments reducing energy use.
Previously, BP assumed that only in the scenario depicting the most aggressive policy actions to address climate change, would peak oil use be pulled forward. Now, BP believes peak oil may have occurred in 2019.
Those scenarios (Rapid and Net Zero) describing an acceleration in decarbonizing and electrifying the economy ensure that wind and solar energy become the fastest growing energy sources. This will result in the need for between 300 gigawatts (GW) and 550 GW of wind and solar generating capacity, respectively, to be added yearly, at an annual investment of $500-$750 billion per year. That investment will exceed the amount of all upstream spending in the oil and gas industry.
The importance of hydrogen as a fuel carrier will grow during the second half of the 30-year forecast period. As a result, by 2050, hydrogen will supply 6% of the Rapid and15% of the Net Zero scenario fuel mixes. Hydrogen does not play a role in the business-as-usual scenario. Blue and green hydrogen will provide roughly equal shares of supply by the later portion of the forecast period.

A chart Mr. Dale spent time discussing focused on how the evolving energy future is impacting the shares of primary energy source in the Rapid scenario. From 1900 to 1960, coal was the dominant source of energy. In 1960, oil surpassed coal’s share, and four fuels – coal, oil, natural gas and nuclear - supplied all our energy. Going forward, coal’s share is in a strong downward trend, while renewables’ share is soaring. The one aspect about the future energy scene is that renewables growth is not driven primarily by economics and superior fuel performance, but rather by edict and policy. That is a key difference, as the energy output, space use and employment requirements of these renewable fuels mark a reversal from the historical evolution of energy sources.

Exhibit 16. How BP Sees The Energy Transition Happening SOURCE: BP

While Rapid’s energy mix chart is interesting, another BP chart shows primary energy consumption by fuel source for all three scenarios compared to 2018’s fuel mix. Coal and oil see their market shares shrink in all three scenarios, which is not a big surprise. The natural gas share remains stable in the Rapid scenario, but declines in Net Zero, but increases meaningfully in the Business-as-usual case. We were surprised to see hydro and nuclear growing in all three scenarios, given that we are tearing out dams and shutting down nuclear plants. We need to pay greater attention to the evolving energy markets in Asia, India and Africa. Again, no one should be surprised that BP sees the share of energy from renewables growing in all scenarios, and becoming the dominant share in Net Zero. That growth speaks to the magnitude of new wind and solar power capacity BP says needs to be added to the world’s energy supply, as well as the huge investment requirement.

Exhibit 17. Fuel Mix Will Shift In Each Scenario SOURCE: BP

JP Morgan Asset Management’s annual energy report produced a chart based on data from Professor Vacal Smil and BP covering the last three energy transitions. It shows each transition needing roughly 40 years to attain a 15%-20% share of the world’s primary energy consumption. Environmentalists will claim that the renewables revolution has required less time to reach the 15%-20% target. They will say that it wasn’t until 2010 that renewables became the new fuel. With that start date, it will look like the target penetration level was attained in around 21-22 years, assuming the target share is reached in 2031-2032, as suggested in BP’s Rapid scenario. On the other hand, if we mark the start of the political push to use renewables to NASA scientist James Hansen’s 1988 Congressional presentation. BP predicts the 15% share should be reached about 2025 and 20% in 2031-2032, a 37- to 44-year time frame. However, one might say that renewables have taken 130+ years to reach the target range based on the orange line in BP’s chart in Exhibit 18.

Exhibit 18. Energy Transitions Are Not Quick Affairs SOURCE: JP Morgan Chase

JP Morgan sees several similar energy trends as BP. These trends help explain how primary energy use will change as electricity and hydrogen become energy transit agents. A substantial portion of primary energy is wasted in the form of heat when fossil fuels are burned. This is how BP is able to project that under its Net Zero scenario, where renewables account for more than half the energy consumed, total energy use declines.

Exhibit 19. How Much Energy Is Lost In Combustion SOURCE: JP Morgan Chase

When we see which of the fuels powers key economic sectors, the challenges of the energy transition become clearer. For example, in the transportation sector, petroleum is the primary energy source because of its energy density and its liquid form, facilitating mobility.

Exhibit 20. Which Fuel Is Used Where In The World SOURCE: JP Morgan Chase

What these fuel mixes will look like in 2050 will be quite different, as electricity will account for much larger shares in the industry and residential/commercial markets, and most of the transportation sector demand.

Two other charts that support BP’s forecast show how energy-intensive manufacturing is moving from developed economies to developing (emerging) ones. This shift is one reason why carbon emissions in the developed economies, such as the United States and Europe, have been falling. This has been helped by the shift from coal to cleaner natural gas to power economies.

Exhibit 21. Global Manufacturing Shift Impacts Energy SOURCE: JP Morgan Chase

As a result, BP predicts that all the energy growth will be in the developing economies, which is also supported by the International Energy Agency (IEA) forecast by regions. As we have pointed out in the past, this shift will actually impact the pace of the global energy transition, as many of these countries will focus on using their domestic natural energy resources. In many cases, that means the increased use of coal. Coal energy is more labor intensive, helping governments address jobs for their rapidly growing populations. Secondly, renewables require the importation of equipment and hardware – wind turbines, solar panels and the like – that are not manufactured in-country. It requires that they have foreign currency, or they have to go into debt. Developing mines and clean-burning coal-fired power plants helps keep the money inside the country and the economy growing. This reality is why the climate change movement is aggressively targeting the financial community. It needs to block financing of fossil fuel energy projects to be successful, regardless of harm to local economies.

Exhibit 22. Energy Demand Will Be Primarily In Asia SOURCE: JP Morgan Chase

As Dr. Smil has forecast many times, energy transitions require decades to unfold. Today’s climate change push is designed to scare the world into action, by predicting that we have only a handful of years to address carbon, thereby we need aggressive via government actions. As Mr. Looney of BP stated in his concluding comments at the company’s strategy presentation, “people want cleaner, reliable and affordable energy.” This is what BP is striving to deliver. To truly be successful, it needs policymakers to incentivize carbon choices, i.e., overturn energy market dynamics, so investing in lower-return investments can be justified.

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