September 6th, 2012
by Elliott Morss, Morss Global Finance
Energy transitions are fascinating. But when it comes to investing, take care. History tells us that during transitions, much money is made and lost as bets are made on different technologies. Just ask T. Boone Pickens! Right now, there is considerable displeasure with our energy uses. To those concerned about global warming, any fuel that emits CO2 is bad, i.e., coal, oil, natural gas, biomass, and electricity generated from any of these. To those concerned about being dependent on the politically dicey Middle East, oil (primarily gas, diesel, and jet fuel) is bad.
But there is a prior question: are we really in an energy transition or are we really just hearing a lot of misguided talk with no connection to reality? In this article, I address this question by looking at the numbers. I then ask whether there are some sure bet investments we should make.
Looking Back at Energy Transitions
Global history is interesting. Many activities/events reoccur with similar patterns. Energy transitions are a case in point. We started as cave men. Why the cave? Because caves protect men from animals and weather. But man realized he was smarter than animals. So animals became food and were collared to supplement man’s labor. Man figured out how to generate heat via combustion. He used the heat initially for warmth and cooking. And then, another important discovery: something round will roll. And that led to the wheel. Put an axle between two wheels with a cart on top and get an animal to pull. That was man’s mode of transport for centuries. In the eighteenth century, a transition began whereby the increased use of coke and coal to produce steam transformed production and transportation, spurred urbanization, and lead to fundamental changes in the way of life.
The steam engine: should it have been used to power vehicles? Some think so. But the Stanley brothers did not aggressively market their product. The internal combustion engine made petroleum a critical source of energy while electricity made from burning coal and falling water became essential to modern life. And on the oceans, ships were powered by wind. But wind is intermittent (sound familiar?). But then probably the greatest engineer ever – Isambard Kingdom Brunel – developed the first propeller-driven steamship.
In each of these transitions, older sources of energy continued to be used as newer ones came on line. Each transition was tied to sweeping changes in technology, economy, culture and politics. There are multiple factors that fostered, hindered, and modulated these transitions: the role of governments, the availability of capital, the pool of knowledge and its application, the adaptability of social arrangements, and the distribution of social costs. And there is much to be learned from the analysis of dead ends. For more on the history of energy transitions, see Daniel Yergin’s great book, The Prize.
Lessons from the Past
What are the key lessons to be drawn from this very brief review of energy transitions for today’s world?
- During past energy transitions, much money was made and lost as various actors tried to guess which new technologies would succeed.
- Money-making energy choices are not always the right ones. Deep pockets, government subsidies and aggressive marketing can turn a bad choice into a winner.
- Transitions take a long time. This happens in part because the infrastructure needed for new energy technologies is expensive. And as long as the old energy providers can make money selling their product, they will.
Globally, energy consumption has increased by 126% since 1971. In the US, energy consumption is up 20% over the same period. Table 1 compares energy use in 1971 with uses today for both. Fossil fuel use is down for both because of the drop-off in oil use. But in both cases, coal consumption is up as is the use of nuclear energy. The share of natural gas is up for the world but down for the US. And renewables? No change for the world and up slightly for the US. And the prominent renewable is biomass. As I have indicated elsewhere, the CO2 emissions from biomass are about the same as oil, lower than coal.
The above numbers do not convince me that a significant energy transition is underway. Fossil fuel use is down a bit, but over the next few years, it might go back up as nuclear use falls resulting from fears generated by the Fukushima nuclear disaster. What can we learn by looking ahead? The US Energy Information Agency has developed a model that looks ahead. Table 2 compares 2009 uses with 2035 projections.
And like looking backward, looking forward does not convince me that a significant energy transition is underway.
But let’s think “outside the box” for just a moment. The EIA model does not take account of growing concern over nuclear. Nor does it factor in what will happen to oil prices as the growing middle classes of China and India buy motor vehicles. In an earlier piece, I calculated that if vehicles per capita in China and India got to just half the US density, oil demand would grow by 40%! This is not going to happen. There will half to be at least a “mini-energy transition” in auto engines. And then there is the “natural gas boom” in the US.
Natural Gas in the US
We hear about this almost daily. Either that natural gas prices have plummeted or that fracking for oil shale will destroy the environment. There are also suggestions that natural gas will make significant inroads into the US coal market. For example, Marc Anthony has written an interesting article with informed comments on this subject.
Well again, let’s look at the numbers. In particular, let’s ask whether US natural gas supplies, with or without fracking for shale, are large enough to make significant inroads into the coal market. Table 3 provides data on US natural gas reserves. And certainly, the growth in US shale reserves has been impressive, from 34,xxx quadBTUs in 2008 to 97,xxx in 2010. And that growth has surely continued in 2011 and into 2012. And this growth is by itself responsible for all the growth in natural gas reserves.
But the final column in this table is worth noting. In 2010, the US consumed 7% of its proved reserves (22,239/304,625). If US natural gas reserves did not grow, that would mean the US has only 13+ years left of natural gas supplies. Of course, natural gas reserves will grow. But how much? And what if there is a “fracking incident”, like the water supply of a major city is contaminated?
And let’s keep this in perspective. At current consumption levels of coal, the US has 270 years of proved reserves left.
Betting on Natural Gas
But despite all this, you might want to join T. Boone Pickens and bet on natural gas. Yes, this is the same Pickens that was telling us last year to bet on wind mills. If you do, I suggest you consider the Clean Energy Fuels Corp. (CLNE). CLNE is “building America’s Natural Gas Highway”. It is planning to build 150 liquid natural gas (LNG) filling stations across the country and expects to have 70 completed by the end of 2102. It also has a number compressed natural gas (CNG) stations.
It does not make money and is not expected to in the near future. At the end of 2011, it had $238 million in cash for its investments. That was down to $173 million by the end of June 2012. For an interesting discussion of its prospects, see the article by David Wren and the comments following the article. So what will happen?
- Will there be enough trucks equipped to use LNG to allow CLNE to generate a profit before its funding runs out?
- Will it be bought out for a nice capital gain for its investors, or
- Will it run out of money and be forced into liquidation?
Who knows? I am not that sort of gambler.
Is there a major energy transition underway? I don’t see it. Right now, low natural gas prices in the US are causing real problems for the renewables. How long will natural gas prices stay down? Will natural gas reserves grow enough in the US so it can be considered as a long term fuel?
Investment implications? Oil companies. They have big pockets. When they run down their oil reserves, they will launch renewables or some other form of energy. Too bad we can’t invest in Saudi Aramco, Gazprom, or the National Iranian Oil Company, the three largest oil companies in the world. ExxonMobil (XOM), PetroChina (PTR), BP (BP), and Royal Dutch Shell (RDS-A) will just have to do. Or you might prefer an oil company ETF, like VDE or IXC.
Author's Disclaimer: I am not an investment adviser and nothing I write should be taken as a recommendation to buy or sell an asset.
Elliott Morss has a broad background in international finance and economics. He holds a Ph.D.in Political Economy from The Johns Hopkins University and has taught at the University of Michigan, Harvard, Boston University, Brandeis and the University of Palermo in Buenos Aires. During his career he worked in the Fiscal Affairs Department at the IMF with assignments in more than 45 countries. In addition, Elliott was a principle in a firm that became the largest contractor to USAID (United States Agency for International Development) and co-founded (and was president) of the Asia-Pacific Group with investments in Cambodia, China and Myanmar. He has co-authored seven books and published more than 50 professional journal articles. Elliott writes at his blog Morss Global Finance