Commentary: Four Supply and Demand Imbalances That Foreshadow Rising Energy Risks – Geoffrey Cann – Canadian Energy News, Top Headlines, Commentaries, Features & Events

Energy risks are suddenly front page news, but the signs were there all along, provided you knew what to look for.

These risks evolve from basic supply and demand forces in the energy industry. Balancing the supply of, and the demand for, energy perfectly, with all its necessary infrastructure and services, all the time, everywhere, for everyone, across all energy products, is pretty much impossible. Misalignments are frequent, and create both risks and rewards.

Here are four looming imbalances that will make some energy industry participants incredibly rich and give others savage haircuts.

Transmission Infrastructure Delays.

The timelines for getting new energy generation and transmission infrastructure approved in the developed world are lengthening, and to levels that are totally misaligned with decarbonization commitments, according to this research from Arbo.

Across North America, getting approvals for such facilities (power lines, pipelines, power generation plants, wind farms, solar farms) in the face of landowner opposition, environmental activism, and regulatory dysfunction is now the single greatest risk that project proponents face.

Europe has halted any new pipeline construction from its former key gas supplier, Russia, and is unlikely to ever bring Nord Stream back on-line.

Canada’s federal government had to bail out the country’s last big national pipeline project 6 years ago to keep it alive. No new pipeline projects are under serious consideration.

Meanwhile, global energy demand continues to grow.

This yawning gap between projected energy needs and the pace of supply of new energy infrastructure confers an artificial advantage to incumbent energy suppliers that can expand existing capacity without needing extensive new approvals.

Example winners are pipelines that can add compression to boost throughput, power corridors that can boost line capacity, and any operator that can reduce downtime with improved maintenance.

Crude Carrier Shortfall.

There has been a collapse in the order books for very large crude carriers (VLCCs, ships that carry two million barrels or more of crude oil).

There are 910 VLCCs of all ages currently at work moving crude oil to market, and they have a useful life of 20 years, give or take. Every year, the global shippers retire the oldest 5% of the fleet which is 45 or so ships, and order replacements for the retirees as well as new ships for market growth. It takes 2-3 years for the ship building industry to build and commission one of these ships.

No new VLCCs will be delivered at all in 2024 and just one in 2025. Spot rates for chartering a VLCC breached US$100k per day in 2023, double the long run average. Shipyards have no capacity to expand, as they are flat out building LNG carriers and container ships.

Ship owners are concerned that new VLCCs, which are intended to earn a return for 20 years or more, will become stranded well before their time is up. By not building new ships, they will win big as the day rates for their ageing fleet stay elevated. Consumers will all lose as fossil fuel energy prices rise because of this shipping bottleneck.

Producer Consolidation.

You’ve no doubt noted this recent round of producer consolidation.

ExxonMobil has bought Pioneer Resources. Chevron has acquired Hess. APA Corp (Apache) has purchased Callon Petroleum. Occidental has merged with CrownRock Minerals. Chesapeake Energy and Southwestern Energy aim to merge and create a new entity.

Market consolidations trigger all kinds of supply and demand imbalances. For example, a huge number of oil and gas professionals are about to get packaged out from the acquired companies, creating an excess of job seekers into markets that normally grow at an annual 2-3% pace. Many will struggle to find work.

Acquirers pay for their purchases by capturing cost reductions afforded by their new larger scale of operations. That means some suppliers (usually those in the service of the acquired) lose, and those serving the acquirer win. A huge group of lawyers, bankers, auditors, engineering firms, consultants, and service companies will all see losses of business.

Of course, none of these risks are manifest until the transaction is well along, and then suddenly, a thousand people are laid off.

Wind Farm Development Crash.

Sometimes, it’s not energy markets themselves that break, but their key inputs.

As part of their decarbonization commitments, power utilities on the US east coast contracted for new off shore wind farms before and during the pandemic, and a handful of global energy businesses piled in to compete for these choice long term contracts. Power agreements struck at the time reflected the prevailing low interest rates, well-functioning global supply chains, labour market certainty and low commodity prices.

This segment of the energy industry ultimately went pear-shaped as input commodity prices for steel, aluminum and copper jumped, interest rates doubled, supply chains were delayed, and labour costs rose. Capital costs for these wind projects rose between 10 and 50%, rendering them uneconomic.

Danish giant Ørsted simply cancelled two projects (Ocean Wind 1 and 2), taking a 30% stock price hit. BP and Equinor wrote down their off shore projects by $540m. Shareholders lost big.

Power utilities are now behind in their commitments to decarbonize, and may now have to purchase credits or higher cost green power, if it’s even available, and plans to adopt green energy are now years behind.

What Should You Do?

If any of these imbalances impact you directly, you should be making contingency plans now.

Brace for Impact.

Employees of oil companies that have been acquired, for example, should be buffing up their resumes and updating their LinkediN profiles. There are plenty of jobs emerging in new energy areas (hydrogen, carbon capture, and geothermal), but you’ll need to position carefully for them.

Oil shippers need to anticipate severe capacity constraints for the next few years. FOB terms will be fashionable. Longer charters will protect trading margins. It’s no surprise that big oil companies have been beefing up their trading arms of late. Buyers should be gearing up their hedging strategies.

Energy companies with operating infrastructure (pipelines, power lines, generating plants) need to double down on plans for incremental capacity addition, operations optimization, and maintenance improvements. Growth will be less through the shovel and much more through the tough slogging of improved business practices.

Get Ahead Of The Curve.

Beyond planning for these disruptions, try to get ahead of energy risks.

Broaden your reading list.

Is your reading list dominated by the publications that directly address your sector? Look beyond this narrow focus and keep an eye on energy factors beyond your peer group.

Read your history.

Energy markets are sophisticated and well documented, and these supply and demand forces are likely repeats of the past. You’ll likely find events in the past that closely mirror those of the present day, and how energy market participants reacted in the past hold important, and importantly, profitable lessons.

Engage with an old-timer.

Where energy markets are poorly documented and monitored, then your next best source of insight is the elder statesmen of the industry. Europeans call them ‘grey-haired gold’. Their experience is particularly valuable in very niche areas which have escaped the attention of industry analysts.

Bring New Tools to Bear.

Your final move, if you have the resources, is to bring modern tools to help your business get ahead.

Digital twin modeling.

Digital models of existing plants and networks are great places to explore the impacts of more extreme conditions, such as a collapse in demand (caused by a take over of a key client), or a feedstock supply failure (as with a shortage of crude carriers).

Game Play.

A variant of the digital twin is the use of game theory to run simulations of market factors. Games can be incredibly powerful ways to surface competitive dynamics, the impacts of a change in capital stock, and the likely behavior of customers in the face of disruption. Game theory used to be an all-too-costly strategic tool that was out of reach for many organizations, but no longer.

Industrial Modernization.

Most energy companies are still at the early stages of modernization driven by digital. It’s now time to accelerate to a future of cloud computing, workforce mobility, and generative AI.