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Oil investors have decades ahead of them: Morningstar

Lewis Jackson  |  14 Dec 2021Text size  Decrease  Increase  |  
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Oil demand is set to dodge the precipitous collapse forecast by energy bears in place of a modest decline over the three decades to 2050, according to new research from Morningstar.

Rapid adoption of electric vehicles and trucks in the years to 2050 will be offset by continued demand for oil in difficult-to-electrify sectors such as shipping and air travel as well as industries like plastic making. The report also forecasts how the politics of carbon taxes are likely to mute their impact across the globe.

The death of oil has been greatly exaggerated, says Morningstar senior equity analyst Preston Caldwell in November’s Morningstar Energy Observer.

“We project oil demand to peak around 2030, with demand decreasing only gradually after that,” he says.

“The business-as-usual scenarios reflect pessimistic attitudes when it comes to major clean technologies like electric vehicles. On the other hand, the bear scenarios reflect very rosy assumptions around the implementation and efficacy of carbon policy.”

Caldwell’s base case sees oil use shrinking 11% by 2050 compared to 2019 levels, versus the 46% drop expected by energy bears. Business-as-usual forecasts expect a slight rise of 4%.

Declinist forecasts rely on falling oil use in passenger vehicles, road freight, air travel and shipping, thanks to electrification, renewable fuels and high carbon taxes. Caldwell concurs with bullish forecasts for electric vehicles but argues other sectors lack economically viable renewable alternatives.

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“We see a lot of hand waving assumptions around how fast the energy transition can play out in many sectors,” he says.

“For planes, we see very little ability for oil to be disrupted by substitute fuels owing to exorbitant costs. For ships, we think displacement of oil by green ammonia will be modest.”

Petrochemicals, a key input into plastics, highlight the dilemma for those forecasting an end to oil. Demand is set to rise, with plastic use tracking GDP since the late 90s. Plant-based alternatives complicate recycling and have dubious environmental benefits once land use is factored in.

“Plastics are indispensable to the modern economy, and they have no feasible substitute other than recycling,” says Caldwell.

He forecasts petrochemical demand to grow by over 60% by 2050 even after assuming a steady increase in plastic recycling.

Stronger for longer oil demand means billions in investment are still required to keep enough supply in the system, says Caldwell. Contrary to doomsday predictions, this should translate into decades of cash flow for shareholders in the form of dividends or buybacks.

The bullish forecasts come as local energy producers splash out on new projects and acquisitions even as they eye a lower carbon future.

In November Woodside greenlit a $16.5 billion gas mega project and confirmed its merger with BHP’s petroleum assets. It claims new gas fields will speed Asia’s transition away from coal. Weeks later it earmarked another $7 billion for green hydrogen and ammonia projects.

Oil Search (ASX: OSH) and Santos (ASX: STO) confirmed their merger last Friday in a move that’s set to double production at the new $22 billion market cap firm.

The spending comes against a backdrop of bumper profits from surging global energy prices. Third quarter revenue at Woodside Petroleum (ASX: WPL) jumped 19% in October as supply shortages and a rapid demand rebound sparked vertiginous price hikes in oil and natural gas.

Energy remains one of the few undervalued sectors in an Australian market that Morningstar views as overvalued. The median price to fair value ratio for energy is 0.7%—a median discount of 30%—versus 1.14% for the ASX as a whole.

Cost not carbon prices to drive change

Carbon prices dominate discussions around the future of energy use, but in practice may be less important than originally thought, says Caldwell.

The reason is twofold. First, steep carbon prices are unlikely to come to pass because of the political backlash. Proposed hikes to diesel taxes in France sparked the 2018 gilets jaunes that forced President Macron’s government to backtrack. In their absence, any transition from oil hinges on the availability of cheap renewable sources.

The future of oil will be determined by falling costs for alternatives, not carbon taxes, he says.

“If substitutes to oil are able to achieve cost parity (as we expect with electric vehicles), then even gentle policy interventions can make a big difference.”

And the rapid price declines that typified wind turbines, solar panels and electric batteries may not repeat for the speculative technologies required to cut out oil in shipping or aviation, says Caldwell.

Green hydrogen—produced using renewable energy—is the most promising candidate, whether burnt directly or made into combustible ammonia. Fortescue Metals founder Andrew Forrest is betting billions it will power difficult to electrify processes.

Caldwell is more circumspect, giving 50:50 odds it can be produced at the economically viable price of US$2 per kg in 2050.

“Dramatic cost reductions in both electrolysis and renewable electricity will be needed to reach the goal of $2 per kg,” he says.

“The reports that are upbeat on green hydrogen assume large electrolyser cost reductions despite this lack of a track record.”

Oil use to concentrate in emerging markets

The future of oil lies in emerging markets, with demand set to decline across the major advanced economies and China in the years to 2050.

Faster economic growth in developing countries relative to the developed world will drive the shift, says Caldwell. He forecasts oil demand to fall by 35% in the US, Europe and other advanced economies such as Australia. China, the driver of oil demand for the last two decades, will see use fall by 17% as it aggressively embraces electrification.

Most emerging economies will struggle to follow China’s lead in cutting oil demand, says Caldwell. China is investing heavily in electric vehicles with an eye to dominating the future industry, an ambition few developing countries can follow. It will also be difficult to electrify industry and transportation given limitations in state capacity and investment.

is a reporter and data journalist with Morningstar. Tweet him @lewjackk or get in touch via email

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