Trends And Changes In The Global Energy Market
May 31, 2016
by Marianne Brunet
Michael Mauboussin’s 10 Attributes of Great Investors [Pt.1]
In 2016, Michael J. Mauboussin completed his 30th year on Wall Street. The analyst, who was working at Credit Suisse at the time, decided to celebrate by reflecting on the ten attributes of great investors he had observed over the previous three decades. He published his ideas in a report in August 2016. I've summarised Read More
For 30 years, the conventional wisdom in the energy industry has been that the price of oil will go up because it is a scarce resource with exponential demand growth. Therefore, energy companies will be profitable – at least in proportion to their oil reserves. But according to Amy Myers Jaffe, this blind belief is completely wrong because of structural changes in the energy sector.
Jaffe is a leading expert on the geopolitics of oil and gas and energy security; the executive director for energy and sustainability at the University of California-Davis; and the chair of the World Economic Forum (Davos) Global Agenda Council on the Future of Oil and Gas. She spoke on May 9 at the 69th CFA Institute Annual Conference in Montréal on trends and changes in global energy markets. A replay of and slides from her presentation are available here.
From 2003-2011, she said, institutional investors could basically “throw a dime” and make money investing in shale. “Well, that’s not going to be true anymore,” she said. “Now you’re actually going to need to know what you’re doing.”
Jaffe predicted that we will see a dramatic change in the long-term competitive outlook of the oil sector because of improvements in technology. She argued that technological innovations will have far-reaching effects on both supply and demand in the global energy market, and that this will lead to transformational structural changes “that will further decouple energy use and economic growth.”
Why energy markets are changing
Jaffe explained that recent decades were marked by exuberance in oil and gas markets because of three assumptions: reserves will eventually deplete; oil production is inherently expensive, and therefore prices need to stay high to cover costs; and there will be insatiable demand because the growing middle class in the developing world will want to live the same lifestyle enjoyed in the West.
According to Jaffe, though, these beliefs are fundamentally flawed because they fail to account for technology-driven changes.
First, Jaffe explained, countries and businesses will no longer be able to assume that an asset pulled out of the ground will be more valuable in the future. This is because there are now sophisticated techniques to extract oil from many different sources. Innovations are allowing us to expand production to a wider variety of locations, alleviating concerns that resources are being depleted.
Second, innovations that render the extraction process more effective are already pushing costs down. Jaffe confidently asserted that upstream costs will not be a driver of high oil prices in the future, contrary to conventional wisdom in the oil industry.
Third, Jaffe said, investors can no longer assume that there will be exponentially growing demand from emerging markets. Energy demand will continue to grow as emerging economies develop. However, she added, the demand from countries like China will slow in coming decades as the pace of Chinese industrial growth slows. Jaffe also posited that, although the middle class of developing economies will increasingly demand energy, their needs will be met with a lot less fuel because of efficiency gains.