Published June 2021
The oil and gas sector has been one of the most disliked and out-of-favor sectors among investors for a while now.
Some traders have played with it short-term due to the global reflationary rebound, but few investors are willing to commit to it long-term at this point. It’s nothing more than a post-pandemic transitory bump in most peoples’ minds. The general consensus is that solar and wind technologies will take the oil and gas sector down over time, so there isn’t much opportunity left.
Investors piled into the sector a decade ago, constantly providing funding to shale companies that destroyed capital with drilling activities that were not free cash flow positive, while oil majors made bad acquisitions at cycle highs and suffered major write-downs as well. As a result, the sector’s total returns have been abysmal since 2008:
Now, after a decade of financial losses in the sector along with rising ESG mandates to restrict capital to the sector, there isn’t much funding for oil and gas companies or pipelines.
The companies in the sector don’t get rewarded by investors for reinvesting in growth anymore; they get rewarded by strengthening their balance sheets, being disciplined with drilling, producing free cash flow, and returning a lot of that cash to shareholders.
Due to this, I think there’s a good case to hold high-quality oil and gas producers and transporters over the course of the 2020s decade, and/or to buy far-out 2024/2025 oil futures. This lack of investment in the sector is setting up a probable shortage and structural bull market that could very well last longer than investors think, as we move into the years ahead.
Back in mid-2020, folks were pronouncing the energy sector dead. Now, as of this writing in late June, oil and gas companies in the US shale industry, and more broadly among publicly-traded independent oil companies, are on track to make record free cash flows in 2021:
Chart Source: Bloomberg
While this trend will have its ups and downs based on the economic cycle, there’s a good case for a more structurally positive environment for free cash flows and shareholder returns going forward for the oil and gas industry this decade than has existed for a while.
I published two bullish articles on oil/gas/uranium back in October 2020 within my research service, and we’ve had quite a move up since then in terms of price. However, I still think there is a longer bullish trend ahead of us, so this is the public expanded piece on energy, drawn from those two earlier pieces.
- The Authors of Bull Markets
- Global Energy Demand Overview
- The Difficulty of Replacing Prior Energy Sources
- Beyond Energy: Hydrocarbon Products
- Green Living vs Green Signaling
- Case Studies: Germany and India
- Investment Outlook
The Authors of Bull Markets
The well-known natural resource investor Rick Rule has a quote for the natural resources sector: “Bear markets are the authors of bull markets, and bull markets are the authors of bear markets”.
When commodity prices are high, whether it’s gold or oil or copper or something else, it attracts a ton of producers to spend money on exploration, development, and extraction of those relevant commodities. This tendency, combined with cyclical demand, eventually results in a period of oversupply, which leads prices to crash.
When commodity prices are low for a while, few entities want to invest capital into the space to find and produce more supply. Eventually, demand outpaces supply and causes an imbalance, rocketing up the prices. This starts the cycle anew.
Price serves as a signal and incentive for producers to come out with new capex and supply, or to curtail capex and supply. It also serves as a signal for consumers to use those commodities liberally, or to tighten up their consumption habits.
That’s why the commodity sector is a very boom/bust type of business compared to many other sectors. Since it is a mostly uniform product, producers have very little pricing power or customization to differentiate themselves. It’s a “commoditized business” in other words, in the truest sense of the phrase. The only economic moat a producer can have is to own the lowest-cost sources of supply.
If we look at a broad measure of commodity prices, we can see that the 10-year compounded price change tends to hit extremes to the upside or the downside at relatively regular intervals, albeit with long spans between those extremes:
Chart Source: 2021 Incrementum IGWT Report
During the 2010s decade, North American shale production kicked into overdrive. With the cost of money so low and new technologies becoming available, investors asked if they could, not whether they should, produce a ton of shale oil. And the answer was yes, they could.
Chart Source: US Energy Information Administration
Many producers weren’t sustainably profitable; they just kept drilling semi-unprofitably, focusing on growth and relying on issuing equity and debt to finance their efforts. The oil price crash in 2014 due to oversupply was their signal to pack it up and stop for a while, but then they started again, and eventually were crushed by the 2020 pandemic shutdowns.
Since 2014, oil has been in a 7-year price trough, as part of a longer 13-year bear market from its peak price in 2008.
Chart Source: St. Louis Fed
A chart I put together a couple months ago was the 5-year cumulative percent price change for oil over the past century and a half. It filters out year-by-year fluctuations in this volatile market, while still focusing on the rate of change. In addition to oil, it shows the 5-year cumulative percentage change in the broad consumer price index as well:
The oil bear market we have been experiencing is one of the three worst ones of the past century.
As one would expect, after the big post-2014 declines in the price of oil and then additionally from the 2020 pandemic shutdown, global oil capex has been pretty low. The sector has been dealt what is effectively a one-two knockout combo in 2014 and 2020. Here’s a global oil and gas capex history and forward estimate:
Chart Source: Rystad Energy
Some updated sources suggest that oil majors may do a bit more capex in 2021 than 2020 thanks to rising prices, but still at a rate that is lower than 2019 and far lower than 2014. Ironically, for companies that got through this period without having to dilute themselves, they’re starting to reap the rewards of higher free cash flows.
Due to structurally lower capex, in part from ESG pressure, I think we’re setting up an oil and gas bull market that could last longer than many folks think. It’ll have ups and downs due to economic cycles, but structurally the forward supply/demand balances are set to be tighter than the past several years.
Global Energy Demand Overview
Developed countries aren’t growing their oil and gas usage by very much in recent years. Some of them are even gradually using less over time, as their total energy use is relatively flat and other forms of energy take some market share.
However, it’s important to have a global view when it comes to energy analysis. Most of the global growth in energy demand is coming from emerging markets. That’s where the majority of global GDP growth is, and where the majority of the global population lives.
Wikipedia maintains an updated list of oil consumption rates by various countries, referencing sources such as the BP Statistical Review of World Energy and International Energy Agency. If we plug in some rough population numbers, we can get an idea of per capita oil consumption.
Wealthy city states, certain islands, and the Persian Gulf nations tend to use the most energy per capita. For the second tier of energy usage, developed countries with a lot of land mass and large home sizes (USA, Canada, and Australia) are near the top. Third, many other developed countries including Japan and a host of European countries. For the fourth tier, there are high-energy-consumption emerging markets like Thailand, followed by the rest of the spectrum into places like India and sub-Saharan Africa.
Here’s a chart of some key examples:
The United States uses about twice as much oil per capita as Japan, and three times as much as Thailand. Thailand uses twice as much per capita as China. China uses well over twice as much per capita as India. Comparing top to bottom here, the United States uses 5-6x as much oil per capita as China, and about 15x as much as India.
So, when we imagine future energy use, we would have to be pretty bearish on long-term emerging market economic prospects in order to imagine that they won’t continue to grow their energy consumption, in one way or another, and that probably involves significant oil demand.
It’s also worth mentioning that the developed world outsourced part of its energy consumption to emerging markets over the past two decades, via globalization and the shifting manufacturing base. A key reason why the developed world was able to flatline its energy usage for the past two decades is that some of our most dirty and energy-intensive businesses were sent to places like China and Thailand. So, some of their energy consumption isn’t even for themselves; a good chunk of that energy usage basically flows back to developed markets as finished goods. We pay them to burn energy on our behalf.
So, developed markets generally “consume” a bit more energy than these reports say, and emerging markets “consume” a bit less. In other words, over the long arc of time, emerging markets still have quite a long runway of increased energy consumption if they are to ever get close to the low end of developed market energy consumption.
Overall, I’m pretty bullish on the amount of energy in all forms that the world will use over the next few decades, unless an event seriously reduces population or causes some other massive tail risk outcome. The question, then, is what types of energy will the world use?
The Difficulty of Replacing Prior Energy Sources
When we think of energy advancements over time, we think about replacing prior energy sources and intuitively assume that’s how it works. Coal replaced wood, oil replaced coal, hydro and natural gas cut into the market share of oil, and now we have nuclear, solar, and wind. Right?
In other words, we picture the global energy mix like this next chart, in percentage terms. Each new energy source takes market share from the prior ones, making the prior ones look like they’re getting phased out:
Chart Source: Our World in Data
However, it’s important to be aware of the absolute numbers as well. Historically for two centuries now, whenever humanity finds a better energy source, we add it onto the previous energy sources, rather than replace them. The previous energy sources remain flat or even continue to grow in absolute terms, while the new one grows faster and becomes more important:
Chart Source: Our World in Data
This is primarily due to rising total energy demand. As both population and per-capita energy usage increase over time, any new forms of energy generally end up being additive, rather than phasing out prior energy sources in absolute terms. This could eventually change if/when human population starts to level out and a greater percentage of people have their basic energy needs met, but until then, that’s the trend.
Although individual nations have phased out previously dominant energy sources (like coal) specifically for their electricity grid, the world as a whole has never phased out previously dominant energy sources. In addition, the world as a whole has never downgraded the power density or the energy return on investment of its dominant energy source. Coal is more energy dense than wood. Diesel and gasoline are more energy dense than coal. Uranium is more energy dense than diesel and gasoline. Hydro and geothermal, in the right places, are also extremely energy dense. Solar and wind in most locations are a step down in terms of energy density.
Power Density, EROI, and Payback Period
As a basic overview, we can quantify several measures of energy/power density and speed. This is different than how green they are; it’s about how effective they are.
One measure is power density, referring to how much energy per unit of time that a given energy source can provide, compared to how much space it requires to do so. For example, a nuclear facility and associated uranium mine produce a ton of energy from a rather small amount of area. A coal power plant and an associated coal mine also offer a high power density. Down from there, solar panels have a low power density, meaning it takes a lot of land to produce a similar amount of power to those previous sources. Biomass, for example using corn for energy, is generally among the least power dense sources as well.
Another measure is energy return on investment or EROI, which measures the ratio of how much energy you get out of an energy source during the full course of its lifetime vs how much energy you have to put into it in order to produce that energy. In other words, you have to put in some energy to dig an oil well, but then you get a ton of energy out, so the energy multiple that you achieve from that activity, or the energy return on investment, is very high. Similarly, it takes energy to dig up the materials and assemble/install a solar panel, but then you produce decades of energy from it.
A 2013 study by Weissbach et al measured the energy return on investment of various energy sources:
Chart Source: “Energy intensities, EROIs, and energy payback times of electricity generating power plants” 2013 Weissbach et al
Biomass and solar photovoltaics are on the weak side, nuclear is on the strong side, and natural gas or CCGT is in the middle.
Energy return on investment is challenging to estimate because it depends on how far back into the supply chain you analyze, and whether you include storage and decommission costs. Some older studies found different numbers, but this has been one of the most heavily-cited papers on the subject.
The “buffered” versions on the above chart account for storage. A big factor that hurts solar and wind energy is that if we were to rely on them primarily, we would need massive storage to maintain power during times when they aren’t producing much energy.
Any particular paper is vulnerable to bias or error. Proponents of solar and wind may leave out their low capacity factors, high energy storage costs, and decommissioning costs, for example. Proponents of nuclear may understate the initial construction costs or safe long-term storage costs of spent fuel (although this particular Weissbach study included variables like that). That’s why you’ll see some arguments that solar energy is now cheaper than everything, while others are still saying solar is nowhere near close enough to being economical; it all depends on how complete and objective the analysis is.
Plus, it changes over time and depends on location. Solar power in Germany and climates like that, will have a much lower energy return on investment than the same system installed in Saudi Arabian deserts or high-altitude Chilean landscapes.
During the long arc of time, fossil fuel sources will gradually have lower energy returns on investment, because the easy-to-reach sources get used up, leaving only the deep/unconventional resources that require more energy input to extract. In contrast, tech-based power sources like solar, wind, geothermal, and nuclear energy should earn higher energy returns on investment over time, up until they reach physical limits (although solar/wind have relatively low physical limits). Nuclear power plants are able to last decades longer than previously thought, for example, which increases their lifetime energy return on investment by quite a bit, since the initial construction costs are a large part of the energy input.
A third measure is payback period: how many years it takes the project to pay back the input cost, in terms of energy and/or money. We can imagine, for example, two energy sources that have identical EROI ratios. You put in energy, and get 20x as much energy back over the lifetime of the project, in this example. One of them is dirty, but the payback period is very frontloaded; you get a 20x return on energy in 10 years. The other one is very clean, but the payback period is linear; you get a 20x return on energy over the next fifty years.
If you’re an energy-abundant society with a long time preference, and are planning out decades in advance, the second source would be better. If you’re a fast-growing and energy-constrained market, you need the energy payback to be faster, and so you might opt for the first source.
Concentrated or Not Concentrated
The reason wind and solar energy are not very power dense and don’t have high energy returns on investment, is because they are not concentrated. Most forms of energy on earth, other than geothermal energy and nuclear energy, comes from the sun’s active warmth towards the planet.
Solar and wind and biomass are more directly from the sun, and thus the energy sources are renewable but not very concentrated. Coal, oil, and gas are more concentrated forms of solar energy from ages long ago, but that’s what makes them nonrenewable in our lifetimes.
Hydroelectric dams tap into the combination of the planet’s gravity and the sun’s warmth, which evaporates water and keeps a river moving. The hydro dam channels hundreds of square miles of geographic landscape that naturally collects water into a river and through the turbine thanks to gravity, making it more concentrated than a simple wind turbine despite being rather renewable. Nuclear reactors instead tap into the power of atoms made from stars billions of years ago, and geothermal energy taps into the heat of the planet’s core.
One of the biggest correlations with human development and longevity over the past few centuries, is high energy consumption. And our ability to consume large amounts of energy relies on being able to generate a high energy return on investment, which so far only comes from tapping into these concentrated fossil fuels or things like geothermal or hydro or nuclear energy. Humanity spent the last two centuries working up into denser and denser energy sources with better energy returns on investment, and now is trying to figure out how to step back and rely on less-dense energy sources with weaker energy-on-energy returns.
For modern life to continue comfortably, high energy return on investment is critical, regardless of location.
The importance of power density on the other hand can vary quite a bit, and depends on how much available land area a country has relative to their population centers. A sovereign city-state like Singapore, for example, has a greater need for high power density than Australia with vast uninhabited space.
Similarly, the importance of the payback period also varies. It depends primarily on how fast-growing and energy-abundant a country currently is. Germany, for example, can allow for longer payback periods than India in exchange for cleaner energy sources.
We have some significant engineering problems ahead of us in order for energy to be both abundant and cleaner in the future, on a worldwide basis. For this reason, the world is most likely quite a long way away from phasing out oil and gas.
People who imagine a primarily solar-and-wind future, are betting on the idea that for the first time in history, humanity as a whole will sharply reduce prior energy sources, and do so with energy sources that offer lower power density and lower energy return on investment. And that we’ll do this in the next two decades.
I’m a huge proponent of cleaner energy sources, but only when an engineering process is applied to ensure the whole lifecycle is cleaner and more efficient, and that various negative ramifications are taken into account.
The boom in human population and quality of life over the past two centuries has been significantly tied to shifting energy sources. As humanity learned to tap into big natural batteries of concentrated energy (coal, oil, gas, and uranium) that offered far higher energy returns on investment than previous energy sources, it gave us a parabolic technological boom.
The combination of finding dense energy sources and creating technological advancements to harness them, resulted in being able to do orders of magnitude more work per unit of energy expended by us:
Chart Source: John Kemp, June 2021 Energy Transitions Chartbook
Applying an engineering mindset to find places where the math and politics might point in different directions, can help find investment bottlenecks and opportunities.
Beyond Energy: Hydrocarbon Products
In addition to relying on oil and gas for a large percentage of global energy mix, we heavily rely on them for a multitude of products in our daily lives. This computer/keyboard/mouse/desk setup I’m using to write this article, for example, uses a significant amount of petroleum-based products.
I do my best to reduce the need for hydrocarbons in random products. I avoid shampoos or creams that use them, I minimize their use in my clothing, I prefer glass over plastic where possible, and so forth. However, when considering containers and electronics and all sorts of things, hydrocarbons are inescapable in the current framework that we operate in.
Here’s a subset of the types of products that are often made in part from oil and gas:
Table Source: Ranken Energy Corporation
One of my largest investments is an energy and petrochemical transport infrastructure business called Enterprise Products Partners LP (EPD). They recently had a useful slide listing some of the products that their various natural gas liquids are used for, by category:
Chart Source: May 2021 EPD Investor Deck
They also had another set of interesting facts in the deck as well:
Chart Source: May 2021 EPD Investor Deck
Many investors underestimate to what extent we would need to overhaul and redesign global supply chains, production methods, and production materials in order to meaningfully reduce our reliance on oil and gas products within the next couple decades.
Other than its use in making steel, coal doesn’t have nearly this deep of a connection to everything else in the way that the oil and gas sector does. Metallurgical coal will be important for the foreseeable future, but phasing out thermal coal is a realistic possibility in the decades ahead, at least outside of China, India, Indonesia, and a few other countries.
Phasing out oil and gas would necessitate an immense change to everything, and a change of that magnitude has a high probability of taking longer than people imagine.
Plus, in much of southeast Asia and sub-Saharan Africa, billions of people don’t have access to clean cooking, and instead rely on biomass. From the International Energy Agency:
Updated data this year show that the number of people without clean cooking facilities has been declining gradually. Over 450 million people have gained access to clean cooking since 2010 in India and China, as a result of liquefied petroleum gas (LPG) programmes and clean air policies. The challenge in sub-Saharan Africa remains acute, with a deteriorating picture: only 17% of the population have clean cooking access. In total, more than 2.6 billion people worldwide still do not have access, and household air pollution, mostly from cooking smoke, is linked to around 2.5 million premature deaths annually. The Covid-19 pandemic is putting countries further away from reaching universal access to clean cooking.
According to the IEA, about 30% of people in China, about 50% of people in India, and about 80% of people in sub-Saharan Africa, don’t have access to clean cooking. Natural gas pipeline infrastructure is hard to construct in impoverished areas, so natural gas liquids tend to be the most economic way to improve their cooking energy access and thus improve their indoor air quality.
Green Living vs Green Signaling
A widespread issue I see with behaviors around energy, is that individuals and institutions are more interested in looking green or feeling green, than being green. In other words, we get a warm feeling when we think we did something green or we can make others think we did something green, regardless of whether it truly is green in the full lifecycle of its existence.
An example of this type of thinking is advocating against certain types of oil and gas pipelines, including advocating against replacing existing aging pipelines to improve capacity and safety. When that happens, and pipelines are unavailable, oil and related petroleum products instead get transported by rail, which is ironically less safe for the environment and people, and less efficient for this purpose. As long as the consumption demand exists, advocating against the safest and most efficient form of transporting it can cause more problems than it solves.
This type of approach would be like banning air travel due to its environmental effects, resulting in more people driving long distances, thereby emitting more pollutants and dying more frequently.
That doesn’t mean every pipeline should be approved, but this sort of advocacy is often misapplied to every pipeline on principal. People who are against oil and gas would do better to focus on the demand side. But overall, this sort of political risk is important to watch, because curtailing supply and transport capabilities of oil and gas, while still having growing demand for them, can result in price spikes.
Similarly, if we replace coal with natural gas liquids in certain regions, which reduces particulates and CO2, we don’t really get points for that, even though it’s better by basically every metric. The same is true for nuclear energy. Those aren’t firmly in ESG’s favor at this time.
I initially majored in electrical engineering back in the 2000s in part because of my interest in solar panels and wind turbines. And there are regions of the world where they are very economical and efficient. Solar panels are ideal for deserts and other sunny regions, while wind turbines are ideal for certain coastal areas and other windy regions. And in general, I tend to be optimistic that in the long arc of human ingenuity, these systems will get more efficient and more recyclable over time.
However, while not every energy source is equally bad for the environment, each type does have environmental issues to be aware of and manage. Some of the negative effects are more subtle than others and are often overlooked. Plus, some types of energy sources are better for base-load power, while others are nice for additional marginal power, and still others are deal for providing peak power with fast turn-on and turn-off cycles as needed.
There are very few power sources that can truly be considered “green” or “renewable” in a strict sense of their meanings, once you have awareness of the engineering details and supply chains involved.
Biomass is the earliest and lowest-tech energy source. Cavemen and cavewomen figured this out ages ago when they realized they could light wood on fire. Biomass power (including cow dung) is still heavily used in many impoverished areas of the world.
Some countries use industrial-scale biomass. For example, in the United States, we add 10% corn ethanol to gasoline.
The problem with modern biomass, like from corn farming, is that the power density is very low, the energy return on investment is very low, and it’s actually pretty bad for the environment despite being renewable. Massive amounts of fertilizers and chemicals are used, and they run off the land into the rivers and into the oceans, contributing to toxic algal blooms and oceanic dead zones.
In the United States alone, we have tens of millions of acres of corn dedicated to ethanol production, mostly for political/regulatory reasons. It’s a lot of cost without a lot of payback. That land can serve better purposes.
One of the points worth keeping in mind from that example is that “renewable” and “green” do not necessarily mean the same thing. An energy source can be renewable, but environmentally destructive.
Coal is one of the worst overall power sources for the environment due to particulates and other acute toxins it puts into the air, land, and water.
First of all, multiple studies show that upwards of 100,000+ people die per year in the United States from the effects of air pollution, with a significant portion coming from burning coal for electricity and from smog emitted out of gasoline-powered cars, which causes particulates in urban air that can exacerbate health conditions, and increase the risk of heart attacks, stroke, cancer, asthma, cognitive disabilities, and more. For example:
We estimate that anthropogenic PM2.5 was responsible for 107,000 premature deaths in 2011, at a cost to society of $886 billion. Of these deaths, 57% were associated with pollution caused by energy consumption [e.g., transportation (28%) and electricity generation (14%)]; another 15% with pollution caused by agricultural activities. A small fraction of emissions, concentrated in or near densely populated areas, plays an outsized role in damaging human health with the most damaging 10% of total emissions accounting for 40% of total damages. We find that 33% of damages occur within 8 km of emission sources, but 25% occur more than 256 km away, emphasizing the importance of tracking both local and long-range impacts.
–PNAS Published Paper, April 2019
Worldwide, the number of annual deaths from air pollution is estimated to be in the several millions from a combination of coal, gasoline, cooking fuels, and so forth.
Secondly, coal as a power source is one of the largest contributors to oceanic mercury, which makes eating many types of seafood unsafe in significant quantities.
Third, burning coal emits a particularly large amount of CO2 into the atmosphere per unit of energy it produces. While the full long-term effects of that are not completely understood (and indeed, some amount of CO2 in the atmosphere is essential), seeing the atmospheric concentration of CO2 go vertical in the past several decades and break out of a long-term multi-million year range, should at least catch the attention of folks who know a thing or two about control engineering and system stability:
Chart Source: NASA
Based on various ways of measuring it, our current CO2 levels are now hitting levels not seen for perhaps 20 million years, and are on track to hit levels in the century ahead that previously had not been seen for 50-100 million years. Even though we can’t fully anticipate the effects, it’s a variable worth being mindful of.
In the long run for environmental purposes, by just about any metric, coal is the major power source to ideally phase out over time. Even CO2 aside, the particulates and mercury that come from it are problematic each and every year, rather than according to future models.
However, as previously described, it is heavily used in many markets for a few important reasons. One reason is that coal power plants have a fast payback period. The second reason is that many countries have coal deposits but not oil and gas deposits, and so unless they want to run a massive structural trade deficit to buy oil and gas from the Middle East and Russia, it is more economical for them to use domestic coal, or coal from nearby neighbors. China, India, and Indonesia are all large-population countries that produce and use a lot of domestic coal, for example.
Oil and Natural Gas Shortcomings
Refined liquid versions of oil and gas have historically been ideal transportation fuels due to their high energy density, while natural gas has been ideal for generating electricity and heat.
By most metrics, oil and gas are better than coal, but far from perfect. Natural gas releases less CO2 than coal per unit of electrical energy produced, and way less particulates and other pollutants. Oil is also cleaner than coal, but gasoline and diesel vehicles are a huge contributor to deadly smog in densely-populated areas.
Chart Source: May 2021 EPD Investor Deck
Carbon capture technologies can further reduce the impact of natural gas CO2 emissions for electricity generation, although it adds expense and lowers the energy return on investment. It’s an efficient enough energy source to still be economical despite adding this, for countries with long time preferences.
Plus, as previously mentioned, one of the shortcomings of oil and gas is simply that many countries don’t have deposits of them, but do have coal deposits.
When we compare ICE vehicles to EVs, there are a few considerations.
ICE vehicles emit more pollutants in the area of use, such as in cities, and that has all sorts of health consequences related to smog as previously described. And they rely on oil, a non-renewable fuel that many countries need to import.
As technology improves, EV vehicles can reduce that problem. However, EVs rely on grid electricity, which is produced by fossil fuels and/or other forms of energy on this list that each have their own environmental impacts. Different regions have different energy mixes powering their grids, so they get different levels of benefits by shifting over to EVs. Plus, EVs rely more-so than ICE vehicles on semi-rare metals which are rather environmentally destructive to mine (and use diesel-fueled equipment to do so) and again, tend to be concentrated in certain countries and thus need to be imported in many cases.
Wind Turbine Shortcomings
Wind turbines produce efficient power in windy areas. Wind is indirectly generated by solar energy.
However, it’s not consistent enough to serve as base load power, but it can be part of the power mix to add a renewable portion to the grid. Additionally, turbines currently use petroleum-based products as part of their construction material and as lubricants, are built in facilities that often (but not necessarily) use fossil fuels as a power source, and are assembled and maintained by machines running on diesel fuel using iron and other materials dug up by machines running on diesel fuel,.
Basically, wind energy is just not a very concentrated energy source, which makes it useful as a power contributor as part of a diversified grid mix, but not something a society can base itself mainly around. For wind energy, we put in quite a bit of energy, and get out more than we put in, but not a huge multiple of what we put in, especially if we completely factor in a proper deconstruction and recycling process (which we’re not currently doing) as well as energy storage if we try to make it a greater portion of our grids.
Going back to the recycling problem, Bloomberg had an article last year about how wind turbine blades (which for context are each the size of a large commercial airline wing) aren’t recyclable, because they are in significant part made from plastic:
Tens of thousands of aging blades are coming down from steel towers around the world and most have nowhere to go but landfills. In the U.S. alone, about 8,000 will be removed in each of the next four years. Europe, which has been dealing with the problem longer, has about 3,800 coming down annually through at least 2022, according to BloombergNEF. It’s going to get worse: Most were built more than a decade ago, when installations were less than a fifth of what they are now.
So, they go to dry tombs:
“The wind turbine blade will be there, ultimately, forever,” said Bob Cappadona, chief operating officer for the North American unit of Paris-based Veolia Environnement SA, which is searching for better ways to deal with the massive waste. “Most landfills are considered a dry tomb.”
In terms of volume and waste, this is the equivalent of burying thousands of discarded commercial airplanes each year, and it’ll grow each year as long as we keep increasing wind turbine usage. That’s not very green. Some of the pictures in the article are shocking to look at.
Late last year, GE and Veolia announced a recycling plan to turn discarded wind turbine blades into cement. We’ll see what percentage of the global wind turbine disposal rate this starts to absorb. Vestas, one of the world’s largest wind turbine makers, is targeting zero waste by 2040, or nearly two decades from now.
Solar Energy Shortcomings
Solar panels cuts out the middle man (wind) and get energy right from the sun. It take a lot of energy and materials to produce the panels and structures, but from there, they can produce decades of electricity from the sun. Like wind, it’s not concentrated, so the energy return on investment isn’t particularly high, and neither is the power density. It also has one of the longer payback times.
Over time, improving technology has made solar power cheaper and more competitive. For these reasons, along with government incentives and lower costs of capital, it’s the fastest-growing source of energy production; way faster than wind energy and other types of energy in percentage terms. However, when we dig into the details, it’s not quite that simple.
A significant part of the reason why solar panels got cheaper in recent years is that their production increasingly shifted to China. China makes around 70% of global solar equipment, often using coal as a primary energy source for the manufacturing process, along with cheap labor.
Plus, a number of major publications like the BBC and NY Times have reported on how much the region of Xinjiang is involved in Chinese solar supply chains. This is the region where the Uyghur population is used in forced labor, along with other extremely serious human rights issues that are beyond the scope of this article. Due to the use of forced sterilization on women in the region, some countries have labeled it a genocide. From the BBC article:
“The [Chinese] government claims that these programmes are in accordance with PRC [the People’s Republic of China] law and that workers are engaged voluntarily, in a concerted government-supported effort to alleviate poverty,” the report says.
“However, significant evidence – largely drawn from government and corporate sources – reveals that labour transfers are deployed in the Uyghur Region within an environment of unprecedented coercion, undergirded by the constant threat of re-education and internment.”
The solar industry also faces a significant e-waste problem. Much like the wind blade problem, most of the solar panels produced over the past two decades of rapid solar growth are not easily recyclable. In fact, it can take more energy to separate all of the different elements to recycle them, than it took to make the panels in the first place. So, instead they often end up in landfills, where some residual toxic material can leak into the environment. An article in Discover Magazine in late 2020 called “Solar Panel Waste: The Dark Side of Clean Energy” provides an accessible overview of the problem. From the article:
Tons of solar panels installed in the early 2000s are reaching the end of their lifecycles, posing a serious problem for the industry to contend with. Current solar panel disposal practices are far from being environmentally friendly.
In other words, in a global sense, we burn coal and use cheap labor (and in some cases perhaps outright slave labor) to make solar panels, which helped drive down costs along with various policies that reduced their cost of capital. Then the panels produce energy for a few decades, but are not very recyclable, and so they get thrown out and contribute to accumulating e-waste and environmental toxins.
In this configuration, that’s not a great renewable foundation to build upon as a massive part of the global electrical grid. We would need to do better for this to be truly green.
Imagine the scale of this e-waste problem if all of this if wind and solar power capacity was 10x-20x the size it is now, as it could be in a couple decades.
This is why I don’t consider wind and solar energy to be truly green in most cases. The energy sources themselves (wind and sunshine) are renewable, but our ability to capture that energy isn’t renewable, yet.
We could eventually learn to make solar panels more inherently recyclable and to manufacture a greater share locally around the world in a more distributed way, but they would likely be more expensive to produce and less efficient. The amount of energy we get out compared to how much energy we would put in would be less, all else being equal. And solar energy return on investment is already less than oil and gas and nuclear. Doing it properly, with full recycling and everything, would further reduce the multiplier unless we can make major breakthroughs in panel longevity and efficiency.
And as a final shortcoming, the densest population center in the world where half of the world’s population lives, east Asia, isn’t ideally-suited to either wind or solar energy (but has a lot of coal):
Chart Source: Zeihan on Geopolitics
Hydroelectric power is one of the most dense forms of energy with a great input/output energy ratio, and has served as an electrical backbone for many regions for a long time.
However, it can only be applied in certain regions, where a suitable river exists. Just as importantly, hydroelectric dams can reduce biodiversity in that area by interfering with the natural water flow, along with causing other ecological problems.
Any particular published study can be flawed, but there are a lot of them out there, and some of them like this one have pretty damning conclusions:
We tested how sediment trapping by hydroelectric dams affects tropical estuaries by comparing two dammed and two undammed rivers on Mexico’s Pacific coast. We found that dams demonstrably affected the stability and productivity of the estuaries. The two rivers dammed for hydroelectricity had a rapid coastal recession (between 7.9 and 21.5 ha year−1) in what should otherwise be an accretional coastline. The economic consequences of this dam-induced coastal erosion include loss of habitat for fisheries, loss of coastal protection, release of carbon sequestered in coastal sediments, loss of biodiversity, and the decline of estuarine livelihoods. We estimate that the cost of the environmental damages a dam can cause in the lower part of basin almost doubles the purported benefits of emission reductions from hydroelectric generation.
Basically, hydroelectric power can only provide so much energy due to geographic limitations, and despite being a very effective energy source, is not without large environmental consequences in some areas, including ironically releasing sequestered carbon from the environment.
Geothermal power is one of the best of all energy sources, but only for areas of the world that exist on fault lines, where the earth’s heat is right up near the surface. That heat can be tapped into in order to provide dense and clean baseload power with minimal environmental impact. It’s like hydropower but far less environmentally destructive. It can be considered truly green, unlike many other methods on this list.
The problem is that such ideal places for geothermal energy are quite limited, and as such, geothermal energy is a very small portion of energy production outside of certain hotspots like Iceland.
There are enhanced/deep geothermal technologies that can drill down miles into the Earth’s crust to tap into heat almost anywhere, but those are far more expensive. Some geologists are concerned about the risk of increased earthquake activity caused by this energy source, while others believe the risks can be minimal since the power plants don’t need to be co-located with dense population centers.
Overall, these enhanced/deep geothermal technologies have been on scientists’ radar for a long time. This 2008 Yale article, for example, had the following premise:
Until now, geothermal technology has only been used on a small scale to produce power. But with major new projects now underway, deep geothermal systems may soon begin making a significant contribution to the world’s energy needs.
Here we are 13 years later, and geothermal energy is still a tiny part of global energy mix. Some newer projects are getting interesting, so it’s not as though there were no advancements over these years. I’m optimistic that this could one day catch on, but it’s not exactly moving swiftly. It’s probably an area that would benefit from more research funding.
Nuclear power began being used in the 1950s and 1960s, and new reactors were built heavily into the 1970s and 1980s during the golden era of nuclear energy. It’s an extremely dense energy source that doesn’t emit almost any CO2 or air/land/water pollution under most circumstances.
However, there are some famous exceptions.
In 1979, the Three Mile Island meltdown occurred in the United States about one hour from my hometown in Pennsylvania (before I was born). This was a contained meltdown, ranked 5 out of 7 on the International Nuclear Event Scale. No fatalities occurred, and subsequent studies showed mixed results but that overall, cancer was not really an elevated issue around the location in the subsequent decades.
In 1986, the Chernobyl nuclear power plant in the Soviet Union had a more catastrophic explosive meltdown; a full 7 out of 7 disaster on the international scale. A couple staff died during the explosion, and then dozens of first responders died from acute radiation exposure. From there, estimates vary wildly about how many people died or were severely affected from moderate radiation exposure over a wide area in the following decades, but the high-end estimates are in the thousands. It also caused environmental damage over a wide area, to flora and fauna.
In 2011, the Fukushima Daiichi reactor had a meltdown from an earthquake/tsunami event. Although it was not as bad as Chernobyl, this was also ranked a full 7 out of 7 disaster due to the severity of the meltdown. There was one acute radiation death, several injuries, and as of yet unknown multi-decade consequences from moderate radiation exposure, including dumping radioactive wastewater into the ocean.
So, dozens of people have directly died from nuclear reactor disasters over the past 50+ years despite being such a big part of global energy production, and when we include estimated cancer deaths or severe health consequences from those disasters, it probably stretches into the thousands at the high end of the estimate range. The radiation effects have done severe localized environmental damage to Chernobyl in particular.
This is terrible, and yet is also just a tiny fraction of the number of people estimated to die every single year from coal and gasoline air pollution.
In that sense, comparing nuclear power to other power sources is a lot like comparing air travel to car travel. It’s safe, but intuitively scary. By almost any measure, air travel is way safer than car travel. And yet, far more people are afraid to fly than to drive, even though flying is statistically far safer. More people die from cars every year globally, than died from commercial air travel since inception of the industry in the early 20th century. However, every once in a while when a commercial airplane crashes, it makes global news.
Nuclear power has been like that for fifty years now; statistically safe and effective, but with some infamous events that shift public opinion.
Plus, it’s important to keep in mind that all three major nuclear disasters, including the 2011 disaster, were from nuclear plants built in the 1960s and 1970s. Humanity hasn’t exactly put a lot of research dollars into 21st century nuclear capabilities in recent decades, including smaller reactors or thorium reactors. Large ultralong-term waste disposal sites would also make for nice infrastructure projects if countries are serious about bringing about cleaner energy. We should conceivably be able to make an already safe and dense energy source even safer.
When I imagine the long arc of human energy consumption, it’s challenging to see how we’ll make this work without 21st century nuclear technology being an important part of the mix for baseload power. I’m bullish on uranium, in other words.
Case Studies: Germany and India
Looking at the electrical grids of a developed country and a developing country over the past 5-10 years can show us how different types of economies have different energy needs.
As an example of countries that have been able to change their individual energy mix, Germany has been at the forefront of shifting towards solar and wind energy for its electrical grid. The following chart shows their sources of energy for grid electricity generation capacity:
Chart Source: Clean Energy Wire
This chart is only for grid electricity, meaning it doesn’t include all of the fossil fuels for transportation (cars, diesel equipment, ships, planes) or for non-electric heating and cooking (for which the majority of households in Germany use natural gas), or all of the fossil fuels that went into the construction of the wind and solar systems and that will eventually go into their decommission and replacement, or all of the fossil fuels that went into manufactured goods that they bought from China and other emerging markets.
Electricity is a minority percentage of total energy consumption (about 20%) in Germany and many other places, and so despite adding a lot of solar and wind to the electrical grid, Germany is still primarily reliant on fossil fuels when all of these other sources of demand are included.
Even on this list of power generation capacity over a nearly two-decade period from a country pushing hard to make a less carbon-intensive grid, they gradually increased their natural gas usage, and barely reduced coal usage. Their overall fossil fuel usage for their grid was flat.
What has made it challenging for Germany is that they also wound down their nuclear capacity after the 2011 Fukushima disaster in Japan. So, Germany emphasized wind and solar for their electrical grid. For folks who are bulls on wind and solar, this has been about the fastest possible transition around. Localized examples like this are possible, at least for the electrical grid.
However, when we analyze it a bit, we can start to see some issues.
First of all, Germany has among the highest electricity costs in the world, at over 30 euro cents per kWh. There are a variety of reasons for that, so we can’t fully attribute it to their energy mix.
Second of all, for about two decades Germany was building a larger and larger energy surplus that they could export, and for the past five years as this shift towards solar and wind kicked into high gear and nuclear wound down, their surplus has been shrinking. If the current trend continues, Germany is on track to shift to being a structural net energy importer by the mid-2020s decade.
Third, if Germany had not wound down their nuclear capacity, Germany could have instead wound down their coal-burning much faster.
The National Bureau of Economic Research “NBER”, which is a well-known nonprofit U.S. research organization that is one of the key organizations for defining U.S. recessions, published a 2019 economic working paper on Germany’s nuclear phase-out. It was written by a PhD candidate and two professors, from the University of California and Carnegie Mellon. Here was their key summary:
Many countries have phased out nuclear electricity production in response to concerns about nuclear waste and the risk of nuclear accidents. This paper examines the impact of the shutdown of roughly half of the nuclear production capacity in Germany after the Fukushima accident in 2011. We use hourly data on power plant operations and a novel machine learning framework to estimate how plants would have operated differently if the phase-out had not occurred. We find that the lost nuclear electricity production due to the phase-out was replaced primarily by coal-fired production and net electricity imports. The social cost of this shift from nuclear to coal is approximately 12 billion dollars per year. Over 70% of this cost comes from the increased mortality risk associated with exposure to the local air pollution emitted when burning fossil fuels. Even the largest estimates of the reduction in the costs associated with nuclear accident risk and waste disposal due to the phase-out are far smaller than 12 billion dollars.
–NBER Working Paper 26598, December 2019
Germany’s decision to phase out nuclear energy instead of coal was economically costly according to their analysis, mainly in the form of increased mortality from urban air pollution compared to what it could have been.
Fourth, as previously described, solar energy in particular has some ethical supply chain issues related to China, and both wind and solar systems contribute to landfills and e-waste. Plus, northern Europe’s climate doesn’t get a very good energy multiplier out of solar compared to desert areas of the world. It’s a good region for wind, at least.
Fifth, also as previously described, the other three-quarters or more of Germany’s energy consumption for transport and heating and other uses, is still primarily from oil and gas. If we look out a decade or two in the future, we can suppose that Germany and many other places could shift primarily over to electric cars rather than internal combustion engines. A big percentage of the gasoline and diesel energy that Germany uses, would instead have to go over the electrical grid, which means a lot more electrical transmission infrastructure and a lot more electrical production. That extra production will be particularly difficult to do with just solar and wind, without the use of nuclear energy, deep geothermal energy, or fossil fuels.
In a slow-growing country, it’s possible to gradually replace a portion of prior energy sources with new energy sources, at least for the grid. In a fast-growing country, it’s nearly impossible to phase out old energy sources, or even stop growing them.
As an example of this additive effect, India grew their solar generation by an absolutely massive annualized rate over the past decade:
Chart Source: Mercom India
And yet despite that, they’ve also been growing their coal usage as well, which remains their dominant source of electricity generation. In fact, even though solar energy is growing at a far faster percentage pace, in absolute terms there were far more TWh of coal power added to the grid over the past five years than solar:
Chart Source: US Energy Information Administration
Coal has a fast payback period, high power density, high return on energy investment, and can be done almost anywhere regardless of climate. In areas with rapid energy demand growth, coal has generally been the go-to energy source. Plus, India has large coal deposits. The main downside, of course, is that it’s one of the dirtiest sources of energy, especially in terms of immediate air/land/water pollution but also in terms of CO2 emissions.
Plus, like Germany, electricity generation only represents a small percentage of India’s energy usage. As the country develops, they get better access to hydrocarbons for cooking and transportation.
The number of passenger cars in India continues to grow at a fast pace, and yet still remains a small percentage compared to the total population:
Chart Source: CEIC
Most of those cars are of course gasoline-powered, but even if they were electric, they would indirectly mostly be running on coal.
While I am a big proponent of cleaner energy sources (meaning truly cleaner, in terms of the full lifecycle), I think many people underestimate the difficulty of phasing out oil and gas usage, and also underestimate the importance of nuclear energy in the world’s likely long-term energy mix.
A lot of ESG mandates, current valuations, and capital allocation practices in general, are assuming a rather rapid phase-out of fossil fuels in favor of wind and solar energy. They’re betting on being able to phase out prior energy sources and to reduce the power density of our primary energy sources, for the first time in human history, as though it’s a given. Many of them also appear to be underestimating the technical limitations or true “greenness” of solar and wind power, as it relates to the energy return on investment, recycling issues, reliance on fossil fuels for manufacture, reliance on China to make them cheaply, and so forth.
While I do think solar and wind will become a larger percentage of the global electrical grid in an additive way, they’re not very well-suited to actually replace prior energy sources, unless we make some absolutely massive (not merely incremental) breakthroughs in energy storage or turbine/panel longevity.
This sets up a decent asymmetric investment opportunity in my view. I think this gap between engineering viability and public/investor perception is providing a long-term opportunity for oil and gas investors, as well as uranium investors. We’re embedding a lot of assumptions into the future energy mix, without necessarily investing in the capex required for that vision, or fully considering some of the technical challenges associated with that vision.
For example, even in a realistic scenario where oil and gas demand levels off in the next decade (rather than collapses), we need a lot more oil and gas than currently-pumping wells are providing:
Chart Source: Bloomberg
Especially with institutional investors and developed sovereign funds not particularly interested in funding oil and gas companies due to ESG concerns for the foreseeable future, much of the capex will need to come from the companies’ free cash flows, which means prices need to be high enough in order for companies to be incentivized to maintain and grow production.
I can imagine a futuristic world where we get a lot of electricity from, say, 21st century nuclear power, deep geothermal power, appropriately-placed wind and solar and hydro, and some carbon-captured natural gas. Using better battery technology or hydrolysis, we could then convert an increasing portion of that electricity for transportation needs with electric vehicles and/or fuel cells. Hopefully we can learn to make more of our products without heavily relying on oil and gas as foundational materials.
However, when taking into account real-world limitations, there is a big gap between now and that vision. So, we likely have another notable oil and gas bull run ahead of us, due to ongoing gradual global demand growth combined with cyclical and structural reductions in capex in recent years for political and ESG reasons.
There will be business cycles and valuation cycles for investors to analyze and trade around, and I’ll continue to cover these sectors and the economy in general in rate-of-change terms. As a backdrop to that for context, however, it’s important to keep these long-term technical realities in mind.
Whenever valuations are reasonable, I think investors should consider maintaining some oil and gas exposure, in the form of low-cost producers in diverse jurisdictions, energy transporters with solid balance sheets, and/or long-dated oil futures. Being long uranium holding companies or uranium miners is also a nice diversifier along these lines.
This chart from Yardeni shows the ratio of the energy sector of the US equity market compared to the S&P 500. When it’s going higher, it means the energy sector is outperforming, and when it’s going lower, it means the S&P 500 is outperforming. This recent pivot upward, in my view, has a good probability of being the start of a longer trend.
Chart Source: Yardeni Research
For simplicity, investors can consider an oil and gas ETF like the iShares Global Energy ETF (IXC) along with a uranium producer ETF like the Global X Uranium ETF (URA) or the North Shore Global Uranium Mining ETF (URNM).
In terms of individual energy producers or transporters, I like names such as Canadian Natural Resources (CNQ), Lukoil (LUKOY), Enterprise Products Partners (EPD), and Kazatomprom as buy-and-hold positions.