The Energy World is Flat. Lacalle Daniel
the dotcom bubble finally burst in 2001. Equity valuations had collapsed across the board. Many companies went bankrupt. Others were not worth much more than the cash they had raised from investors. There were many winners too, who took advantage of the situation and expanded through acquisitions. Among them was Apple, who in 2000 acquired SoundJam MP and its team of developers. Apple simplified the user interface, added the ability to burn CDs, removed its recording feature and skin support, and renamed it iTunes. In October 2001, Apple launched the first iPod as “one thousand songs in your pocket”.
But for internet and broadband, competition and overcapacity made them available at a fraction of what had been anticipated. Bad news for the telecoms industry. Good news for consumers.
The future of the energy world is highly uncertain, but it is not unthinkable (in fact it is our base case) that the large development of “parallel” infrastructure will lead to a similar situation.
Commodity assets and prices are driven by marginal economics. Large imbalances between supply and demand can result in sharp swings in valuations, as producers know well.
The current energy revolution is relevant. Previous oil crises were largely “just about oil”. This time it is not only oil supply and demand forces competing against each other. This time we have new dimensions as natural gas, renewables, and other fuels become real threats to crude oil's relevance. With more options available, the impact of price spikes and peak pricing is eroded, preventing economic shocks. As such, despite constant global conflicts, the “oil burden” (the amount of money devoted by OECD countries to pay for imported oil) has not surpassed the “tipping point” of 5.5 % of GDP.14
The internet revolution was a game changer. It opened a whole universe of new opportunities that (for most people) were unimaginable, even at the peak of the market in 2001.
The success of the internet, Apple, and Facebook has left a long list of direct and indirect casualties across industries. Look at Blackberry or Nokia for example, once upon a time leaders in their sector, today at risk of disappearing. Or look at music-buying patterns. CD shops are history. Or think about the impact on the advertising industry, increasingly dominated by companies like Google and Facebook. Many newspapers are struggling as their advertising revenues via digital are a fraction of the print. Who would have said that 10 years ago?
The needs of the consumers are being addressed but they are being served and consolidated with superior and new technologies. The old and expensive technologies are dead (even if they don't know it yet).
Thanks to the development and overcapacity in broadband, wireless, and applications like FaceTime or Skype, I am now able to have a live high-definition videoconference (voice and image) with someone across the Atlantic pretty much “for free”. Yet, a telephone call (voice only) would cost me an arm and a leg. “This must go down in history as a major inconsistency”, I keep thinking to myself. “I can eat and smell a cake, cheaper than just smelling it. This is crazy. Something has to give”, and it does not take a genius to figure out who the losers in this battle will be.
In the energy world, the “shale revolution” has already had a major impact in North America across many industries. And the implications do not stop there. They are global and are already feeding through the energy system, flattening the world.
Look for example at US coal. The surge in US natural gas production and cheap prices resulted in a significant displacement of coal demand. Power generation used more natural gas and less coal. The displacement of coal did not only result in lower prices within the United States, but also made more and cheaper coal available for export. Producers outside of North America felt the impact too. In March 2010, in search for new markets and responding to strong incentives and regional premiums, Colombia shipped a cargo of coal over 10,000 miles, all the way to China.15 Some of the switching is very “price sensitive”, and may flip back into coal as and when the economics make sense. But in the long run, the availability of more environmentally friendly natural gas (as a rule of thumb, coal pollutes three times more than natural gas for a given unit of energy produced) may result in the retirement of coal-fired power plants. The impact is therefore more global and more permanent than what the large majority believes today.
Another example is the renaissance in the fertilizers and petrochemical industries in North America. A version of what is being called as “re-shoring” (the reversal of “offshoring”), as industries return to North America.
Perhaps most importantly, over the medium and longer term, the energy revolution has the potential to change the transportation industry and challenge crude oil's monopoly. Cheaper electricity and natural gas provide a strong incentive to switch away from oil. This process is already happening and faster than many people think. And, just like coal, the impact will be more global and more permanent than what the large majority believes today.
Yet another example is how solar has impacted the electricity market and taken over peak capacity in countries like Germany. See Chapter 14 for more details.
The effect of these forces and competition ultimately results in winners and losers. And along the process, perhaps the major beneficiary of the flatter energy world is the consumer. Just like the internet revolution.
As discussed before, the bubble played an important role in the development of new technologies, the overcapacity, and the availability at cheap prices. But bubbles are complex processes. When do they accelerate, when do they peak, what triggers the burst?
“We are fine. We do not need to be bailed out”16 said the Finance Minister of Portugal in 2009. And it may have well been true, when, at that time, Portuguese credit spreads were at 2 % and they could finance themselves. Under those market conditions, Portugal was solvent.
But not everyone believed it, and investors in Portuguese debt started demanding higher and higher returns for the risk they were taking. Downgrades by rating agencies such as Standard & Poor's, Moody's, and Fitch compounded the problem. The cost of borrowing increased, and servicing the debt started to become a problem. Portugal was still solvent, but the pricing dynamics were quickly deteriorating the “fundamentals” of the country. The process started to accelerate into a “vicious cycle” that fed on itself. Higher credit spreads resulted in higher servicing costs, which in turn would push credit spreads higher, until, eventually, the yield of the 10-year bond reached 8 %, a level regarded by many as the “tipping point” when a country's finances become unsustainable. The price of the bonds collapsed as the yield exploded above 15 % within just a few weeks.17 Prices had impacted fundamentals. Portugal was no longer solvent.
“We have agreed to a bailout package”, said the same Finance Minister. Was he lying a few months before when he said the country did not need a bailout? Well, not necessarily. Portugal was solvent, but vulnerable to higher rates and refinancing needs. Should the price path had been different, Portugal might have not needed to be rescued. But the reality was different.
And the “domino effect” that had “knocked out” Iceland, Greece, Ireland, and then Portugal, repeated itself once again and brought Spain and Italy to the brink of collapse. It took decisive action by Mario Draghi, President of the European Central Bank (ECB) to support the euro “by all means possible” and the introduction of the LTRO (Long Term Repurchase Obligation) programme to contain the negative spiral.
Once under control, the process reversed and through a virtuous cycle, the 10-year Spanish bond, having been at 7.5 % in the summer of 2012, reached historical low levels in December 2014. Enough to swing a government from solvency to insolvency.
These reflexive relationships also exist in the energy markets.
The “quiet revolution” in North America, the Fukushima nuclear crisis, ongoing geopolitical tensions in North Africa and the Middle East, and monetary easing have all contributed to the large price divergences that act as the catalyst
Ronald Stoeferle (12 March 2012).
Javier Blas (2010). A market ee-emerges.
Bruno Waterfield and Robert Winnett (2010). Euro under siege after Portugal hits panic button.
Bloomberg, Portuguese Government Bonds – 10 Year.