Ignoring Energy Transition Realities - 2020

Oil & Natural Gas / Conventional Oil & Gas Resources

Goehring & Rozencwajg opined in late 2020 that we [aka investing Americans] are making a terrible mistake when it comes to future energy policies. In previous letters, the authors have touched upon the challenges of the so-called “energy transition.” ... they continue "Today, we will explain in detail the imminent harm awaiting investors and policy makers who fail to acknowledge certain realities. Every green energy proposal we have examined relies on the trifecta of wind, solar, and electric vehicles combined with various battery technologies [Notice no mention of nuclear power].

In recent months, a renewed “hydrogen mania” has broken out as well, which adds a fourth leg to the green energy stool. Unfortunately, based upon our extensive research, these plans, including the current hydrogen craze, are bound to at best severely disappoint and, at worst, outright fail in what they attempt to accomplish. Not only will these proposals cost trillions, but policy experts and investors will soon realize that none of these options will address the very CO₂ problem they are designed to solve. Currently, there are 410 parts per million of CO₂ in the atmosphere. By keeping the concentration below 450 ppm, it is widely believed warming trends can be curbed. This would require lowering annual CO₂ emission nearly 60% from 34 billion tonnes today to 15 billion tonnes by 2040. Most energy transition plans advocate the widespread adoption of renewable energy and electric vehicles to drive down carbon emissions. Unfortunately, our research suggests these plans have little hope in solving the CO₂ problem [Claims made but no basis...]

Vaclav Smil, Distinguished Professor Emeritus in the Faculty of Environment at the University of Manitoba, is the best energy scholar we have ever read, in our opinion. In his Energy Transitions, he notes that historically a new energy source takes between 40–60 years to gain significant market share. The current proposals assume wind and solar will make comparable gains in only 20 years. Ambitious plans often carry ambitious budgets, and the green energy transition is no exception. Using extremely aggressive cost saving assumptions, a widespread move to renewable power is expected to cost $70 tr over 20 years, nearly $50 tr more than if we stayed on the current trajectory. Unfortunately, our research tells us this additional spending will not even come close to generating the expected reduction in global carbon.

The sums involved are monumental, and much of it could fall into the category of “malinvestment” with disastrous results. The further down the current path we go, the less likely we will be able to change course later. A decade ago, a series of failed promises and bankruptcies plagued the battery industry, making it nearly impossible for subsequent ventures to find financing and move forward. We worry the same could occur on a much larger scale if
tens of trillions of “green” investments are eventually written off.

This essay will serve as a jumping off point outlining our research on various energy transition topics. We intend to follow this up with a series of essays, podcasts, and videos going into greater detail on each topic we introduce here. Please visit our website (gorozen.com) for ongoing updates. This discussion comes at a critical moment. Over the last 12 months, green energy momentum has exploded. Investor euphoria has now reached new heights bordering on mania. Renewable investments (as measured by the RENIXX, ICLN and QCLN ETFs) have advanced between two and three-fold since the start of 2020. Tesla is up ten-fold and sports a market capitalization of $800 bn. Hydrogen stocks have done even better: Plug Power is up 2000% since January 2020 resulting in a market capitalization of $31 bn (or 100 times revenue).

Investors have taken notice and poured huge sums of capital into green ETFs. Shares outstanding of the four most prominent clean energy ETFs are all up between three-and six-fold. Traditional energy has been on the other side of this trade. Over the same period, shares outstanding of the XOP ETF (designed to track S&P exploration and production stocks) are down 25%.

Stretched valuations leave investors vulnerable to any setback or delay in the green energy transition. The ICLN ETF holdings currently trade at 70x earnings, 6x sales and 6.25x book value, suggesting dramatic growth is already priced in. What would happen if the energy transition proved more challenging than anticipated?

Green energy Special Purpose Acquisition Vehicles (SPACs) are also a troubling sign. Green SPACs have raised $40 bn in 2020 alone with a mandate to acquire as-of-yet unidentified clean energy assets. Oil and gas exploration and production companies on the other hand raised only $5.2 bn in 2020 to develop their existing proven asset bases. Given how challenging clean energy product development can be, we fear the bulk of these green SPACs will likely end up being written off entirely.

Adding to the current green momentum, several reputable agencies released reports in 2020 predicting an acceleration in renewable adoption. The International Energy Agency (IEA) released its World Energy Outlook in October 2020. In their report, they lay out a “Sustainable Development Scenario” in which global oil demand peaked in 2019 and will fall by 34% by 2040. Countless news articles picked up on the “peak demand” prediction and pointed to the strength in renewable equities as “proof ” the era of hydrocarbons is now ending. The combination of stock performance and news articles has created a dramatic feedback loop, pushing prices up even further and in turn giving more credibility to the energy transition thesis.

The IEA’s World Energy Outlook generated a lot of attention when it was released. Upon closer inspection, we believe the report makes two critical mistakes. While CO₂ emissions fall to 15 bn tonnes by 2040, the drivers of the reduction seem questionable. For emissions to fall 60% over the next twenty years, the IEA assumes per capita energy demand will fall by 25% while CO₂ per unit of energy drops by 50%, offset by population growth of 20%.
Together, these factors equate to a 60% reduction in total carbon emissions and keep atmospheric CO₂ to within 450 ppm. Unfortunately, neither energy intensity nor carbon intensity are likely to fall anywhere near the amount predicted by the IEA.

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