Lately, I have read countless articles seeking to explain the motives behind why the big oil companies are buying up smaller competitors and why clean energy project cancellations are a failure of government policy to motivate a rapid energy transition.
The line on oil companies is that they must be motivated by bullish oil demand forecasts. Bunk.
Conventional energy companies overspent on the shale revolution, drove their returns on capital towards zero and had their credit card revoked by their shareholders, sending the industry into a consolidation phase where it’s cheaper to buy assets than it is to build them. (read Revolting Shareholders – More on the Energy Blame Game) If those assets are low-cost, no likely amount of future decline in oil demand will materially affect the economics of the purchase, as commodity prices are set by the high-cost producers. More importantly, the average worldwide natural decline rates of oil and gas reservoirs of 5-8% per year dwarf annual demand growth of 1-2% today and distant future demand declines of comparable size[1]. This means prices must be high enough to justify reinvestment sufficient to offset declines, and those declines occur whether demand is growing or shrinking. In short, profitability in commodity industries is driven solely by cost competitiveness. (read This Just In: Supply and Demand Drive Energy Prices)
That brings us to clean energy where some offshore wind projects are getting cancelled because they are not competitive. Yes, their costs are up but so too are everyone else’s. Is this a failure of government policy? (read Why Problems With Renewables Have Hurt the Utility Sector)
Despite the need to reduce carbon emissions and despite government policies seeking to affect this negative market externality, the energy system is largely owned and operated by profit maximizing private entities. Those entities exist to earn a return on their owner’s capital which taken together is society’s surplus; the net savings generated by an economy that produces more than it consumes. That surplus gets allocated to projects with the highest return on capital. THAT’s why it’s called capitalism and not top-line-ism, not EBITDA-ism and not carbon-abatement-ism. And capitalism is less a “system” than a force of nature. Successful policies addressing market failures harness that force with the least cost in the same way that successful onshore wind and solar projects harness natural forces with the least cost. High-cost producers, whether clean or conventional, are usually poor investments and are usually the first to lose policy support.
But let’s not forget about the motives of utility-maximizing customers, who want the best performance and the lowest price. Buyers of clean energy or electric vehicles want reliability, convenience, safety, and low cost, not just “clean.”
Successful investments in energy (or any industry) need happy shareholders and happy customers. Subisides may affect the equation on both ends, but they do not negate the basic forces at play regardless of whether that energy is new or conventional. Bottom-line per share profitability and customer acceptance will drive the energy transition as it drives all industrial transitions.