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A Structural Change in Energy Inside of an Energy Cycle; Peak Oil on the Horizon?



The year 2023 was one of record investment in renewables but a challenging year for energy transition investments.  The double hit of higher interest rates and slow rollout of clarity for US clean energy investment tax incentives created a cloud over companies related to the energy transition.  This challenge was especially painful in the second half of the year as the Federal Reserve discussed higher for longer interest rates and the Treasury Department missed the statutory deadline of mid-August for final clarity for many incentives.  As we enter the final few weeks of 2023 and look forward into 2024, those pressures are abating.  A steady stream of clarity from the Treasury regarding tax incentives for clean energy is finally being released.  A declining inflation rate is impacting the Fed’s narrative reducing concerns about higher for longer interest rates.   Energy transition related investments are rebounding and one area of help from the inflation front has been oil prices. 


As the year 2023 comes to an end and we start looking at 2024 we can start to see the world nearing peak oil.  This is not coming from a concern about the planet or from geostrategic considerations but from a changing energy landscape.  The trend of a weak oil demand rebound since the COVID pandemic is now becoming clearer and, in our view, suggesting something is changing in oil markets and the energy sector.  The chart below very clearly shows the increasing disconnects between global oil demand growth and global GDP growth, which has become more pronounced since the COVID pandemic.  This decoupling of economic growth from oil demand is from more than just increasing efficiency in the use of oil; structural changes are forming.  That lion’s share of the structural change is coming from EV sales.



Despite the headlines, EV sales continue to grow at a substantial clip.  As documented in the chart below, five years ago 1 in every 50 cars sold globally was electric.  As we end the year 2023 that number is closer to 1 in 5 with around 18% of global new vehicles sales being electric (13% fully electric & 5% being Plugin Hybrid).  This change has been meteoric to say the least.  The cause is not from government mandates but from the decline in cost of EVs, increased charging infrastructure and range improvement.  On the cost front, the BYD Seagull EV from China has a starting price of $11,400.  The low cost BYD Seagull is an important factor for EV growth – affordability.   



EVs


The EV price drop will be a major driver going forward for EV demand.  China is leading the world in EV production and demand.  Its EV sales are 40% of new vehicle sales as we end 2023, documenting that China has reached the cost inflection point with EVs (25% being BEV and the rest being PHEV).  On the other hand, the US, although not quite there yet, is very near that inflection point.  The chart below shows how, in the past three years, the US has gone from an EV price gap of over $15,000 to one of less than $4,000.  The narrowing of price supports the strong sales growth of EVs which are nearing 10% of US new vehicle sales. 


Looking into 2024, we expect strong growth in EV sales in the US because dealerships can start discounting the EV tax credit (max of $7,500) at the point of sale compared to the current procedure of getting the discount when individuals file a tax return.  Early

next year, the EV tax credit would place the sale price of many EVs at a cost below those of comparable internal combustion engine vehicles, representing a major inflection point for the mass adoption of EVs.  In 2024 on a global level, we expect EV sales to grow around 25-30% from the drop in cost. This issue brings us back to the question of oil demand.



The rise of EVs is beginning to impact oil demand.  According to BloombergNEF, EVs of all kinds (from 2-wheel vehicles to buses and semis) had displaced 1.5 million barrels a day of demand by the end of 2022.  On top of the 1.5 million barrels a day of demand destruction through 2022, new EV sales will soon be displacing another 350k – 500k barrels a day in demand by the end of 2023.  This pace of demand destruction for oil products used in transportation will likely continue to grow in perpetuity.  The marginal demand destruction has now turned transportation into a headwind in oil demand growth.  As the total inventory of internal combustion engine light vehicles begins to shrink, it makes it harder to see strong growth in oil demand in the face of headwinds for the largest source of demand from an oil derived product.  This slowing demand growth and possibly peaking demand has caused surplus capacity to reach its highest levels since the 1980s.  In our view, it shows a structural change in demand is happening as spare capacity is now 2x the average of the previous 30 years. 


The rise in spare capacity shows that oil producers are misjudging the demand for oil and this challenge is unlikely to abate anytime soon for oil producers as EV demand continues to eat into oil demand.  Our view is that the drop in costs of EVs to a price point lower than comparable internal combustion engine vehicles will create a lower price point for oil when demand destruction occurs.  This is why outside of a temporary jump in oil prices if OPEC+ makes a major cut or a major supply disruption, we think oil prices will be challenged. We also think we could see a chance of Saudi Arabia flooding the market to break fracking in the US since in a way Saudi Arabia is subsidizing the industry with all of the productions cuts over the past 18 month.      




Rise of Renewables


The trend of investment in energy continues to favor renewables.  During 2023 the world continued to invest more in renewable energy than in upstream oil and gas.  This trend will likely continue into 2024 as the cost advantage of renewable energy production continues.  As shown in the chart below, even in a year of high interest rates and an increase in cost from 2022, renewable energy attracted almost $700 billion in investments globally. As interest rates and costs start to reverse the post Covid bump, we expect this trend of increasing investment to continue.  On the other hand, despite a drop in upstream oil and gas investment following COVID, we will likely see soft pricing from a glut of spare capacity in the oil sector. We anticipate the trend of increasing renewable generation investments to increase around 15% next year globally. 



 Battery Energy Storage Systems

               

The rise of battery energy storage has been much more rapid than that of renewables.  Over the past six years, battery storage systems have gone from almost nonexistent to an integral part of almost all renewable energy projects trying to get on the grid as shown on the chart below.  This rise has occurred with the rise of EVs.  The reason is that battery storage systems have a substantial amount of overlap with battery technology for EVs, helping both technologies quickly scale.  As interest rates and battery costs start to drop from a Covid era bump we expect the demand for battery storage to continue to maintain strong momentum.  We expect battery storage system installation growth of between 50-100% next year.



Hydrogen

               

As the year closes, the only thing for certain is that clean hydrogen had a disappointing year.  Both in the US and Europe, regulation was much slower to give clarity on incentives, hampering investment.  On the other hand, China has been very aggressive in building out large scale electrolyzers and the beginnings of a hydrogen pipeline network.  As we enter 2024, we expect the US to give clarity on clean hydrogen incentives and for the Europeans to start giving grants in February 2024 for clean hydrogen projects.  We are cautiously optimistic that we will start to see the beginnings of a global clean hydrogen industry in 2024. 



As 2023 comes to an end we have already reached an inflection point for peak coal demand and peak internal combustion engine vehicles globally.  Despite high rates and a temporary bump in cost in energy transition technologies in 2023, these technologies continued to gain market share.  They did so because energy transition technologies offer a lower cost option.  We expect the declining cost trend to return in 2024 as three years of supply chain challenges and increasing interest rates abate.   This will be most pronounced in EVs, battery storage systems and clean energy production.  Consequently, we anticipate peak oil demand within the next two years.   We look forward to energy transition related investments reaccelerating as rates and costs drop.  The future is bright for the energy transition as this macro trend is driven by global market forces.     

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