A year ago, Brent crude prices were trading at some US$40/b. With the world then coming off the first wave of Covid-19 infections, this was seen to be a decent price for crude oil. Several waves later, Brent prices reached US$50/b in January 2021, with the beginnings of a global vaccination drive promising recovery. And what a recovery it has been. As we reach the half year point, Brent crude prices are now trading at US$75/b. That’s a 50% jump in over 6 months, one of the best performances for crude prices ever and the highest level in over 2 years. The question on everyone’s minds right now is: what’s in store for the second half of the year?
In pure market terms, crude prices are now reflecting the rapid recovery in global economic activity matched against output levels that are still curtailed. Led by rapid vaccination progress in the US, Europe and China – with the rest of the world slowly catching up – fuel demand has recovered to the point where market analysts have commented that the massive glut built up by the collapse in consumption in 2020 has been virtually eliminated. Even the beleaguered airline industry is back on its feet; regional travel within Europe has opened up again and American Airlines made the headlines last week for cancelling up to 15% of its daily flights…. not because of empty planes, but because it did not have enough staff to man those planes.
The acceleration in consumption recovery has some market observers predicting that crude oil prices could return to the prodigious US$100/b mark by the end of the year. And these are not just any market observers. This is the Bank of America, Goldman Sachs and the world’s second-largest independent oil trader Trafigura. The market, it is said, is hungry for oil. Even though demand has not yet fully recovered, it is far stronger than was predicted. But on the supply side, there is the continued supply quotas imposed by OPEC+ that is keeping prices high, as well as what Trafigura is calling ‘structural underinvestment in new production.’ By which he means that the shock of Covid has held back new upstream projects that could otherwise start producing now, which is also exacerbated by the furore around climate change that is scaring off investment by publicly-traded companies. And, unusually, the US shale patch has not responded to the strong price signals in the way they would previously. Where the mantra had been ‘drill, baby, drill’, US shale players are now practising unusual discipline, focusing on building shareholder value than chasing greater volumes and revenue. All of which means that crude supplies are unable to keep full pace with charged-up demand.
This is, of course, a recipe for OPEC+ to loosen its supply quotas. Following a nervous January, the OPEC+ club has been progressively allowing for higher output every month in 2021. This will continue when the group meets next to decide on its targets for August and beyond. Further relaxation of quotas is on the table – which will be cheered on by most club members, especially Russia, Kazakhstan, Iraq and Nigeria – but don’t expect quotas to be eliminated completely. Some form of supply control will be present well in 2022 at the very least. Because OPEC+ countries have an incentive to keep prices relatively high, to rebuild their battered fiscal budgets and recover from the Covid revenue disaster. The US$70-80/b sweet spot is just right to meet national budget requirements while also balancing consumption drivers. But any higher and demand destruction starts kicking in. Which, in combination with the climate change debate, could be a potent combination in demonising oil and gas even further. So, if the Bank of America is right that we are heading towards US$100/b oil, expect OPEC+ to start making concrete moves in the opposite direction to keep prices in an acceptable range.
The odd combination of discipline within OPEC+ and the US shale patch is having an interesting effect on prices. Specifically the Brent-WTI spread. At less than US$2/b, the spread is now at its narrowest in 8 months, and much lower than the US$4/b spread the last time oil prices were at this level. Why is this? Well, the spread is typically based on four factors – US crude production, US crude supply/demand balance, North Sea crude operations and geopolitical issues in international crude markets. The first and the last are of most interest right now. Since US onshore shale drillers aren’t rushing to restart rigs – only 470 rigs are currently operating in the US according to Baker Hughes – US crude production is more than 3 mmb/d off its pre-Covid peak. With US refineries now running at near-record utilisation rates to meet surging demand, refiners are bidding up US crude prices to secure domestic supplies rather than see them leave as exports. Which explains why the WTI is in a growing backwardation structure, where oil for prompt delivery is more expensive than futures contracts, because there is a demand for oil now.
On the flip side, OPEC+’s relative discipline has been instrumental is keeping prices high since any relaxation in supply quotas lags behind demand growth. But, crucially, there is also no geopolitical risk premium that is typically the main factor that blow out the Brent-WTI spread. Instead of an isolated Iran, world powers are now negotiating a return to the 2015 nuclear accord that could see Iran resume its status as a major crude exporter. The prospect of this has already kept Brent prices slightly subdued since May compared to WTI. Depending on how long the tightness in the US crude market lasts and how OPEC+ reacts with its supply relaxation programme, it is conceivable that WTI could close the gap with Brent even further. It could possibly even reach parity and exceed Brent – a situation that has only occurred a handful of times in the history of crude oil trading. We live in interesting times. The first half of 2021 was fascinating to observe as a crude market observer, being faster and brighter than anyone expected. The second half of 2021 could be similar. Let’s watch it play out.
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Two very different economic blocs. Two pathways to a carbon-free future, one younger and one more mature. And one more with plenty of ambition but hamstrung by inaction. Between China, the EU and the US, three of the most powerful economies in the world all agree that pursuing a carbon neutral future is necessary if the planet is to limit global warming levels to 1.5 degrees Celsius above preindustrial levels, as committed under the Paris Climate Agreement. But the question of how to get there is the tricky one. In the past two weeks, both China and the EU have unveiled their own sweeping plans meant to limit greenhouse gas emissions, both incredibly ambitious in their own right but both also facing headwinds.
Let’s start with China. In Shanghai, the Shanghai Environment and Energy Exchange launched the country’s national emissions trading system on July 16. Currently focused on its own companies, the Chinese emissions trading system is already the world’s largest carbon market from the first day of operations. Covering an initial 2225 power plants that are estimated to emit more than 4 billion tonnes per annum of carbon dioxide, that amount already exceeds the European Union’s scheme, which covers about 2 billion tpa of emissions according to the International Emissions Trading Association. And there is still plenty of room to grow.
China decided to kick off its carbon trading platform with a focus only on power companies, given that they are among the most polluting of industries contributing to roughly 40% of China’s annual carbon emissions and roughly 14% of global carbon emissions from fossil fuel combustion according to the IEA. This initial phase allows the domestic participating companies to cover their own emissions by purchasing surplus allowance from those that have been able to cut their emissions through the exchange. Within the first week, Chinese energy giant Sinopec already closed a huge bulk deal by buying a 100,000 tonnes of carbon emission quota through its subsidiary Unipec. In the first day alone, a total of 4.1 million tonnes were traded, with the price rising from the opening CNY48 (US$7.41) to CNY51.23 (US$7.89), reflecting strong demand as the Chinese state aims to reach peak carbon emissions by 2030 and carbon neutrality by 2060. While the current price is still well under the €50 ($58.87) per tonnes under the EU emissions trading scheme, it is a bold step forward that can only grow.
In time, China intends to add other sectors such as iron and steel, cement, aluminium, paper, domestic aviation, building materials, and petrochemicals to future phases of the trading scheme. In addition, the first phase of the Chinese ETS is only limited to spot transactions by domestic players, but over-the-counter transactions and foreign/individual investors are expected to be added eventually one the exchange matures. Stricter carbon caps by industry may also be added, although the timing and scope have yet to be determined; China’s scheme is based on carbon intensity, rather than the EU’s absolute cap on emissions, which means that total emissions can still rise as power generation grows. For now, the price paid per on will be passed on to consumers, which promotes efficiency and incentivises emissions-cutting by giving a cost advantage to companies that are able to slash their carbon faster than required.
It’s a good start, even though it is unlikely to result in an acceleration of emissions reduction soon, given that there is not enough surplus renewables capacity to match the emissions of carbon-intensive industries. Which means that China will need to continue on its mammoth rollout of solar, wind and nuclear energy over the next decade to truly make a difference.
If China is just starting out with a framework that will service it for the next half century, then the EU is racing ahead to beat its own previous targets. The EU Commission has unveiled a new – dubbed the European Green Deal – that intends to achieve and exceed its commitments under the Paris Agreement, which bound the bloc to cutting greenhouse gas emissions by 55% in 2030 from 1990 levels and achieve net-zero emissions by 2050. The adoption of this target has already had ramifications across the continent, with almost all major energy companies adopting carbon neutral targets along the same timeline. And in some cases, even further, with the recent court judgement in the Netherlands that Royal Dutch Shell must accelerate its emissions-slashing plans globally from its already ambitious plan.
The new EU proposal aims to cut reliance on fossil even further and promote renewables. Central to this is a requirement that the share of renewable energy sources as part of Europe’s mix must rise to 40% from 20%, while limiting pollution from fossils fuels from key sectors like power, transportation, shipping, agriculture and housing – resulting in a 61% fall from 2005 levels by 2030, compared to the current target of 43%. Controversially, the EU proposal also deals with the idea of ‘imported pollution’ – carbon leakage that is caused by shifting production to countries with loose or no emissions rules by imposing a carbon import tax that will begin in 2023 for full implementation in 2026. This would ensure domestic competitiveness within the EU while incentivising trading partners that do adopt carbon plans by allowing the carbon price (as determined through China’s emissions trading system, for example) to be deducted from the carbon cost bill when entering the EU. It is a plan that has already sent shudders through global supply chains, triggering accusations of bias by developing countries. But there is also dissent for the plan in Europe itself. Emmanuel Macron’s government in France, one of the main pillars of the EU, is reportedly already lobbying to watering down the proposal to create a new carbon market for domestic heating and road transport, and phasing out all combustion engine cars by 2035. Other countries, including the Netherlands and Hungary, are also worried about the social impact, since the plan would drive up costs for average citizens. The EU Commission claims the increase in costs will not be too much, on the assumption that revenues generated from the new carbon market will be channelled to subsidise fuel bills of low- and middle-income households.
Between China and the EU, bold moves have been made to progress on a carbon neutral future. But there is one major player that has plenty of ambition as well, but is unable to proceed with similar bold steps due to politics. Since taken over the White House in January, US President Joe Biden has made renewables a focus of his administration – announcing initiatives to scale back on fossil fuels and move to 100% carbon-free electricity by 2035. But his ability to push further – by, say, creating a national renewable standard or fund renewable infrastructure is hampered by Republican obstruction and state pushback. The likelihood that the Republicans may increase their power in the next mid-term elections also pours water on the idea that Biden’s big ideas can take shape eventually. But where the American government can’t step up, private investors can step in: witness the recent shareholder revolts at Chevron and ExxonMobil. The march towards carbon neutrality will be tortuous and long, but at least there is some progress happening now to ease the difficult path the world must take in the future.
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In 2020, renewable energy sources (including wind, hydroelectric, solar, biomass, and geothermal energy) generated a record 834 billion kilowatthours (kWh) of electricity, or about 21% of all the electricity generated in the United States. Only natural gas (1,617 billion kWh) produced more electricity than renewables in the United States in 2020. Renewables surpassed both nuclear (790 billion kWh) and coal (774 billion kWh) for the first time on record. This outcome in 2020 was due mostly to significantly less coal use in U.S. electricity generation and steadily increased use of wind and solar.
In 2020, U.S. electricity generation from coal in all sectors declined 20% from 2019, while renewables, including small-scale solar, increased 9%. Wind, currently the most prevalent source of renewable electricity in the United States, grew 14% in 2020 from 2019. Utility-scale solar generation (from projects greater than 1 megawatt) increased 26%, and small-scale solar, such as grid-connected rooftop solar panels, increased 19%.
Coal-fired electricity generation in the United States peaked at 2,016 billion kWh in 2007 and much of that capacity has been replaced by or converted to natural gas-fired generation since then. Coal was the largest source of electricity in the United States until 2016, and 2020 was the first year that more electricity was generated by renewables and by nuclear power than by coal (according to our data series that dates back to 1949). Nuclear electric power declined 2% from 2019 to 2020 because several nuclear power plants retired and other nuclear plants experienced slightly more maintenance-related outages.
We expect coal-fired electricity generation to increase in the United States during 2021 as natural gas prices continue to rise and as coal becomes more economically competitive. Based on forecasts in our Short-Term Energy Outlook (STEO), we expect coal-fired electricity generation in all sectors in 2021 to increase 18% from 2020 levels before falling 2% in 2022. We expect U.S. renewable generation across all sectors to increase 7% in 2021 and 10% in 2022. As a result, we forecast coal will be the second-most prevalent electricity source in 2021, and renewables will be the second-most prevalent source in 2022. We expect nuclear electric power to decline 2% in 2021 and 3% in 2022 as operators retire several generators.
Source: U.S. Energy Information Administration, Monthly Energy Review and Short-Term Energy Outlook (STEO)
Note: This graph shows electricity net generation in all sectors (electric power, industrial, commercial, and residential) and includes both utility-scale and small-scale (customer-sited, less than 1 megawatt) solar.
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