Op-Ed: Big Energy Confronts An Unfamiliar Power: Competition

Source: By Liam Denning, Bloomberg • Posted: Monday, February 26, 2018

You may not have noticed, but you’re spending a lot less on energy these days.

Less than four cents of every dollar of U.S. consumer spending went to gasoline, electricity and natural gas last year, according to Bloomberg New Energy Finance’s recently published ”Sustainable Energy In America Factbook.”

The oil crash is an obvious cause, but that’s just one part of a bigger story.

Here’s something Spencer Dale, chief economist at BP Plc, said this week as he launched the oil major’s annual long-term outlook:

Energy demand is growing less quickly as we get better at using energy more efficiently. But on the other side, improving technology means we get better and better at producing that energy; so there’s an abundance of energy. Moreover, the strong growth in renewable energy means there are more and more energies competing for that demand.

Growth in the economy and energy demand, once tied at the hip, are drifting apart. As I wrote here, the first decade of the 21st century was also the first decade in U.S. history where primary energy consumption actually fell — even as the economy expanded by 18 percent.

Hugh Wynne, an analyst at investment-research firm SSR, noted in a recent report that power generation has lagged economic growth over the past five years in regions representing more than 90 percent of the world’s electricity output. Energy efficiency is a big reason why we are generally doing more with less:

Meanwhile, technological advances have led to more abundant energy supply. The oil and gas industry, for example, is embracing things like digitalization and standardization to cut costs in order to open up more reserves and be profitable come what may. This structurally lowers the cost curve.

Meanwhile, cheaper natural gas has helped to reduce electricity costs. And steep drops in the cost of solar and wind power have made renewable energy competitive in a growing proportion of the world. Their free fuel costs tend to do to the power cost-curve what shale has done to oil and gas curves.

This emergence of competitive energy markets is a novelty. Big Oil and Big Power largely grew up on the back of regulated or cartel-like models. Cracks began to appear toward the end of the 20th century, as the oil-futures market gave buyers and sellers an alternative to OPEC’s price-setters and deregulation started chipping away at utility monopolies.

These forces have accelerated, opening up more competition between energy providers — and, importantly, between energies themselves. For example, oil’s vice-like grip on transportation is now being eroded by electrification. This breaking down of barriers, even if nascent, is a profound change.

Incumbents are reacting in different ways. Saudi Arabia, whose current economic model isn’t compatible with competitive energy markets, is doubling down on trying to manage prices. Riyadh has cozied up to Russia to the point where energy journalists are speculating on how to re-brand OPEC (R-OPEC gets a lot of votes but personally I favor ОПЕК; either way, we’re clearly a fun crowd). Yet such efforts also buoy those oil futures that got going 35 years ago, spurring competing supply from non-OPEC producers, and encourage conservation.

Oil majors, meanwhile, are suddenly courting consumers in a big way. Besides recent moves by Royal Dutch Shell Plc and BP, Exxon Mobil Corp. is touting its customer-facing refining and chemicals operations as the key to making money on shale output. It has even recently invested in Yoshi Inc., which is like Instacart for gasoline. The rationale for all this is to capture more margin from each molecule and try to own the customer as competition erodes returns at the well-head.

The same is true for electricity. The sudden consolidation of the U.S. merchant-power industry is a response to flat demand and the flattening of price spikes by renewable energy. Hence, Calpine Corp. and Dynegy Inc. are shuffling off the stock market, while Vistra Energy Corp. and NRG Energy Inc. tout their retail power businesses. Wholesale power markets themselves are having to change or consider it as they grapple with more supply coming at the unfamiliar marginal cost of zero or negative dollars.

Similarly, regulated utilities are shifting ever more of their investment — the basis of their returns — to wires and away from generation. Giant new power plants are tough to justify, and there’s a stronger case to be made for expanding and strengthening grids to better accommodate renewable and distributed energy sources (including electric vehicles).

That brings up the biggest potential disruption.

Renewable energy technologies such as wind and solar break with the experience of the past two centuries because they represent manufactured rather than extracted energy.

In manufacturing, costs tend to fall over time due to experience curves, while costs tend to rise for drilling and mining.

Things aren’t always so straightforward: You only have to look at what innovation in tight-oil-and-gas drilling — itself modeled on a repetitive, manufacturing approach — has done to costs there. However, the most bullish argument for oil today is essentially that the price is too low to encourage enough drilling — or keep shaky petro-states functioning — threatening a supply shock.

Yet a spike in oil or gas prices would mean a short-term windfall to producers but also provide another big push toward efficiency, electrification and renewable energy. Those cats aren’t going back in the bag.

Molecules and electrons becoming true, competitive commodities portends deflation. In turn, more of the value accrues to customers or companies that can produce that raw commodity at the very lowest cost — or turn it into a compelling, differentiated consumer product.

The latter means concepts such as mobility rather than gallons, or cleaner, smarter power supply and management rather than just a meter and a bill. Get it right, and Americans might even pay a bit more than 4 cents for that.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal’s “Heard on the Street” column. Before that, he wrote for the Financial Times’ Lex column. He has also worked as an investment banker and consultant.