21 Sep 2015

It hardly looks the ideal backdrop for a deal on climate change. In a few action-filled weeks as global leaders prepare for crunch talks in Paris in December, the price of oil has collapsed to fresh six-year lows.

The plunge in crude prices from $115 a barrel last summer to less than $50, has shone a harsh spotlight on cleaner forms of energy.

The worry is that, as oil and natural gas become cheaper sources for transport and heating fuels across the globe, the shift could undermine the case for investing in renewables and slow the development of more environmentally friendly energy sources that could replace fossil fuels.

It is not just renewables that could be affected by oil’s slide. Efforts to replicate the US’s shale revolution elsewhere by using new technology to extract “unconventional” oil and gas reserves may struggle, too.

Meanwhile, oil companies are scrambling to slash costs and improve efficiency. As a result, the price collapse could lead to a wave of innovation.

According to a study by Bloomberg New Energy Finance, the global power generation mix will change radically by 2040, from a system comprising two-thirds fossil fuels to one where 56 per cent of energy comes from sources creating zero carbon emissions.

Renewables, the report says, will command just under 60 per cent of 9,786 gigawatts of new generating capacity to be installed in the next 25 years, and two-thirds of $12.2tn investment.

“Economics — rather than policy — will increasingly drive the uptake of renewable technologies,” it says.

As project costs come down, wind power — already the cheapest form of new generation capacity in Europe — will be the least costly option “almost universally”, while solar power is projected to boom, accounting for almost a third of global investment.

So far, despite cheaper gas, there is little evidence of a reversal in this trend.

In recent months, several companies have made eye-catching investments in solar and wind power. US private equity group KKR has swooped on Gestamp, a Spanish solar developer. Germany’s Siemens won an order for wind turbines from Denmark’s Dong Energy worth up to $1.2bn and US renewables juggernaut SunEdison agreed to buy the Vivint solar-installation group.

Some investments, though, have stalled. Plans by Canadian gold miner Iamgold to build a solar plant at a mine in Burkina Faso in west Africa have been put on hold, after the savings from switching to solar panels from power generators run on heavy fuel oil became less obvious.

For some small island nations and large parts of Africa, where unreliable electricity supplies mean high dependence on diesel and other fuel oil for generators, a leap to renewables now appears less likely.

The longer term effects, should prices stay low, are harder to read.

Ben Warren, a financier with consultancy EY, says renewables have been “largely isolated” from oil prices because the power they produce is sold under long-term contracts at fixed costs. Moreover, he says, capital, operating and financing costs have fallen sharply in the past several years.

For example, a UK government auction this year for a pot of renewable subsidies worth nearly £4bn showed how competitive wind and solar have become — two solar panel projects showed they could produce electricity for nearly 60 per cent less than the government had set as a maximum benchmark for that form of power.

The greater threat to the sector’s prospects could come from a scaling back of government backing, he says. “The risk is primarily a political one. If the government in question doesn’t see renewables as making an affordable contribution to the energy mix over the longer term, then there is a risk subsidies will be reduced or withdrawn,” he adds.

Indeed, that is what has happened in the UK following the victory of the Conservative party in the UK general election in May, which freed it from coalition government.

According to Simon Virley of KPMG, Britain’s decision to cut subsidies for solar and biomass, coupled with a clear signal from the government that it intends to curb spending on deployment are “bound to presage a period of reassessment by investors of their investment plans.”

Elsewhere, however, diversification into alternative energy sources is becoming urgent. Saudi Arabia, for example, uses more than a quarter of its oil production to meet its domestic energy needs. A growing economy means this will only increase — and efforts are being made to speed up solar’s development.

In the kingdom, more than $200m has been raised to fund expansion at a California-based producer of wafer thin silicon photovoltaic (PV) modules for commercial and residential rooftops to convert solar energy directly into electrical power.

The bigger impact from oil’s slide is likely to be felt by fossil fuel producers themselves. Some believe that it could jeopardise prospects for developing shale outside the US.

Melissa Stark, global managing director for new energy at Accenture, says that shale development in countries including Australia and Mexico will be most affected by falling crude prices.

In Mexico, companies will need prices above $80 to make shale profitable in the first instance. “Lower oil prices will also make development challenging in Europe,” says Ms Stark.

She estimates large-scale development of shale outside the US is at least five years away. Uncertainties over the extent of recoverable resources and the fiscal terms on offer, as well as questions surrounding geology, land access, drilling technology and the availability of skilled workers need to be resolved.

In such an environment, Argentina, China and Saudi Arabia, all with strong state-backed national oil companies, could be better placed to extract shale commercially. YPF of Argentina has signed a $1.2bn deal with Chevron, the US oil major, to develop Vaca Muerta, the biggest shale field outside the US.

The fall in the price of crude is expected to keep many investments on hold, however.

Meanwhile, the world’s biggest oil and gas groups will further tighten their grip on capital spending, deferring multibillion-dollar projects in the hope that they can benefit fully from falling costs through the supply chain.

According to Wood Mackenzie, the energy consultancy, about $200bn of spending on proposed oil and gas projects has already been shelved.

Accenture’s Arthur Hanna suggests the sector’s largest groups will look for greater efficiency savings, extending co-operation on shared procurement to areas such as finance and back office functions. Such efforts could lead to technological innovation.

“Virtual warehouses” for tracking stock have the potential to save millions of dollars by giving oil groups swifter access to spare parts and equipment.

Offshore, engineering advances could extend the ability of oilfield operators to perform maintenance without the need for costly on-site human intervention. Digital technologies, from radio-frequency identification to drones and robots, can further help reduce costs and improve labour efficiency, says Mr Hanna.

Source: http://www.ft.com/cms/s/0/1ac357e4-3a06-11e5-bbd1-b37bc06f590c.html#ixzz3mNDqGLsg