Analys
Getting to zero, getting the job done
Politicians have been talking and talking for decades but with only marginal improvements in terms of emission reductions. Primarily because actually doing the job has earlier been technologically and economically almost impossible. Now suddenly renewable energy has come of age with prices set to decline yet further. And onshore transportation can soon be electrified cost efficiently. For politicians there is now a viable path. It is still a large task but now it is more and more about just getting the job done. In rough terms some € 150 – 250 bn per year to 2050 is probably needed to build EU’s new power system.
In 2019 the EU + UK consumed 15,000 worth of fossil fuels. It all needs to be gone by 2050. In 2019 the EU + UK produced 3,200 TWh of electricity of which 1,295 TWh (40%) was fossil fuel based. Thus 60% of the power supply is already non-fossil. However, if we look at the larger picture of energy we see that the region consumed nearly 15,000 TWh of raw (evaluated pre-combustion) fossil fuels that year of which only 3,000 TWh was used for power. The remaining 12,000 TWh of fossil fuel consumption was consumed for heat, transportation, petrochemical and industrial uses. I.e. the lion’s share of fossil fuel consumption in the region is non-power related.
Thus getting to zero by 2050 is far more than swapping out of the 3,000 TWh of fossil fuels (pre-combustion) used for power supply today which post combustion creates 40% and 1,295 TWh of the regions electricity supply. The challenge is also about replacing the other 12,000 TWh of fossil energy for non-power uses.
As most know the conversion of fossil fuels to useful energy and work done is highly inefficient. In cars one rarely get more than 30% of the energy converted to useful driving with the rest just lost as heat. In large, power plants the conversion ratio is usually around 35% to 55% but mostly below 50%. Gas for heating purposes is of course highly efficient as almost all of it naturally is converted to heat.
The region is now aiming to go green by 2050 and that mostly means going electric. This again means that some 15,000 TWh of fossil energy spent today needs to be replaced by non-fossil based electricity. Given the highly inefficient burn of fossil energy to useful work it is no surprise that we don’t need the same amount of electricity output to replace it but rather something like only 30% to 50% as much.
When it comes to synthetically generated “electric fuels” (power to liquids or hydrogen) we are talking about an up to 200% replacement ratio because up to 50% of the electricity is lost in the conversion of power to liquids. But for most other purposes like electrifying transportation and replacing the burning of fossil fuels for power etc. the replacement ratio is often more like 30% to 50%. When it comes to replacing gas for heating purposes it is a one-to-one replacement.
In our calculations the region is going to need 6,731 TWh of new non-fossil based electricity by 2050 in order to replace the 15,000 TWh worth (pre-combustion) of fossil energy spent today. I.e. a replacement ratio of 46%. It is thus good news that we don’t need at total of 15,000 TWh of new non-fossil based power supply by 2050 but instead “only” 6,731 TWh.
This replacement is still huge! In comparison the supply of electricity in 2019 was 3,200 TWh (including fossil based power). I.e. the region needs to build its total power supply of today more than two times over by 2050 and at that point in time reach a total power supply of 8,574 TWh.
If we equate the challenge to the number of nuclear power units needed to cover it we are talking 570 new nuclear power units each of 1,500 MW capacity. In 2013 there were 131 operational nuclear power plants and today we are probably closer to 110. Thus to do the job by nuclear we need to increase nuclear power by more than 500% by 2050.
While the job is challenging it is by no means impossible. If we take the new UK Hinkley nuclear power plant as an example in terms of capex we have the following. It will generate about 25 TWh of electricity per year and cost about € 27 bn to build. I.e. €1.1 bn for a 1 TWh/year supply rate. Multiply by the needed 6,731 TWh/year of new power supply by 2050 and we get a needed capex € 7,147 bn in total which again equates to € 238 bn/yr over the next 30 years. Nuclear power is today considered to be a quite expensive source of new electricity with renewable energy often being significantly cheaper (up to 50% cheaper) though not providing baseload supply and rather intermittent supply.
Capex spending in the EU + UK should be in the ball-park of € 150 – 250 bn per year or 1.3% of GDP. Capex spending on new power supply over the coming 30 years should probably be in the ball-park of $ 150 – 250bn/year. And then some additional investments for a lot of infrastructure adaptation. EU and UK thus needs to spend some 1.3% of its GDP per year for the energy transition (€ 238 bn/yr divided by GDP of € 18,292 bn in 2019). But that of course assumes that there is no further declines in the cost of new renewable energy which by most measures is projected to continue to fall year by year. And going electric in the transportation sector (on land) will in not too long be a pure net saving as electric cars becomes cheaper than fossil cars while electric cars are also much more energy efficient than fossil cars.
The example of nuclear energy is for simplicity purposes. It is not in the cards at all today that the region is going big-time nuclear. The direction is rather much more renewable energy.
On the table we already have a pledge of 2,100 TWh/year of offshore wind by 2050. On the drawing table we already have an announced build-out of 300 GW of new offshore wind by the EU and 100 GW of offshore wind by the UK. Both by 2050. What does that mean? At a 60% offshore wind utilization ratio this equates to 2,100 TWh/year of new power supply by 2050. Thus already today a total of 31% of the new, needed 6,731 TWh by 2050 is firmly on the drawing table.
For many decades there has been endless political discussions about climate change. As a result we have moved a little forward but not all that much. We have gotten the European emission trading scheme (EU ETS) which is good and where we now have a decent carbon price of € 42/ton which starts to matter and where abatement (carbon reductions) is happening on the margin.
We have now come to the point where it is all bout getting the job done. To actually build what needs to be replaced. However, we have now gotten to the point of crunch-time. The time to act. The time to start the real change. Now it is about figuring out how to get to zero by 2050. Now it is all about getting the job done for real. Our sense is that thousands of engineers across Europe today suddenly are mapping out detailed plans of what we actually need to do to get there. It is not easy. It does not happen by itself. But it is absolutely doable and it will require some €150 – 250/bn per year in capex spending on new non-fossil based power supply over the next 30 years. But probably less than that as the cost of renewable energy continues to decline.
The region is not going to get to zero by 2050 by marginal abatement in the EU ETS emission system. The region is going to get there by outright building the alternative and then increasingly retiring the current system. And what it looks like already is that offshore wind is going to be a major part of the solution with plans already in place to solve 30% of the challenge.
IEA estimated in a report from 2019 that technical offshore wind power resources in Europe is 60,000 TWh worth of power supply. That is almost 10 times as much as what is needed to solve EU + UK’s goal of zero emissions by 2050. And as stated above the two have already committed to build 2,100 TWh/year of offshore wind power supply by 2050. So on the drawing table we are already one third of the way.
Norway is not really on the map here yet but it could easily offer to build 2,000 TWh of offshore wind power supply if EU agreed to buy it and pay for it at an agreeable price. If so this would lead to a real offshore wind bonanza over the coming 30 years equal to the build-out of the oil and gas on the NCS.
The EU + UK needs to kick the habit of consuming close to 15,000 TWh worth of fossil fuels per year by 2050 (evaluated pre-combustion). The replacement is going to happen by building the alternative and governments will be involved big-time to get it done. The current power supply for the region needs to be build more than two times over by 2050 to get the job done.
The EU + UK produced a total of 3,200 TWh of power in 2019 of which 1,295 TWh (40%) was generated by fossil fuels. In total the EU + UK will need 6,731 TWh of new non-fossil based power supply by 2050 in order to kick 15,000 worth of fossil fuels (evaluated pre-combustion) out the door. At that point total power supply in the region needs to be 8,574 TWh/year in order for the region to go green. Of the 6,731 TWh of new non-fossil power needed we already have a pledge by the EU and the UK together of 2,100 TWh of new offshore wind power supply by 2050. Thus 31% of the power needed to go fully green by 2050 is already pledged for through offshore wind. In the following graph ”EU” is short of ”EU+UK” for the sake of abbreviation.
The following graph shows how much new non-emitting power supply the EU + UK needs for each sector to go electric and green by 2050. Today’s consumption of 15,000 TWh (pre-combustion) is mostly outside of the power sector. Some 1,900 TWh of current power supply can be kept for the future as it is non-emitting like nuclear, wind and other renewables. Total non-emitting power supply in the region needs to be 8,574 TWh by 2050 in order to go green.
Technical offshore wind potential in Europe is close to 60,000 TWh per year according to a recent report by the IEA published in November 2019. Almost 10x of what the EU + UK needs to go fully green by 2050. And much of the capacity is in the North Sea between the UK and Norway.
Brent rallied 2.5% last week on bullish inventories and bullish backdrop. Brent crude gained 2.5% last week with a close of the week of USD 89.5/b which also was the highest close of the week. The bullish drivers were: 1) Commercial crude and product stocks declined 3.8 m b versus a normal seasonal rise of 4.4 m b, 2) Solid gains in front-end Brent crude time-spreads indicating a tight crude market, and 3) A positive backdrop of a 2.7% gain in US S&P 500 index.
Brent falling back 1% on diesel concerns this morning. But positive backdrop may counter it later. This morning Brent crude is pulling back 0.9% to USD 88.7/b counter to the fact that the general backdrop is positive with a weaker USD, equity gains both in Asia and in European and US futures and not the least also positive gains in industrial metals with copper trading up 0.4% at USD 10 009/ton. This overall positive market backdrop clearly has the potential to reverse the initial bearish start of the week as we get a little further into the Monday trading session.
Diesel concerns at center stage. The bearish angle on oil this morning is weak diesel demand with diesel forward curves in front-end contango and predictions for lower refinery runs in response this down the road. I.e. that the current front-end strength in crude curves (elevated backwardation) reflecting a current tight crude market will dissipate in not too long due to likely lower refinery runs.
But gasoline cracks have rallied. Diesel weakness is normal this time of year. Overall refining margin still strong. Lots of focus on weakness in diesel demand and cracks. But we need to remember that we saw the same weakness last spring in April and May before the diesel cracks rallied into the rest of the year. Diesel cracks are also very seasonal with natural winter-strength and likewise natural summer weakness. What matters for refineries is of course the overall refining margin reflecting demand for all products. Gasoline cracks have rallied to close to USD 24/b in ARA for the front-month contract. If we compute a proxy ARA refining margin consisting of 40% diesel, 40% gasoline and 20% bunkeroil we get a refining margin of USD 14/b which is way above the 2015-19 average of only USD 6.5/b. This does not take into account the now much higher costs to EU refineries of carbon prices and nat gas prices. So the picture is a little less rosy than what the USD 14/b may look like.
The Russia/Ukraine oil product shock has not yet fully dissipated. What stands out though is that the oil product shock from the Russian war on Ukraine has dissipated significantly, but it is still clearly there. Looking at below graphs on oil product cracks the Russian attack on Ukraine stands out like day and night in February 2022 and oil product markets have still not fully normalized.
Oil market gazing towards OPEC+ meeting in June. OPEC+ will adjust to get the price they want. Oil markets are increasingly gazing towards the OPEC+ meeting in June when the group will decide what to do with production in Q3-24. Our view is that the group will adjust production as needed to gain the oil price it wants which typically is USD 85/b or higher. This is probably also the general view in the market.
Change in US oil inventories was a bullish driver last week.
Crude oil time-spreads strengthened last week
ICE gasoil forward curve has shifted from solid backwardation to front-end contango signaling diesel demand weakness. Leading to concerns for lower refinery runs and softer crude oil demand by refineries down the road.
ARA gasoline crack has rallied towards while Gasoil crack has fallen back. Not a totally unusual pattern.
Proxy ARA refining margin with 40% gasoil crack, 40% gasoline crack and 20% bunker oil crack.
ARA diesel cracks saw the exact same pattern last year. Dipping low in April and May before rallying into the second half of the year. Diesel cracks have fallen back but are still clearly above normal levels both in spot and on the forward curve. I.e. the ”Russian diesel stress” hasn’t fully dissipated quite yet.
Net long specs fell back a little last week.
52-week ranking of net long speculative positions in Brent and WTI as well as 52-week ranking of the strength of the Brent 1-7 mth backwardation
So far this week, Brent Crude prices have strengthened by USD 1.3 per barrel since Monday’s opening. While macroeconomic concerns persist, they have somewhat abated, resulting in muted price reactions. Fundamentals predominantly influence global oil price developments at present. This week, we’ve observed highs of USD 89 per barrel yesterday morning and lows of USD 85.7 per barrel on Monday morning. Currently, Brent Crude is trading at a stable USD 88.3 per barrel, maintaining this level for the past 24 hours.
Additionally, there has been no significant price reaction to Crude following yesterday’s US inventory report (see page 11 attached):
- US commercial crude inventories (excluding SPR) decreased by 6.4 million barrels from the previous week, standing at 453.6 million barrels, roughly 3% below the five-year average for this time of year.
- Total motor gasoline inventories decreased by 0.6 million barrels, approximately 4% below the five-year average.
- Distillate (diesel) inventories increased by 1.6 million barrels but remain weak historically, about 7% below the five-year average.
- Total commercial petroleum inventories (crude + products) decreased by 3.8 million barrels last week.
Regarding petroleum products, the overall build/withdrawal aligns with seasonal patterns, theoretically exerting limited effect on prices. However, the significant draw in commercial crude inventories counters the seasonality, surpassing market expectations and API figures released on Tuesday, indicating a draw of 3.2 million barrels (compared to Bloomberg consensus of +1.3 million). API numbers for products were more in line with the US DOE.
Against this backdrop, yesterday’s inventory report is bullish, theoretically exerting upward pressure on crude prices.
Yet, the current stability in prices may be attributed to reduced geopolitical risks, balanced against demand concerns. Markets are adopting a wait-and-see approach ahead of Q1 US GDP (today at 14:30) and the Fed’s preferred inflation measure, “core PCE prices” (tomorrow at 14:30). A stronger print could potentially dampen crude prices as market participants worry over the demand outlook.
Geopolitical “risk premiums” have decreased from last week, although concerns persist, highlighted by Ukraine’s strikes on two Russian oil depots in western Russia and Houthis’ claims of targeting shipping off the Yemeni coast yesterday.
With a relatively calmer geopolitical landscape, the market carefully evaluates data and fundamentals. While the supply picture appears clear, demand remains the predominant uncertainty that the market attempts to decode.
Brent crude has fallen USD 3/b since the peak of Iran-Israel concerns last week. Still lots of talk about significant Mid-East risk premium in the current oil price. But OPEC+ is in no way anywhere close to loosing control of the oil market. Thus what will really matter is what OPEC+ decides to do in June with respect to production in Q3-24 and the market knows this very well. Saudi Arabia’s social cost-break-even is estimated at USD 100/b today. Also Saudi Arabia’s purse is hurt by 21% US inflation since Jan 2020. Saudi needs more money to make ends meet. Why shouldn’t they get a higher nominal pay as everyone else. Saudi will ask for it
Brent is down USD 3/b vs. last week as the immediate risk for Iran-Israel has faded. But risk is far from over says experts. The Brent crude oil price has fallen 3% to now USD 87.3/b since it became clear that Israel was willing to restrain itself with only a muted counter attack versus Israel while Iran at the same time totally played down the counterattack by Israel. The hope now is of course that that was the end of it. The real fear has now receded for the scenario where Israeli and Iranian exchanges of rockets and drones would escalate to a point where also the US is dragged into it with Mid East oil supply being hurt in the end. Not everyone are as optimistic. Professor Meir Javedanfar who teaches Iranian-Israeli studies in Israel instead judges that ”this is just the beginning” and that they sooner or later will confront each other again according to NYT. While the the tension between Iran and Israel has faded significantly, the pain and anger spiraling out of destruction of Gaza will however close to guarantee that bombs and military strifes will take place left, right and center in the Middle East going forward.
Also OPEC+ wants to get paid. At the start of 2020 the 20 year inflation adjusted average Brent crude price stood at USD 76.6/b. If we keep the averaging period fixed and move forward till today that inflation adjusted average has risen to USD 92.5/b. So when OPEC looks in its purse and income stream it today needs a 21% higher oil price than in January 2020 in order to make ends meet and OPEC(+) is working hard to get it.
Much talk about Mid-East risk premium of USD 5-10-25/b. But OPEC+ is in control so why does it matter. There is much talk these days that there is a significant risk premium in Brent crude these days and that it could evaporate if the erratic state of the Middle East as well as Ukraine/Russia settles down. With the latest gains in US oil inventories one could maybe argue that there is a USD 5/b risk premium versus total US commercial crude and product inventories in the Brent crude oil price today. But what really matters for the oil price is what OPEC+ decides to do in June with respect to Q3-24 production. We are in no doubt that the group will steer this market to where they want it also in Q3-24. If there is a little bit too much oil in the market versus demand then they will trim supply accordingly.
Also OPEC+ wants to make ends meet. The 20-year real average Brent price from 2000 to 2019 stood at USD 76.6/b in Jan 2020. That same averaging period is today at USD 92.5/b in today’s money value. OPEC+ needs a higher nominal price to make ends meet and they will work hard to get it.
Inflation adjusted Brent crude price versus total US commercial crude and product stocks. A bit above the regression line. Maybe USD 5/b risk premium. But type of inventories matter. Latest big gains were in Propane and Other oils and not so much in crude and products
Total US commercial crude and product stocks usually rise by 4-5 m b per week this time of year. Gains have been very strong lately, but mostly in Propane and Other oils
Last week’s US inventory data. Big rise of 10 m b in commercial inventories. What really stands out is the big gains in Propane and Other oils
Take actual changes minus normal seasonal changes we find that US commercial crude and regular products like diesel, gasoline, jet and bunker oil actually fell 3 m b versus normal change.
Diesel concerns drags Brent lower but OPEC+ will still get the price it wants in Q3
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Also OPEC+ wants to get compensation for inflation
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