Notes from JP Morgan's Annual Energy Paper

"We have much to lose by ignoring the realities of the world we live in, and much to gain by addressing them head on." - Mary Erdoes, CEO JP Morgan Wealth Management

Michael Cembalest, head of Investment Strategy at JP Morgan, put out his annual energy paper today. It covers the energy landscape, the recovery in the oil & gas sector and a warning label on industrial electrification and carbon sequestration forecasts. 

The report puts an emphasis on ignoring the hype, narrative building and hockey stick forecasts and focuses on the actual trends taking place in the energy transition.

Lets dig in. 

To date, the transition to renewable energy has been more whimper and less bang. 

Quoting Mark Twain, reports on the death of fossil fuels are greatly exaggerated. 

Fossil fuel reliance across the developed and emerging world is still high (70% even in Europe) and the International Energy Agency projects that the world may still be 66% reliant on fossil fuels in 2050.

In 1965, fossil fuels accounted for ~95% of the world's energy use. In 2022, that number is 83%. 

50 years and fossil fuels share of total energy use declined by ~10%. The energy transition is not going to happen overnight. 

Living in the US, we may think we're less reliant on fossil fuels because production has effectively moved off shore. Over the last 25 years, the developed world shifted much of its carbon-intensive manufacturing of steel, cement, ammonia and plastics to the developing world.

In recent years, the narrative developed that fossil fuel stocks were dead money since the renewable transition was taking shape. In reality, a lot of the poor performance in oil & gas equities was self-inflicted; the result of management teams focusing on market share and revenue rather than profits, and not because of imminent displacement coming from renewable energy.

Global gas and coal consumption in 2021 were already above pre-COVID levels, and global oil consumption should surpass pre-COVID levels sometime next year.

Europe has been a big focus this year given their reliance on Russian energy. A simple truth is Europe reduced their production of fossil fuels faster than they reduced their consumption of fossil fuels. 

The obvious outcome of this will be recession. Secondary effects could be lower rates of growth, decline in competitiveness of exported energy intensive goods; curtailment of industrial production (steel, fertilizer, cement etc) and related employment; higher food prices; and domestic political tensions as anti-establishment candidates take advantage of distress.

Electricity prices are 4-5x higher in major European countries vs. the US. Natural gas prices are 4x higher. 

Europe is not the only region at risk: on a global basis, capital spending on oil and gas production is declining while oil and gas consumption is not.

Many countries are now faced with three broad choices:

1) ramp up their domestic production of fossil fuels to avoid a geopolitical and economic trap2) rely on the countries in the table below for imported energy; or3) confront the obstacles to a faster renewable transition (namely time and cost) head-on. 

In terms of China, they are the elephant in the room. China's industrial sector consumes more energy than the US, European and Japanese industrial sectors combined. And they are still extremely reliant on coal.

China’s share of coal use in its primary energy is declining, its absolute consumption of coal has not declined at all.  In 2020 and 2021, China built 67 GW of new coal plants while new capacity built in the entire rest of the world was just 35 GW.

Coal accounts for ~60% of China's primary energy vs 10% in Europe and the US.

This is the main reason China still has the highest CO2 emissions and the highest CO2 intensity of energy production in the world.