The Energy Transition in a Complex Global Economy
The global community, as evidenced by commitments made by governments and businesses around the world, is generally aligned toward the goal of reaching net zero emissions by 2050 in an effort to combat the effects of climate change. These commitments will necessitate (1) a dramatic increase in renewable electricity generation, (2) the electrification of transportation and other industries, (3) the more efficient use of all forms of energy and (4) the expansion of carbon offset markets. The ambitious goal to limit warming to 1.5 degrees Celsius by 2050 will require a transformation of our energy production systems and significant changes to the way we use energy as consumers.
Meanwhile, the world is now facing two acute challenges that are causing governments to re-prioritize short-term energy policy: energy security challenges across Europe and skyrocketing energy prices around the world. Oil prices are determined by global supply and demand. We started 2022 with an already tight market. After the world reduced its consumption of oil by 20% at the height of the COVID-19 shutdown in April 2020, oil demand bounced back to pre-pandemic levels of over 100 million barrels per day and continues to rise. Natural gas demand is above pre-pandemic levels. At the same time, a dramatic slowdown of capital re-investment in the oil and gas industry has led to slow supply growth and decreasing inventories, resulting in higher prices.
The invasion of Ukraine by Russia and the resulting sanctions on Russian oil by the United States and Europe have exacerbated already tight markets, causing oil and natural gas prices to hit levels that have not been seen since 2008. The world is in the midst of a global energy crisis.
Oil and gas is a necessity of our current way of life. If we are successful in the global coordination to reach net zero emissions by 2050, the world will still need to produce ~600 billion barrels of oil and ~3,200 Tcf of natural gas over the next three decades as part of that pathway. To put this in perspective, it will require the equivalent of all of the oil produced in Saudi Arabia and Russia in a year multiplied by 85, and that is in a successful net zero pathway. Ignoring the reality of our world’s need for hydrocarbons during the multi-decade energy transition will only lead to the acute energy security challenges we are currently experiencing and higher commodity prices that serve as a regressive tax on our lowest income citizens.
On the other hand, if we acknowledge the need for hydrocarbons during the energy transition, it brings up an important environmental question: where would we prefer to source the oil and gas we need? Historically, Russia and OPEC countries have produced over 40% of global oil production. Today more than ever, it is important to consider the track record of different countries on emissions reductions, energy security, rule of law and human rights. The United States shines in comparison with some of the largest oil and gas producing countries like Russia, Saudi Arabia, Iran and Venezuela. No country has reduced emissions more over the past 20 years than the United States (17% reduction in CO2 emissions since 2000 due to natural gas replacing coal and increasing renewables). The United States is currently producing oil and gas at one of the lowest emission intensity levels of any major producing country in the world. The momentum to continue decreasing emissions from all sectors is overwhelmingly supported by both the public and private sectors in the United States.
Today, the United States is the largest producer of oil (~12 million barrels per day) and natural gas (~96 Bcfpd) in the world. European countries, who currently import ~40% of their natural gas from Russia, are quickly turning to allies like the United States to provide additional liquified natural gas (LNG) in order to diversify their sources of supply. European citizens are suffering from natural gas prices as high as $45/MMBtu (~15x the average price in the U.S. over the last 10 years). The United States currently exports ~12 Bcfpd of LNG out of the ~96 Bcfpd it produces. This makes the United States both the largest producer of natural gas and the largest exporter of LNG. With the call on more U.S. LNG from Europe, many analysts expect exports of natural gas to increase to as high as ~25 Bcfpd by the end of the decade. Surplus natural gas supply in the United States can easily supplant Russian gas in Europe if United States public policy supports development and transportation of this abundant natural resource.
The Federal government has been critical of large oil and gas companies in the United States suggesting that they are not drilling and increasing production fast enough to offset high prices. Despite this rhetoric, the reality of drilling activity and production growth from the sector is actually quite encouraging. The number of rigs drilling for oil and gas in the United States has increased over the past two years from 250 in 2020 to over 750 today. More importantly, the United States oil and gas industry is expected to grow oil production in the United States by roughly 1 million barrels per day in 2022. That is significantly more oil production growth than any other country in the world. Without that additional supply of oil, the world could have been reeling from oil prices as high as $200 per barrel, as commodities are priced based on the marginal unit of output.
The actions of publicly traded oil and gas companies reflect much improved capital discipline after a period of lagging investor returns for the sector. Investors that allocated capital to the oil and gas industry over the last decade will recall a public sector that was overly focused on production growth that relied on constantly raising capital. That strategy led to shareholder performance that significantly lagged the broader markets from 2010 to 2020. The investors that suffered included pension funds, endowments and charitable foundations across the country. Institutional investors and public boards appropriately responded with guardrails on capital spending and a renewed focus on returning cash flow in the form of dividends and share buybacks. Rather than outspending cash flow, public oil and gas companies are spending a portion of their operating cash flow drilling wells and returning most of it to shareholders. This discipline has led to a healthier industry and improved shareholder returns.
The energy private equity industry has become an important driver of investor performance and production growth in the United States. 2021 was the first year in recorded history that private companies were operating more rigs in the United States than their public company counterparts. NGP’s portfolio companies were collectively operating more rigs in the United States in 2021 than Exxon, Chevron, Pioneer or EOG. With this increased activity, private companies must also be leaders in emissions reduction efforts. NGP has emphasized a focus on reducing emissions across its portfolio with portfolio company KPIs, including annual reductions in flaring, methane intensity and total emissions intensity. In 2021, the collective NGP upstream portfolio achieved a 14% reduction in scope one emissions intensity and a 40% reduction in methane intensity. Meanwhile, a third of NGP‘s investment professionals are investing in businesses that are focused on economic solutions to decarbonize the economy through its energy transition investment franchise, NGP ETP. NGP and its portfolio companies are seeking to provide the oil and natural gas production the global economy needs, while reducing emissions intensity and actively investing in the decarbonization solutions required for a successful energy transition.
In a world that is grappling with the sometimes-conflicting goals of energy transition, energy security and energy affordability, the United States is the clear leader in the global energy industry. Asset allocators have the opportunity to invest in the companies that are leading the way toward decarbonizing the global economy. They also have the opportunity to invest in a much-improved oil and gas sector that is balancing the need to return capital to investors, while growing production and focusing on continuously improving ESG performance. We live in a complex global economy that will require many forms of energy in order to provide energy security at a reasonable cost throughout what will be a multi-decade transition.
Chris Carter is the Managing Partner of NGP Energy Capital Management (“NGP”). He received an M.B.A. from Stanford University, where he was an Arjay Miller Scholar, and a B.B.A. from The University of Texas at Austin, where he was a member of the Business Honors Program. Founded in 1988, NGP is a premier private equity firm with over $20 billion of cumulative equity commitments organized to make strategic investments in the energy industry. For more information visit www.ngpenergycapital.com
EIA Short-Term Energy Outlook (June 7, 2022); FactSet as of July 1, 2022; IEA, Net Zero by 2050 (October 2021); IEA, Total methane emissions and methane intensity of production in selected oil and gas producers in 2020. EIA Short-Term Energy Outlook (June 7, 2022); FactSet as of July 1, 2022; IEA, How Europe can cut natural gas imports from Russia significantly within a year (March 3, 2022); Reuters, U.S. to be world’s biggest LNG exporter in 2022 (December 21, 2021); Enverus, North American LNG (April 27, 2022); Baker Hughes North American Rotary Rig Count (July 1, 2022); Enverus Rig Analytics, NGP analysis