First steps in a reshaping of the energy industry landscape

Recent data shows that there is a growing disconnection between current energy trends and climate goals. With global emissions on the rise, persistent concerns over air pollution and unfinished business in achieving universal electricity access, the world is drifting even further away from a sustainable pathway. Yet faced with the pressures of much-needed changes, today’s energy sector is characterised by uncertainties in markets, policies and technologies. This is making the life of investors particularly difficult.

The IEA’s World Energy Investment 2019 tries to shed light on the strategies that energy companies and investors are pursuing in order to take advantage of new opportunities, insulate themselves against growing long-term uncertainties and to better manage capital at risk.

By analysing recent investment patterns, we have shown that the energy industry has experienced a broad shift in favour of projects with shorter construction times that limit capital at risk. More specifically, for upstream oil and gas and power generation we have seen that the energy industry is bringing capacity to the market more than 20% faster on average than at the beginning of the decade. 75% of upstream oil and gas spending and almost 70% of generation additions are now in assets that were built in fewer than 3 years. If we look back at 2010, those shares were less than 60% and 50%, respectively.

There are many reasons for this, including intense industry competition, but it mainly comes down to better project management and improved economics for shorter cycle technologies – particularly for shale and conventional industry as well as solar PV and wind. However, these trends have not necessarily emerged across all sectors and technologies; some traditional ones are showing less progress in improving project development timelines.

While oil and gas demand has grown robustly over the last few years, companies have had to navigate through increasing uncertainty, given rising pressure facing investors about the environmental sustainability of their operations and potential climate-related policy changes which might affect future demand.

The downturn cycle and the shale revolution have also impacted the strategies of oil and gas companies. While operators immediately reacted by cutting costs and squeezing efficiencies, companies also rationalised their portfolios and explored new synergies and opportunities across the entirety of upstream supply. At the same time, varied market prospects have led companies to engage in different strategies between the oil and gas sectors.

In the oil sector, increasing uncertainties on future demand pathways have encouraged companies to prioritise projects that are able to generate cash flow faster. This has translated into multiple trends: shale assets have attracted an increasing share of companies’ annual capital investment, while in the conventional area they favoured investing in brownfield developments in order to minimise upfront capital expenditure. Finally, companies standardised and re-designed new greenfield projects in multiple phases.

In the natural gas sector, however, companies have showed much more confidence on the long-term role of natural gas in the global energy mix, encouraged by very strong demand and policies in key emerging countries favouring a move away from coal. This renewed attention towards gas is supported by three major indicators:

1. Investment in new LNG liquefaction plants (which are by nature long-term) have skyrocketed in 2019, with a new record for the amount of new LNG capacity sanctioned in just one year. To date, almost 90 bcm of liquefaction capacity reached final investment decision (FID), a full quarter more than the previous record set in 2005.
2. Most of the new LNG projects that reached FID in the last three years had at least one of the majors involved. In other terms, almost 80% of new LNG capacity that has been sanctioned includes at least one big oil and gas corporation.
3. Moreover, the financing model of such projects is evolving, with a growing share of projects being financed through companies own balance sheets, a signal of improved industry confidence on medium-long term economics of new investment (more on this in the IEA’s forthcoming Global Gas Security Report)

With electricity demand growing at twice the pace of energy demand and rising pressures on the use of fossil fuels, oil and gas companies have started to also look at emerging possibilities in the power sector. Measured in terms of share of their annual capital investment, activities outside their core business remain limited and on the order of a single percentage point. However, there is significant growing attention on new business opportunities opening up in the sector. How current trends are preparing markets for a rapid shift of investment allocations and what technologies would mostly benefit from such a scenario remains an open (and crucial) question. 

The power sector has experienced several shifts in terms of overall power generation investment, especially in the case of traditional utilities whose business models were typically based on rising demand for thermal power generation.

The share of renewables in global power generation investment increased from about 45% in 2000, to nearly 65% in 2018, underpinned not only by dramatic reductions in capital costs but also by a global shift towards revenue models based on competitive bidding. Renewables technologies with shorter construction times, such as wind and solar PV, benefitted mostly from those trends.

In parallel and over the same period, fossil fuel based generation investment halved, falling from 50% of global power generation investment to around a quarter in 2018. Moreover, while there were high expectations for increasing electricity consumption, since 2010 electricity demand in 18 out of 30 IEA countries has actually declined thanks largely to energy efficiency.

Companies that have not quickly adapted to this changing context have paid a significant price in terms of asset write-downs, returns on capital employed and competitiveness. But on the other side, this new context has also opened up new strategic opportunities that companies are trying to capitalise on. We identify three: 

1. Overall, there has been a fundamental shift away from thermal power and fossil fuels to business models for renewables based on contracted remunerations. We see this also in FID trends of key thermal power technologies – with FIDs for coal and gas fired plants significantly declining. Over last three years, annual FIDs for coal-fired generation have been at around 30 GW annually, falling from the first three years of the 2010s, when they averaged almost 90 GW per year. For gas-fired generation plants, the decline has been less pronounced than for coal but still, the FIDs for gas power have declined about one-third since the early part of the decade.
2. The plunge of investment in thermal power has been the main driver behind a painful restructuring of traditional thermal power manufacturers. General Electric was severely hit by lower than expected activities in coal and gas. More recently, Siemens announced the spinning off of its power and gas division due to a weak gas turbine market, while Toshiba’s significant reorganisation was linked to difficulties in nuclear projects facing Westinghouse, and a reduction of its coal-fired power business.
3. Some power companies are integrating their supply business with greater focus on network assets, retail, flexibility provision, energy efficiency and demand side services (e.g. electric mobility). There are several examples in this area such as Enel’s acquisition of EnerNOC (a leading US-based provider of smart energy management services), but also eMotorWerks (provider of e-mobility solutions) and Demand Energy (developer and operator of energy storage and software). Another type of business strategy is illustrated by Engie’s acquisition of Mobisol, a pay-as-you-go solar home system pioneer and the takeover of Fenix International in 2017, enabling them to provide access and electricity-based services in several key markets in East Africa.

There are a range of open questions for the energy sector right now, including fundamentally how to successfully reallocate capital investments in order to be aligned with sustainability goals and with the ongoing energy transition (see our recent commentary on capital allocation). But one thing is certain: the energy company of the 21^st century is rapidly transforming and will almost certainly end up being very different than what it is today.