Musings on CERA WEEK

Takeaways from Houston CERAWeek, March 7-11, 2022

From my good friend and loyal supporter of the Canadian Global Affairs Institute and our Energy Security Forum. Peter Williams Managing Partner & CEO | Annapolis Capital Limited. Albeit lengthy, this is a very good summation of not only CERA week but the present and future state of the complete energy system. Absolutely worth the time.

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I attended CERAWeek 2022 in Houston during the week of March 7-11. It was a great conference, and it did not disappoint as the premiere North American energy conference. I felt it would be worthwhile to document and share takeaways for those who may be interested. The title of this year’s in person conference spans big ideas: ‘The Challenges, Opportunities, and Pace of Change around Energy, Climate, Technology, and Innovation’. The forum provided a unique opportunity to see so many industries, governments and leaders represented over 5 days in a format that was interview and panel based, versus pre-prepared (tedious) speeches. The event was charged by the events unfolding simultaneously in the Ukraine, both in terms of the united support and empathy for the Ukrainian people and the implications of the war for the greater world. People think of CERAWeek as an oil and gas forum but over the years it has morphed into a conference focused as much on electrons as it is on molecules. Panels and individual interviews included CEO’s and dignitaries across the spectrum of industry and government including oil & gas, hydrogen, CCUS, mining, solar, wind, nuclear, utilities, car manufacturers and emerging technologies. The interviewees and interviewers represented a veritable who’s who including:?Pulitzer prize winning Daniel Yergin as conference host (conducting over 42 interviews), the Secretary General of OPEC Mohammad Barkindo, Special Presidential Envoy for Climate John Kerry, Chairman & CEO of Exxon Mobil Darren Woods, CEO of Rivian RJ Scaringe, President & CEO of Saudi Aramco Amin Nasser, President & CEO of Cheniere Energy Jack Fusco, Chairman, U.S. Senate Energy and Natural Resources Committee Joe Manchin, Secretary of Energy for the US Jennifer Granholm, and CEOs of the IEA, Chevron, Total Energies, ConocoPhillips, Suncor, Petronas, Dow, OXY, PG&E, Hess, Ford Motor Company, Repsol, Edison International and their peers across the energy, climate, technology, and innovation spaces.

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It was not possible to even come close to attending all the sessions. According, my observations reflect only high-level takeaways from those sessions I did attend and some of the messages and themes that repeated themselves over the week. In addition to the main conference there was a parallel conference as part of CERAWeek called AGORA which had 2 physical areas dedicated to what they called the ‘Hydrogen Hub’ and the ‘CCUS’ Hub and conference rooms with presentations on climate, technology and innovation.

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Net 0 by 2050

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A big high-level takeaway for me was how ambitious and aspirational the net 0 by 2050 will be for the developed world.?Aspirations though, without a plan, are difficult to achieve and that was writ large at the conference. As the CEO of Saudi Aramco said we must combine idealism with realism and planning – without compromise to the environment. His message was that idealism is dominating and planning is lacking. 'Plans are of little importance, but planning is essential' -Winston Churchill – who, by the way, was not in attendance. Overall, it was evident that major strides are required to be made by 2030 if there is any chance of achieving 2050 goals. The ultimate solutions will have to come from a combination of all initiatives – in order of perceived priority: coal to natural gas conversions, stopping methane/flaring emissions, aggressive CCUS initiatives, advancement of hydrogen in all its various colors of origin (blue being the most realistic for now, see more on that below) , nuclear (mostly SMR’s, small modular reactors), continued aggressive expansion of solar and wind, long term storage, and nature based solutions, among other things. The challenges are multiple:

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·???????Many of the technologies required to achieve the targets have not yet been developed or are in early stages of development

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·???????The policy work required by governments to establish clearer policy frameworks, tax structures (such as clear rules around carbon tax and production tax credits) and incentives are required to enable businesses to get-on with transition projects with grounded economics. Without a constructive policy framework, it is challenging to scale up projects. Businesses need the economic inputs to plan and to implement and that is lacking – particularly in the U.S.. On that point most energy CEO’s spoke to the desire for an established carbon tax framework – there was no resistance at all to the concept and most volunteered the need to go there and the sooner the better.

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·???????The immense barriers and time delays of getting projects permitted. Folks were talking consistently about 5-8 year lead times in the U.S. and longer in Europe. The permitting issues sounded very much like where Canada has been over the past decade – however the U.S is still not that bad. That said I have not heard before such a hew and cry from the U.S and Euro companies, and they are the ones who will carry the vast responsibility of achieving the carbon reduction aspirations. Pipelines, infrastructure, LNG, transmission lines, mines, wind and solar farms are all experiencing similar issues. It was also pointed out that many of the permitting processes themselves have major flaws and directionally are getting more complicated – not less – creating more uncertainty. Joe Manchin, Chairman, U.S. Senate Energy and Natural Resources Committee advocated that the U.S. may need to activate the Defence Production Act (which is war footing legislation) to begin overriding permitting processes in the U.S.

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·???????Vast shortages of raw materials like copper, cobalt, lithium, rare minerals and other inputs, which are scarce to start with and which have the same or greater permitting issues noted above. This too is adding to inflation. One solar leader said he never again expects to see solar costs as low as they were in 2019. Costs for solar inputs are up on average 50% since 2019. Some costs will mitigate as supply chain issues resolve but much of the cost inflation for renewables is expected to continue. And on the supply chain side an example from a wind farm leader was that delivery on orders made today for new offshore turbines, that have already been permitted, is 2027.

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·???????It is estimated it will require up to $275 trillion (McKinsey Report) to achieve net 0 by 2050. Capital aggregates around certainty and it was difficult to imagine how the various initiatives will scale to achieve actualization in a timely way.?This is not just because of the foregoing points around policy, permitting scarcity and supply chain issues but also because of the chicken or egg conundrum as well – what comes first? - the product or the demand for the product. As one large hydrogen producer said – ‘without certainly of takeaway markets it is almost impossible to finance a hydrogen project’.

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Thus, the overall goals of net zero by 2050 are noble but we should be prepared for the challenges to become more and more evident with time. Great strides are and will occur and need to occur and no one was arguing the point - but massive planning and coordination efforts with all industries and governments is required. As a point to note, no hydrocarbon producer was welcome at COP26 and yet the industry is a vital part of mapping out the transition and achieving overall country and global targets.

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Oil

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Consensus affirmed conventional thinking going into the forum i.e., that we are in a growing demand and lack of supply market (quite independent of Ukraine crises) for oil. Oil markets today were frequently referred to by speakers as being at the beginning of a new ‘super cycle’ for oil and other commodities such as copper and rare minerals.??Biggest reasons behind the creation of the conditions giving rise to the oil super cycle has been a persistent lack of reinvestment from 2015 forward ($300 – $350 billion per year in the last 7 years versus $750 million in 2014) to offset global declines of 7%. Exxon estimated we needed $400-500 billion per year, at a minimum, to offset declines and meet demand. 7 years of insufficient reinvestment has not been close to what was required to offset global declines. In the world of public energy companies, part of the challenge has been investors demands for ‘no more growth’ and return of capital from free cash flow by way of dividends, stock buybacks and debt reduction. Companies deviating from that strategy have been penalized in the markets and most majors and independents at the conference indicated that they had no plans of deviating from their return of capital commitments. Also new equity capital for the energy companies has been scarce to non existent due to divestment policies of many institutional investors and an overall view that oil is an existential business in the near term (cliff transition!) that does not warrant investment (recall the I.E.A. pronouncements about no more expenditures required for exploration to meet global demand). The prevailing view at the conference was that there is a fundamental gap in conventional thought around how long global demand for oil will continue and how necessary it is to achieve the long term transition ambitions.?The fact that the sector has delivered low overall returns over the last 10 years (coming in as the worst performing subsector on the S&P 500 for the 10 years prior to 2021) certainly has not helped to attract capital.?As a side note, Goldman Sachs was of the view that the generalists are not likely to come back to the oil & gas public equity space in a meaningful way unless the broader market bursts. Other reasons for lack of reinvestment includes the desire for companies to use some portion of their capital toward alternatives and renewables. The resulting situation the world finds itself in is no more than 2 million barrels of spare capacity (2% of global supply) which is widely viewed as an insufficient insurance buffer to meet the growing demand and to help balance markets in the event of global disruptions such as we are seeing with the Ukraine and Russia. Expect higher prices for longer.

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It was interesting that consensus from the leading CEO’s was that most U.S oil basins are unlikely to recover to previous highs.?Growth in the U.S. will likely only come from the Permian and mostly in keeping with previous market expectations. Inventories of DUC’s have been depleted, drilling and completion services and manpower are scarce and capital discipline continues to be the mantra – for now.

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Natural Gas?

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Natural gas’ stature has certainly risen in recent years – what was once a vilified hydrocarbon in some jurisdictions, is now being widely recognized as ‘green’ with an integral (if not leading) roll to play in the global energy transition. Without it, the global goals of the transition will not be achieved – full stop. One footnote is that natural gas is now being reclassified as ‘green’ if you burn it, i.e. as an input to displace coal, but in Europe and other jurisdictions it is not considered ‘green’ if you produce it.

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For the Europe energy dilemma there is no quick fix. They will have to use more coal and turn down the thermostats – gas prices are going to remain high for some time. They will wean themselves off Russian supplies but there has been no contingency plan and there is no clear-cut solution. Improving connectivity to excess existing re-gas in Spain and Portugal will help somewhat but Europe needs much more supply to offset the reliance on Russian energy. If Europe has a cold winter next year it will give rise to price wars and hardship. There are no short cycle LNG solutions – however the U.S. has the ability to increase shipments and is doing so in a material way to help – but will not be enough in the short term (4-5 years). An interesting point made frequently was that the energy crises in Europe is going to dramatically accelerate the Euro transition to renewables.

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The nat gas outlook for North America was that markets are tight now, but they are likely to be well supplied over time. There are pipeline constraints contributing to supply challenges in Appalachia in the near term, but the general view is that over the next 2 years Nat Gas will settle back to more reasonable price levels. The abundance of readily available gas would correct itself when supported by the kind of strong pricing being experienced today.??It was felt that increased gas supplies would come from multiple U.S. basins – not just one. The Marcellus has so many permitting challenges that while it should be top-of-list, it is not likely to be until at a minimum egress gets sorted out.

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Copper ?

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The other commodity that kept coming up across many forums… was copper – 3rd largest industrial metal. One industry leader referred to it as the ‘oxygen of decarbonization’. The importance of copper in the transition/transformation is absolutely essential and there are so few, if any, known substitutes particularly for its conductivity properties.?Copper is under immense supply pressures.?One speaker alluded to some short-term supply relief, but beyond 3 years the deficit is expected to be massive.

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The 10 largest Copper mines in the world are all over 100 years old. The current challenges and delays in the U.S. and Europe for permitting mines was illustrative of the challenges of rising to meet the increased demand.??Greenfield copper mines take 16 or more years for permitting and brownfield 5-6 years for design and permitting.

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On a side note, one commentator said, when speaking about rare minerals, ‘God didn’t plant all rare minerals in China’.

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Hydrogen

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Green hydrogen (produced by splitting water into hydrogen and oxygen using renewable electricity) appears to be a decade or more away from being economically competitive. It is simply too expensive. Blue is by the far the most cost effective with a low carbon footprint and is therefore the most likely first mover of scale. Its development will be significant for advancing hydrogen in its contribution to global decarbonization goals. The stigma associated with blue hydrogen (sourced from hydrocarbons with associated carbon capture) is still pervasive and is expected to be a challenge, but it is hard to envision progress in the hydrogen space in the next 15+ years unless it involves a large component of blue hydrogen. Each panelist on the topic of hydrogen (and they weren’t oil and gas folks!) advocated for doing away with the rainbow of colours (connoting the source of energy used to create the hydrogen i.e. pink, grey, blue, turquoise, green) and instead recommended going to a recognized credible carbon footprint measurement system. The view was that it matters not where the hydrogen comes from – the question is what is the most carbon efficient and who can produce it most cost effectively. It was viewed that this will be the only way to advance the hydrogen initiative in a meaningful way.??FYI - the U.S. government is dedicating $8 billion to foster a number of hydrogen hubs in the U.S.

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I repeat a quote from above that highlights one of the many challenges -??‘without certainly of takeaway markets it is almost impossible to finance a hydrogen project’.

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CCUS (carbon capture utilization and storage) will be one of the leading market movers globally in making a true difference. It must be supported and developed and it is one of the most impactful and achievable solutions. The Oil Sands Pathways to Net Zero initiative (the consortium of 8 Oil Sands producers in Canada) will be the largest CCUS project in the world.?Many industries are looking at ways to get into the game and progress is being made. It will be material. The US government is dedicating $10 billion to participate with industry in the creation of 4 CCUS Hubs in the U.S.

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An advantage that Canada has over the U.S. in CCUS is that sub surface pore space for injection is predominately owned by the governments. In the U.S. much of the pore space is owned by freehold landowners, making it more challenging for U.S. projects to aggregate rights to inject.

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One part of CCUS that fails to attract carbon credits is the CO2 enhanced recovery projects used by industry to lift recovery factors in previously discovered oil fields. It is vastly underappreciated how CO2 enhanced recoveries have a much lower carbon footprint than discovering new sources of oil and how effective it is for storage of C02. That was an example where policy needs to adapt.

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Global Energy Poverty and Equality

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Energy equality was a repeating theme. India, Africa and the third world were very clear that they expect a ‘just transition’ whereby they have the right to access traditional hydrocarbon sources of energy which are the most reliable and affordable.?We were reminded that somewhere between 1.2 and 3 billion people (going to 4.5 billion by 2050) do not have access to hydrocarbons for cooking and heating and still use coal, wood and dung. Hydrocarbons are the next step to bootstrapping themselves out of poverty and providing them with a healthier environment. Therefore, cost effective hydrocarbons must be available to them. The demonization of hydrocarbons and resulting higher prices from lack of investment is harming the third world and exacerbating inequalities.?These messages were made passionately and were widely acknowledged by those attending. Also the theme of energy costs for the average citizen in the developed world is a big issue. Governments must plan with consideration of the electorate and not let righteous ambitions tip public support against them and impede the decarbonization movement and push the average citizen closer to poverty and those in poverty into hopelessness.

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Canada

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Surprising to me, Canadians attending (Suncor, TransAlta and others) were much more supportive of current Canadian policy on decarbonization than they have been in a very long time. Observations were expressed of visibly more cooperation and alignment between government and industry (not on permitting) and an appreciation for the progress on carbon frameworks. There was a view that we are further ahead than the U.S. in providing the policy for decarbonization initiatives. On a side note, and a plug for Canada, it was stated that if the world met our ESG standards, GHG emissions globally would drop by 30% - true or false – who knows.

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If you made it this far, you deserve a prize. I hope you find a nugget or two in this and I encourage industry participants to think about attending CERAWeek in the future. It’s worth it!

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Peter