Morgan Stanley
  • Thoughts on the Market Podcast
  • Apr 12, 2021

Innovating Toward Decarbonization

With Martijn Rats and Stephen Byrd


Martijn Rats: Welcome to Thoughts on the Market, I'm Martijn Rats, Morgan Stanley's Global Oil Strategist and Head of the European Energy Research Team.

Stephen Byrd: And I'm Stephen Byrd, Head of North American Research for Power and Utilities and Clean Energy.

Martijn Rats: And today on the podcast, we'll be talking about the global energy transition and the future of energy and power as we move towards a lower carbon world. It's Monday, April 12th, at 3:00 p.m. in London.

Stephen Byrd: And 10 a.m. in New York.

Stephen Byrd: So, Martijn, it is Earth Day this month and it does seem like an appropriate time to chat about a big theme right now for both you and me, and that's the transition to a lower carbon future. It was heavily discussed at our recent Global Energy and Power Conference last month. I know you released a really interesting sit down with Ben Van Beurden of Royal Dutch Shell, which, by the way, is on and the firm's YouTube page. I thought we could start there and talk about some takeaways from that conversation and along these lines, conversations you've had with other majors. And what I'm most interested in is whether or not you see similarity in their strategies to adapt and reposition their models, or do you see a lot of divergence in approach?

Martijn Rats: Yeah thanks, Stephen. Well, by the standards of this group, actually we're seeing quite a lot of divergence. Oil majors have usually, in the past, done very similar things. So compared to that, we're actually seeing them on different trajectories at the moment. Now, of course, there are common denominators. If you take a step back and look broadly at the challenges that climate change provide us with, the solution to those challenges are largely around electrification of the energy system.

Martijn Rats: Now looking at that playing field, so to say, that set of solutions that are out there, there are several approaches within the oil sector. There are various oil majors that are responding to this by saying that they want to actively drive these changes forward and adapt our companies as the energy system changes. However, even within the companies that want to drive this forward, there is a very active debate and different views on how quickly they should move away from oil and gas. Some are planning to do that slower, others are doing that faster. However, there was also a group of oil majors that are simply saying, look, these might be the right solutions, but they are not they are not necessarily for us, these are not where our competitive advantages lie. And look, we still need oil and gas for quite some time to come. The best thing that we can do is just to maximize the amount of cash that we generate, distribute it to our shareholders, and then the shareholders themselves can reallocate that cash to greener and other renewables companies.

Martijn Rats: So compared to the past, where a lot of oil majors did very, very similar things, at the moment we're seeing quite a wide range of different strategies. But everybody is grappling with what is the right approach and how fast should we go down this new paths. So quite a lot of dynamism in the sector all of a sudden.

Stephen Byrd: Oh, that's fascinating. Now, one thing I wanted to discuss is divestment versus encouragement. And one of the points you brought up in your conversation with Shell was this question about investors asking whether they should simply divest. Do you think investors could also drive change by rewarding the companies that are making the most progress and starting a kind of virtuous cycle of change?

Martijn Rats: Yeah, I think that view is becoming increasingly clear and you'll see that in investor conversations. Look, it's totally understandable that people take the view that they simply do not want to be associated with profits that are generated from a product that contributes to global warming. But at the same time, the practical reality is that as long as there is demand from end customers for oil and gas, supply will follow and emissions will take place, whether there is divestment or no divestment.

Martijn Rats: Now, what is more effective in driving emissions down is, I would argue, for shareholders to engage with the companies that are helping to change the energy system over the next couple of years and decades. In the end, that is not going to happen with startup companies only, however important the role is that new technology companies can play. You need contribution from the existing large energy companies that need to make the billions, if not hundreds of billions of dollars of investment that eventually will need to will need to take place. And from that perspective, shareholders can have much more impact if they continue to engage with these companies and push them in the right direction rather than to simply divest.

Stephen Byrd: Well, that's interesting, we're seeing similar dynamics with utilities. Now, one last question I wanted to ask is around the path of oil demand. You said even with the transition front of mind you still don't see a peak in oil demand until 2030. How do you see the interplay between the two forces of traditional tailwinds for oil demand growth and moves to decarbonize?

Martijn Rats: If you look at the set of factors that impact oil demand, you can split them in two categories. On the one hand, we have population growth and rising average wealth levels and they are driving oil demand up. On the other hand, we have efficiency gains. For example, the average new car sold is broadly twice as fuel efficient as the average car on the road, so that has a big impact - efficiency gains. And we have substitution. We replace fossil fuel cars, our gasoline cars with electric vehicles. And so efficiency and substitution are in the other category and they drive oil demand down over time.

Martijn Rats: Now, these latter two factors - efficiency gains and substitution - they get a lot of attention. But population growth and rising average wealth levels also have a very large impact, and they do their work perhaps a little bit more silently in the shadow over time. And to put some numbers around this, how important this really is, the world's population is growing at roughly a billion people every 15 years at the moment. On top of that, over any 15-year period, we're growing GDP per capita by somewhere between 35 to 40%. Now, you can imagine that if you add a billion people to the planet and GDP per capita globally goes up by close to 40%, that just puts tremendous upward pressure on energy demands, including oil demand. So if you then take a realistic, dispassionate view on what's happening with efficiency gains and substitution, which are clearly accelerating, you nevertheless end up with an outcome whereby, at least for the next couple of years, say a decade, these first two factors do play a dominant role and drive oil demand up before efficiency gains in substitution eventually drive it down. And that's why we would argue it's hard to foresee a real peak in oil demand before 2030, despite a lot of efforts on the on the decarbonization side.

Martijn Rats: Now, having said that, Stephen, I want to turn the conversation to what you're seeing in the utility space right now. You've mentioned quite a bit of industry optimism around the U.S. federal support for clean energy, strong commitment to renewable build out. How are the utilities seeing renewables as part of their growth strategies?

Stephen Byrd: Yeah it's really fascinating. We've really now reached a point where renewables have become in many parts of the U.S., the lowest cost form of generation, period. And so we're seeing this virtuous cycle where utilities are looking at their coal fired power plants, which are quite expensive, and concluding that they could shut those coal plants down, still recover their remaining asset value and deploy renewables, and the impact to customers is that bills will go down. With more support from the federal government, those economics just get better and better. So we are optimistic that we'll see further support for solar, wind and energy storage, as well as electric vehicle infrastructure build out.

Stephen Byrd: So with that, essentially, utilities are now pursuing growth strategies with higher EPS growth. To translate all this into financials, that's really what's happening. Essentially, when utilities pursue renewables, the CapEx opportunity is huge. And so with that, their EPS growth goes up as well, while customer bills will stay very low. That is a great virtuous cycle and many of our utilities are pursuing that strategy now.

Martijn Rats: And what else are you watching right now in the new Biden administration infrastructure proposal plans that investors should keep an eye on?

Stephen Byrd: Yeah, it's very active. We're looking at a number of provisions that might get passed that would have an impact. I'd say what we think is most likely to get passed would be, you know, solar, wind storage, tax credit support. Beyond that, there is language around a clean energy standard that would essentially put a price on carbon in an indirect manner, and we think that's fairly unlikely to pass. We do not believe there's sufficient support for that. If we're wrong, that could help the nuclear generators quite a bit.

Stephen Byrd: Another provision we're looking for is what's called cash refundability of tax credits. So for renewables developers, when they build out projects, they generate significant tax losses. And a challenge for them is essentially how do we monetize those tax losses? Because those losses become so large, they have to go to the tax equity market, which is a market where they can essentially monetize those products, but there are limits to the size of that market. If you turn those tax credits into essentially refunds, so literally checks from the federal government, you would boost the liquidity of many of our renewables players. So it's going to be a very active summer. We do expect to see more specifics around legislation in the coming weeks and months.

Martijn Rats: And then finally, Stephen, I'd like to ask you about something that is also very important for the companies that I cover. There seems to be quite a bit of investor attention on U.S. offshore wind. And the Biden administration has said that they may speed up the permitting process for projects off the East Coast. Are we about to see a new acceleration for offshore wind? And what could that whole space look like, say, in five years from now?

Stephen Byrd: Yeah, there's a lot of excitement in the US, especially on the East Coast, but also on the West Coast about offshore wind. Now, the permitting process has been challenging, and the Biden administration has said, just as you pointed out, that they're going to really work to streamline the permitting process.

Stephen Byrd: We see up to 30 gigawatts of offshore wind being developed here in the coming years, and that's a really exciting development, rapid growth rate in the Northeast. And I'd also say look out for further developments on the West Coast. Now, traditionally, offshore wind on the West Coast has been thought of as very challenging because the water gets very deep, very fast. That's we're seeing some new developments in terms of technologies that would allow offshore wind to be developed there, so we're going to keep a close eye there. But I'd say the biggest activity certainly is going to be throughout the northeast US. And that's quite an exciting area of growth that we'll see for really many years to come.

Martijn Rats: Stephen, thanks for taking the time to talk.

Stephen Byrd: Great speaking with you, Martijn,

Martijn Rats: And thanks for listening. If you enjoy Thoughts on the Market, please leave us a review on Apple Podcasts and share the podcast with a friend or colleague today. 

How are oil & gas companies and U.S. utilities tackling the complex transition to a lower carbon future? Expect a lot of divergence in approach.

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