One of the more discomfiting realizations to be faced during energy transition is that despite the rapid growth of renewables, non-renewable consumption keeps growing strongly. If we add to this theme a rebound effect (Jevons) we must also confront the counterintuitive risk that efficiencies unleashed by non-combustible energy may ricochet into even greater total energy consumption. And yes, greater consumption of fossil fuels. To be sure, the broad assumption that energy transition will eventually bend all growth towards renewables is defensible, and reasonable. But here in the murky period, where the two systems both compete but feed off each other, transition advocates may be called upon to defend their view with a fuller explanation.
We do not expect renewables to fight fossil fuels unit for unit, in the early years of transition. Adoption of any new technology doesn’t work that way, as the curve begins to lift. That said, it has been a spectacular decade for renewables growth, as wind and solar primarily take market share. And we are approaching a time when we want to see a real brake on energy growth ex-renewables. But we have not yet reached that tipping point.
In the chart below, annual growth of renewables consumption is recorded against annual growth of energy ex-renewables, in exajoules (EJ). A note on the data: hydro and nuclear are included in the energy ex-renewables series, which for our purposes is helpful because nuclear is not growing at all and hasn’t for nearly twenty years. And while hydro has grown (about 10% since 2012) it has faltered recently due to drought and climate change. I would not pin any hopes on growth in either hydro or nuclear anytime soon, as nuclear retirements continue to drag down contributions from new nuclear, and the climate related water problem pressures hydropower.
It’s impressive that in 2014 and 2019 the marginal growth in renewables came so close to the growth in ex-renewables. However, the big swings around the pandemic are revealing. Here, we see qualities of each energy type expressing themselves. First, note how renewables consumption was barely affected in 2020. This is a crucial aspect of new technology growth: it just powers through macro disruptions because it’s coming up from a small base, and offers better economic value. But incumbency also has its advantages. From a bigger base, ex-renewables shouldered the brunt of the pandemic smackdown. But ex-renewables also rebounded more strongly.
There’s a cynical, bad-faith view of course about renewables growth—how it’s not enough, how it can’t scale, how it makes fossil fuels more expensive, and other such nonsense. This view is of no interest, and can be dismissed with the same lack of effort from which it emanates. Renewables are cheaper, better, faster. And that’s why they are scaling quickly now. Not because of policy. But because of economics.
But as renewables scale, what we want to see develop is a new trend in which total global energy consumption starts to flatten. Yes, flatten. Renewables, because they are far more efficient than combustion, represent a reduction in primary energy consumption because unlike fossil fuels they deliver far more usable energy to end users. We are so accustomed to recording the consumption of primary energy (the inputs) that we forget that at least 40% if not 50% of primary energy is never utilized. Renewables dramatically change that equation. And as they scale, their increasing presence in the system should result in primary energy consumption flattening—even as economic growth continues to advance.
As for the rebound effect (Jevons) there are roughly two paths that stretch out ahead of us. The problematic route sees a growth-boosting deflationary impact from the renewables buildout, which then acts as fuel to increase consumption. That in turn boosts the call on natural resources, and yes, fossil fuels. Just to remind: all previous energy transitions occurred because the new energy source was cheaper and more powerful, which then led to greater economic growth and expanded consumption. It’s also critical to understand that, in the Jevons path, the issue is not the greater extraction of natural resources per se to build out new clean energy infrastructure—everything from wind and solar to battery capacity, transmission lines, and EV. No. The rebound effect is instead about the wider boundary, systemic effect on economies from the exploitation of cheaper, better energy.
Cheaper energy → stronger economic growth → greater consumption of everything → higher demand for energy.
The bet you make with renewables, however, is that economic growth will result in even more demand for renewables. Hence, the second path. Do we have an example yet, of this phenomenon? We do: Europe. Using the Total Europe category from the BP Statistical Review, we find that total energy consumption from all sources has declined from 87.51 EJ to 82.38 EJ over the past decade. But renewables consumption has grown from 4.55 EJ to 10.14 EJ in the same period. In other words, all the energy growth in Europe has swung towards renewables. Compare the Europe chart, below, to the global chart, and notice how many years renewables grew while ex-renewables fell. Note also that the post pandemic rebound in ex-renewables is smaller in Europe than the pandemic decline. And again, renewables shook off the pandemic entirely.
When thinking about rebound effects, we also want to consider underlying growth trends. Europe’s success story in decarbonization is in part due to aging demographics and slow growth. China is a very different example entirely. Although renewables in China are rockets—just completely off the hook, growing like mad—higher GDP growth continues to mean that China’s demand for energy from all sources continues to grow strongly. Indeed, last year’s coal consumption in China was sobering, if not shocking.
The ability of renewables to meet the bulk of marginal growth for energy will be tested, until the renewables base expands enough to answer that challenge. In some domains, like Europe, this crossover has now occurred. In other domains, especially in developing countries, it has not. And then we have third-category situations like the US, where wind and solar are largely meeting marginal growth in the powergrid, specifically.
The IEA sees oil, natural gas, and coal all peaking over the course of the next decade. Not exactly a radical call. And frankly, a call that’s not as encouraging as it seems. The IEA thinks coal demand peaks right around current levels, in the next couple of years. So what? We had one coal peak in 2013/2014 which converted into the most mild of declines for 6-7 years, before consumption surged back again last year to the previous highs. Notice, again, how peak does not in any way initiate outright decline—a problem that The Gregor Letter has highlighted for years.
In natural gas, the IEA sees a resolution to a decade of very high growth, as consumption plateaus. Again, not good enough. The rapid adoption of natural gas in both the US and globally the past 10-15 years means a young fleet of natural gas fired power generation is now firmly embedded in the global landscape. The turbines are modern, super efficient, and economic. Perhaps one could argue that higher renewables deployment will begin to erode those economics. Probably true. But what we’ve learned from the global coal fleet is that unless capacity is actually retired, it remains available. And if it’s available, it tends to be used.
Finally, IEA sees oil demand either rising further, past the end of the decade and then going flat in a “stated policies” scenario, or, rising a bit further before leveling off near current levels by the end of the decade, in an “announced pledges” scenario. These two views are not that different and remind one of the BP forecast offered in 2019: oil demand rising in tiny increments to 2025, then mostly going flat thereafter. The forecast also echoes the view offered in the original 2018 Oil Fall series (update coming) which held that oil demand would peak in the early 2020’s, and then, when the next automobile cycle started, market share would shift so hard to EV that it would not be possible for oil demand to carry onward to higher highs.
The end of fossil fuel demand growth is enticing, exciting, and encouraging. It’s a crucial first step in our pursuit of declines. But it unfortunately represents the start of an entirely new task, and that’s forcing fossil fuel demand into steady decline. So far, whether it’s oil demand in the OECD, or coal demand in the Non-OECD, declines have been exceedingly difficult to achieve. | IEA WEO 2022 website and materials.
A note on the IEA WEO 2022: very unhelpfully, IEA has used a substantially different baseline or starting point in 2021 for world liquids (oil) consumption in WEO, compared to their current estimate of demand in 2021. This appears to be one of those baffling discrepancies that occurs, perhaps, when one team of analysts is working on a long-term forecast, while another team addresses the near term. Whereas WEO 2022 uses 96.7 mbpd as the 2021 baseline on which to project future changes in oil demand, the latest IEA Oil Market Report (OMR) uses 97.67 mbpd as the 2021 demand estimate. That’s why, in the description of IEA’s outlook, the language here in this letter has been generalized: it is challenging to understand the IEA decadal outlook for oil quantitatively. Accordingly, it might be best to simply include the IEA graphic showing future oil demand changes under different scenarios. The bottom line is that whether it’s IEA, or EIA, or BP, or other analytical work, there’s a convergence underway in the view that after 2025, oil demand growth is scant, at best. | see: When does oil demand peak, page 327 of IEA 2022 WEO.
Wind and solar growth is expected to advance 65% over last year, an astonishing market performance from already high levels. Combined wind and solar grew globally by a total of 452 TWh last year, according to BP Statistical Review. This year, however, the combined contribution is expected to advance by 700 TWh, according to IEA Paris. The growth is so substantial, that IEA notes “Without this increase, global CO2 emissions would be more than 600 million tonnes higher this year. The rapid deployment of solar and wind is on course to account for two-thirds of the growth in renewable power generation.”
That wind and solar are able to grow quickly from a far higher baseline underscores that the sector has real momentum, and that within powergrids specifically there is not much risk of a Jevons rebound effect. Growth of electricity demand is being met increasingly by renewables. Indeed, renewables are now dominating. And while this doesn’t necessarily force oil, natural gas, and coal into decline, the large volume of clean electricity coming to the grid has huge implications for decarbonizing transportation as the global vehicle fleet branches towards EV.
Interest rate increases continue to play havoc with markets. A dichotomy has settled into place between the US economy, which remains pretty strong at least in nominal terms, and the global economy which is weak across China and Europe. This gap goes a long way to explain how the US Dollar has begun to unleash damage worldwide, creating volatility in both currency and sovereign bond markets. Combined with the ongoing geopolitical pressure that’s sustained by the Russian invasion of Ukraine, the global economy increasingly looks stagflationary. Not in 1970’s terms, but in the singular configuration we find ourselves. A war, a stimulus hangover, and a contorted business cycle, all wrapped around the finger of a pandemic, and now a post-pandemic period.
In the United States, the entire yield curve is now inverted (or at least, achieved that total inversion during trading hours last week). This is a classic recession signal—when all maturities from a 90 day T-Bill to a Five Year note carry a higher yield than US Ten Year Treasury. Essentially, the US treasury market is saying that rates may be elevated in the near term, as the US Federal Reserve fights inflation and raises rates, but the combination of an economic slowdown with higher short rates will deliver the economy back to lower inflation in the long term.
The Fed’s aggressive, rapid-fire tightening cycle continues to come in for criticism, as US senators now get into the letter-writing game. One crucial aspect of the policy approach that the Fed may have gotten wrong, if not quite wrong, is in how to calibrate the hikes and distribute them over a period of time. Think of it this way: let's say that a feature of a hiking campaign is not just the desired terminal rate, and not just each individual rate hike, but the total amount of time over which you conduct the campaign. Doing 16 rate hikes of .25 percentage points a piece, say, over two years is likely not an optimal way to reach a 4.00% terminal rate. But neither is doing 1.00 percentage point hikes over four months.
The Fed is likely making that exact mistake. By compressing the time period so aggressively, the Fed has taken away from itself the time necessary to obtain actual inflation results. Worse, the rapid and large hikes probably give society the impression that improving conditions will also come quickly. This is a two-edged sword: on one hand, this bolsters the Front Page Fed tactic, in which you want to performatively act out your war against inflation before the public. But, what happens when you want to slow down the pace of hikes? Well, that may be where the Fed is right now, and it means getting paradoxically jammed into something that looks like a pivot prematurely, simply because you compressed the hiking campaign into too small a space.
The essential problem at the FOMC appears to be that in 2020 and 2021 they were comfortable making forecasts. And then when inflation persisted, they became uncomfortable making forecasts. In 2021, when inflation readings began to appear after a large wave of global stimulus, when house prices were going bananas, the FOMC was comfortable in making the forecast that inflation would be transitory. Now they have turned away from the future, and are hammering away at each new monthly print of CPI and PCE, shouting almost at the data, as if to say why aren’t the hikes working? Needless to say, the Fed’s approach, the explanations the FOMC offers for this approach, and much of the fedspeak from various members, does not inspire confidence.
Breaking: As The Gregor Letter goes to print, we learn that Avangrid’s offshore windfarm, Mayflower Wind, is under new pressure from supply chains and higher interest rates, and is seeking to delay until components of the original contracts can be adjusted. This is a key example of how the blunt force trauma of higher interest rates can actually undermine inflation-fighting goals, by slowing or halting the buildout of new infrastructure and capacity, and not just in the energy sector.
The IEA has slightly downshifted its estimate of 2022 oil demand, but it doesn’t really matter. The main takeaway is that this year’s oil demand will, again, not reach the 2019 highs. Unsurprisingly, the IEA has forecasted a more notable rebound of demand next year, above 101 million barrels per day (mbpd). But this seems highly unlikely unless the global economy roars back to life—and not just for part of the year, but the entire year. For what it’s worth, The Gregor Letter view is that global oil demand is fated to oscillate around the 100 mbpd level for several years to come, if not another 5-7 years, before finally starting to tail off. Evidence is also strong that the global oil industry pretty much understands the end of growth is here. That’s why their posture has shifted operationally, with a greater focus on capital discipline, dividends, and not getting too far out the exploration curve.
One of the more providential developments to have occurred in the US power system took place when an entire generation of coal-fired capacity reached retirement age, just as costs for new wind and solar fell through key thresholds. This encouraged a view that combined wind and solar were on a supertrend to replace coal. Mostly true, but leaves out a crucial part of the story: the growth of natural gas. Accordingly, The Gregor Letter is increasingly concerned about the new path dependency now established as a young, highly efficient NG power fleet has been established in the world in just the past five to seven years. No matter how dim you may think the future economic prospect will be for NG power—as a result of wind, solar, and storage—one has to consider that grid dependency on NG will only grow as the global coal fleet retreats further.
—Gregor Macdonald