STOCK MARKET ANALYSIS

While oil prices have been rising steadily since July (see Chart of the week) and are now close to $100 a barrel, hedge funds are accentuating the trend by accumulating bets on black gold. The sector remains volatile in the face of geopolitical tensions and economic cycles. The rise in oil prices is strengthening the appeal of investing in renewable energies for the good of the planet and consumers.

The energy transition is progressing more slowly than political will

Since the Paris Agreement in 2015, then the European Green Deal in 2020 and the RePower EU plan in 2021, or the Bipartisan Infrastructure Law (BIL) in 2021 followed by the Inflation Reduction Act (IRA) in the United States in 2022, the political will to make a success of the energy transition to renewable energies (solar, wind, hydroelectric, etc.) is still very much present, but has encountered major obstacles: Covid-19, the war in Ukraine, etc.

The lower production cost of these energies makes it easier for them to be adopted. The development of new technologies, such as energy storage, smart grids and green hydrogen, is a step towards a more sustainable energy model. What's more, the significant increase in the number of electric vehicles (EVs) on the road and the development of recharging infrastructure, particularly in Europe and China, are speeding up the transition to renewable energies (see Fig.2).

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However, fossil fuels continue to dominate in many parts of the world. Although demand for oil has been affected by the Covid-19 pandemic, it remains relatively strong due to its use in transport, petrochemicals and other sectors. Natural gas, often considered a 'transition energy', helps to reduce emissions by replacing coal in electricity generation. Unfortunately, the war in Ukraine has forced some countries, such as Germany, to return to coal to produce electricity, while alternatives to Russian gas are found. Finally, although the use of coal is declining in developed countries, it remains a cheap source of energy for many emerging countries.

Demand for fossil fuels continues to grow, but at a slower pace

Investment funds and companies have begun to withdraw from the fossil fuel industries, which could have an impact on their long-term financing. Most fossil fuel exploration and production companies have reduced their investments in response to the anticipated slowdown in demand, but also under pressure from investors to speed up their transition to other energy sources. TotalEnergie, for example, is investing in hydrogen production projects rather than oil exploration. In the United States, the State of California has decided to sue certain oil producers for failing to warn of their negative impact on the climate. Without new investment, supply could rapidly fall behind demand.

Saudi Arabia and Russia have both announced production cuts in response to weak growth in China and the economic slowdown in Europe. The OPEC+ countries' management of production is thus keeping prices high (see Fig.3) and well above their extraction costs.

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The International Energy Agency (IEA) expects oil production to peak between now and the end of the decade, before seeing demand and production fall in a sustainable way, thanks to renewable energies.

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Financial fundamentals are solid and benefiting from technological innovations

Oil and gas companies generate strong cash flows and pay high dividends. Lower investment and high margins have reduced debt. They are now in a strong position as geopolitical events and low oil reserves push up prices. Advances in drilling techniques, such as fracking, have also made oil and gas extraction more profitable, which particularly favours US companies extracting shale gas.

Despite the rise of renewable energies, oil and gas remain essential to the global economy, particularly for transport and industrial production. It is now estimated that for every dollar spent on oil and gas projects, $1.50 is spent on renewable energy projects. Investment in shale gas in the United States has followed the rise in prices, but companies are now much more disciplined and the risk of overproduction seems remote.

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Geopolitical tensions not only drive performance, but also inflation

Energy price inflation has complex consequences for the economy (see Fig.4). It is a key component of production costs for many sectors, from manufacturing to agriculture. When energy prices rise, this is often reflected in the cost of producing goods and services, the cost of transport and ultimately consumer prices.

Access to energy resources is a major geopolitical issue. Conflicts, sanctions or agreements between producer countries can influence energy prices and, consequently, inflation. Low-income households are the first to suffer, which may require policy interventions such as subsidies or tax adjustments, which in turn have an impact on inflation.

In short, energy price inflation can have cascading effects throughout the economy, affecting production, consumption and even monetary policy. These effects can be temporary or more lasting, depending on the nature and duration of the energy inflation.

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Conclusion :

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Although the energy transition is underway, fossil fuel industries still play a significant role in the world's energy mix. The pace of the transition will depend on a number of factors, including government policies, technological innovations and changes in consumer behavior. The war in Ukraine is transforming the world order and, above all, calling into question the energy policies previously pursued in Europe. Its dependence on Russian gas should not be replicated by Europe become dependent on China, particularly for its rare earths and solar panels. Energy sources have to be diversified and local solutions should be favoured, such as nuclear power, hydrogen and wind power. The entire value chain needs to be taken into account to assess the relevance of so-called "renewable" energy. In the meantime, the fossil fuel sector can keep its shareholders happy for several more decades.

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