BP's Energy Outlook 2017 - Oil Consumption Increase Based On An Asian Miscalculation?

| About: BP p.l.c. (BP)

Summary

BP agrees with need to decarbonize and then projects oil and gas expansion: contradictory narratives.

A core assumption about increased demand for oil is that affluent Asians will purchase cars; BP does not consider Government controls on ICE ownership.

Transport becoming more important for greenhouse gas emissions, will Governments address this? BEV stimulus obvious answer.

Car industry ready to participate in BEV transition.

Issues concerning narrative are at least as important as consideration of future oil and gas price movements.

Call me boring and old fashioned, but just as I have trouble considering "alternative facts" instead of the real ones, I have problems accepting the validity of arguing that two contradictory positions can be held in developing one's business going forward. This is exactly what BP (NYSE:BP) is seeking to do in its latest "BP Energy Outlook 2017."

What are the contradictory positions?

The first is that BP plans to expand fossil fuel production to participate in its projection that fossil fuels will still provide 75% of energy consumption in 2035 (down only slightly from their 2016 prediction of 80%). This means that fossil fuel emissions continue to rise to 2035. The second position is BP's support for the Paris Climate Agreement, which requires urgent decrease in emissions as of now and complete decarbonization of the world economy between 2050 and 2100. These positions are mutually exclusive and can't be held concurrently.

How to resolve this dilemma? I suggest one pays attention to what BP plans to do, as this will resolve which position BP actually holds. There is no doubt that BP plans to expand its oil and gas operations and hence it does not accept the need to decarbonize, which is the central plank of the Paris Climate Agreement.

There are major business consequences for picking the wrong reality. Here I explore BP's plans and assumptions to decide where reality lies.

The importance of a narrative in business projections

BP is to be congratulated for providing significant information concerning its global energy use projections. With disclosure comes risks and I think a core issue for BP is their narrative. It is important to provide the core context that your business plan is built upon and my reading of the 2017 Energy outlook is that BP thinks its oil and gas business will continue to expand based on affluence in Asia, in particular leading to substantial expansion of private vehicle ownership (which they still see as dominated by ICE vehicles) and hence expanded oil consumption.

I can see that there is a smart team in BP building that narrative, but I think it overlooks the deep forces shaping the new energy outlook and involving a transition from fossil fuels to renewable energy. Why would China, India and other Asian countries who are making major progress on containing greenhouse gas emissions with their limits on coal expansion and contraction of coal use, be passive about a contra trend to expand fossil fuel use through personal transport?

Transport emissions are becoming a key issue and I don't think that the governments of China, India etc, all of which have strong commitment to the Paris Climate Agreement, will be passive about their citizens reversing the problem that they are starting to solve.

Why will China, India and the rest of Asia stop transport based oil consumption going unchecked?

Almost all countries are now engaged in efforts to decarbonize their economies. This indicates the depth of concern for the dangers of global warming through increased greenhouse gas emissions.

To give just one example as to why there is urgency about this issue, consider the latest information about sea level rise.

While there is awareness that a number of Pacific Islands are in danger of inundation, and these are catastrophic for the individual islands, they don't have a major impact on global society. The situation is different for major population centers situated on river deltas. Most talked about are India, Bangladesh, China and The Philippines where 40, 25, 20 and 15 million people respectively are likely to be affected by sea level rise according to The Global Environmental Outlook (GEO-6), a recent UN report.

The US is not immune to the effects of sea level rise and a January 2017 expert report from NOAA (National Oceanic & Atmospheric Administration) shows that the projections for sea level rise in the US by 2100 have been substantially revised upwards since 2012, with the lower range increased by 50% (0.1 meters) from 0.2 to 0.3 metres and the upper range increased by 25% (0.5 meters) from 2.0 to 2.5 meters. This is an astonishing increase in projected rise in less than 5 years, due largely to better understanding of the big changes happening in Arctic and Antarctic melting.

The analysis is very detailed and takes into account a large number of variables that will impact sea level rise. These include oceanographic factors such as circulation patterns, and various geologic factors such as the earth's gravitational field and rotation, flexing of the crust and upper mantle, subsidence or uplift, sediment compaction, change dues to water or fossil fuel extraction, ocean basin shape etc.

A key finding is that, except for Alaska, the US coastline is expected to experience a 25 fold increase in flooding by 2030 in the intermediate-high projection or by 2080 under the low projection. Note that in the last 5 years projections have increased dramatically, so the projections given could be substantial underestimates if the rate of rise projected continues to increase. These are big issues for investors in relation to coastal real estate investment and the economic cost of cleanup after storms.

The above is just one example as to why this is an urgent issue and one which has the attention of not only Governments, but also major corporations who are taking action individually and urging the Trump Administration to take action. At the recent Davos conference business was reported as seeing sustainable (decarbonized) business as a $12 trillion opportunity.

The coal, oil and gas majors are becoming isolated as the group that feigns concern but then just gets on with making the situation worse. BP is quite explicit about this in its Energy Outlook 2017. The strongest claim from the oil and gas majors is a call to price carbon, but this is widely seen to be a ploy to attack the coal industry.

Expand fossil fuel exploitation or begin to exit fossil fuels?

So which future is BP planning, to join in decarbonizing the world economy or to continue to focus on fossil fuel exploitation?

Having followed coal major Peabody Energy (BTUUQ) from a share price equivalent to $250 to bankruptcy, I have the sinking feeling that BP, like Peabody Energy, feels that it is one of the best at what it does and that there will always be a place for the best oil and gas majors. This is the take home message I get from the energy update.

So why is BP bothering with platitudes about the need to decarbonize and stating that it agrees with the Paris climate agreement? I suggest that they do this because it isn't acceptable to be honest about the real goals of the company. Simply put, the times force acknowledgement of the looming climate disaster and the dramatic shift to renewable energy.

BP thinks prosperity in Asia will mean big increases in ICE car purchases

In assuming that affluence in Asia will mean lots of people buying ICE vehicles BP overlooks that the Governments of Asian countries are very focused on reducing emissions because of the pollution problems already affecting their citizens. The fact that China has this year cut between 100 GW and 150 GW of planned coal power plant developments (some already being built) surely indicates that the Chinese Government is serious about decarbonizing their economy.

It is inconceivable that they will allow the scale of expansion of ICE vehicles that the BP Energy Outlook 2017 projections require. There is credible information about Governments banning sale of new ICE vehicles before 2030, in India for example.

In the US, transportation (of which passenger vehicles are a major component) contributes 37% of total energy related CO2 emissions and with coal plant retirements reducing electricity emissions, transport is now a bigger contributor to greenhouse gas emissions than electricity generation. I think this is going to mean that transport will increasingly be targeted for emissions reductions.

There are many intersecting developments currently underway in the transport sector and it is likely that these will become integrated. These include BEVs, self-drive vehicles and ride sharing. Together these will lead to fewer and overwhelmingly electrified vehicles as indicated in an October 2016 report "An integrated perspective on the future of mobility" from McKinsey & Co and Bloomberg New Energy Finance.

The prospects for BEVs

In BP's 2017 energy outlook, the prospects for electric vehicles have been substantially expanded to include 100 million cars globally by 2035, but they assume the global penetration of electric vehicles is still only 6% by 2035. BP assumes that the growth of electric vehicles cannot possibly compete with ICE vehicles in the next 15 years.

Sometimes a picture provides a view that words don't easily capture. Here is a link to a story (with photographs) on a Morgan Stanley report about traffic in New York's 5th Avenue on Easter morning in 1900 and 1913, just 13 years apart. In the 1900 picture the street is full of horse drawn carriages and there is one motorized vehicle. In the 1913 picture, there is one horse drawn vehicle in a large crowd of motorized vehicles. Morgan Stanley used the images to support a bullish report on Tesla in 2011. The actual timing of the window when dramatic change occurs can be argued about, but I suggest that 2017 is a turning point as the first affordable BEVs with 200 mile range are being released.

Recent news from China supports this contention of dramatic change with a plan to have charging stations for 5 million electric vehicles by 2020 and a report from McKinsey and Co and Bloomberg New Energy Finance suggesting EV penetration by 2030 could be 60% in China's biggest cities. That is 10x higher penetration than BP projects.

India is on a similar trajectory with Energy Minister Goyal consistently saying that India will become a 100% e-vehicle nation by 2030. This is a huge claim and unlikely to be fulfilled, but there is now the beginnings of a move to ban new ICE sales between 2025 and 2030 in several European countries (Norway, Holland, Germany) and India. BP noted in last year's Energy report that there is the possibility that the EV trend could dramatically accelerate.

BP has carbon emissions increasing through 2035

The reason that just about every major greenhouse gas emitter in the world (except Russia) ratifying the COP21 Paris agreement is that world leaders after reviewing the science have decided to decarbonize.

BP's graph showing emissions increasing clearly demonstrates that it does not accept that the COP21 Paris agreement will be effective. BP does present some accelerated emissions reductions scenarios, but none would deliver the emissions required for the Paris Agreement. A more puzzling assumption in these accelerated assumptions is that most of the emissions reductions will come from the power sector and the transport sector remains mostly unaffected.

A recent report on policies for decarbonizing transport indicates that the US needs to reduce 2015 fleetwide emissions by 86% by mid-century to meet the Paris greenhouse gas emissions goals. Which Government is likely to do the heavy lifting in the power sector and allow the transport sector get away with little change (especially when there is a solution in BEVs)?

Assumptions about oil price

As was the case last year, BP remains vulnerable to a Brent crude oil price of less than $50-$55. This is the critical level at which its ability to sustain the dividend comes into question.

Anyone who thinks that the oil price has stabilized isn't looking at the various levers that are currently being pulled. On the one hand the OPEC production cuts are helping keep the Brent Crude price in the $55 range, while on the other hand, US producers putting more wells into production is providing downwards pressure. Inventory is rising, which is another aspect that doesn't augur well for upwards price movement.

While most of the oil majors are very focused on a Brent crude price above $50, French company Engie (OTCPK:ENGIY), that is switching from coal to solar power, is talking about oil price crash to as low as $10/barrel in less than a decade.

Conclusion

For those contemplating investment in BP, there has never been a more important time to read the fine print and test the reality of BP's business assumptions as things are changing rapidly as we enter the end of the fossil fuel era.

My take on the just released 2017 energy update is that it continues the tradition of ignoring the reality of the current situation and presenting "assumptions" which are clearly questionable. The big question mark is around their assumption that oil consumption will continue to grow due to affluent Asian buyers buying ICE cars. I don't think Asian governments are going to allow this.

I'd avoid BP until their planning starts to be more realistic in terms of current trends. Unfortunately, I suspect that this caution needs to be applied to other oil and gas majors, such as Exxon Mobil (NYSE:XOM), which have similar problems with their planning assumptions.

If my commentary is thought provoking and helps you assess your energy/transport investments, please consider following me.

Disclaimer: I am not a financial analyst. I seek to understand underlying issues concerning major structural change, especially in the energy and transport industries, as the world begins to adopt renewable energy and exit fossil fuels. I suggest that the narrative in this area is important when assessing a company like BP.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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