BP's (NYSE:BP) World Energy Outlook 2017 concludes that there will be major growth in two key areas (oil and gas) on which it focuses its business. Elsewhere I've addressed the robustness of BP's plans to dramatically expand its oil production. Here I address BP's plans for expansion of its role in what it concludes is an expanding gas market. I argue that all is not what it seems.
What BP says about gas in 2035
Gas is becoming a major focus of BP. Of 7 major projects coming on stream in 2017, 6 are gas projects. Spencer Dale, BP Group Chief Economist, states "We think natural gas will grow strongly over the next 20 years … moving to a globally integrated gas market, held together by liquefied natural gas". Asia is projected to be the largest destination for LNG, with China, India and other Asian countries helping gas grow faster than oil or coal. The Middle East and the US are seen as places where gas has an increasing market share for power generation.
Stripping away the details, the core of the BP case for gas is as a replacement for coal. In arguing this case, BP seems not to have considered that renewable energy might compete with gas for coal substitution. I argue that this is what is happening today and this has dramatic implications for whether or not gas has a future as a bridging fuel.
What is happening? … straws in the wind
1) Is coal being replaced by natural gas? The dominant narrative concerning gas is that it is the bridge fuel, which is reducing greenhouse gas emissions by replacing coal.
When I was researching the future of the Navajo Generating Station in Arizona, this was the story told by essentially all of the news coverage. The story has been that gas is now cheaper than coal and hence the Navajo Generating Station could not compete and had to close. When I did some digging concerning the companies who own the Navajo Generating Plant and have power offtake agreements with the coal plant, a different picture began to emerge.
As a result of a combination of cost reductions and desire by customers for clean power, the LADWP (Los Angeles Department of Water & Power) exited from Navajo ownership and no longer required the 477 MW of coal powered energy. This resulted from completion of a planned renewable energy program 4 years early. Power has been sourced from major solar PV farms (250 MW Moapa Southern Palute Solar Project, 3 large solar plants in the Mojave Desert, and its share of 210 MW Copper Mountain 3 Solar project near Boulder City Nevada), increased energy efficiency and some back up with natural gas.
Four of the five existing owners of the Navajo Generating Plant, Salt River Project (42.9%), Arizona Public Service (14%), NV Energy (11.3%) and Tucson Electric Power (7.5%) have major solar PV and or wind projects. They are all seeking to close down the Navajo plant because the cost of the power is expensive.
Navajo shows it isn't just coal versus gas and a pricing issue. Utilities are responding to customer desire for clean power and also the dramatically falling cost of power generated from solar PV or wind. When a solar or wind project is installed, prices don't matter any more; when they are generating power, they win.
Iowa is an even more striking example. Electricity in Iowa has traditionally been generated by coal; in 2008 75% of Iowa's electricity was generated by coal. But this is changing and in 2016, coal for the first time supplied less than 50% of Iowa's electricity. This is more than a 25% fall in market share. What has been the big winner? It isn't gas, which constitutes ~5% of Iowa's electricity generation. Wind power generated 7.7% of Iowa's electricity in 2008. In 2016 wind generation accounted for 36.6% of Iowa's electric power generation. So wind power accounts for all of the new power generated in Iowa as coal plants have been closed down. This is a powerful refutation of the dogma that gas is substituting for coal.
ii) It isn't just about coal, renewable energy is now displacing gas
Looking at the bigger picture, new data out from the EIA makes clear that increasing renewables in California has as a consequence led to lower natural gas consumption.
California's electricity generation from renewable energy and gas in 2017; source EIA
The Californian figures for 2017 are confronting for the gas industry. Gas consumption is at its lowest for 5 years and solar PV is up 27% for the start of 2017 in comparison with 2016. Lower consumption of gas is occurring in California despite the closure of the San Onofre nuclear plant in 2013. The accompanying graph for 2017 shows renewable energy consistently at least 10% higher than the 2012-2016 average for renewable energy, and for gas the electricity production has fallen by a similar amount.
California is just one of a number of states aggressively driving renewable power generation, and the pattern is similar.
And lest one becomes concerned about Energy Secretary Rick Perry's argument that we are headed for problems by adding renewable power to the grid, it is worth paying attention to Ben Fowke's (Chairman, President & CEO of Xcel Energy Inc (NYSE:XEL)) view on this. Ben Fowke is a useful source as his company is the biggest wind buyer in the US. He said at a recent wind power conference in California that while Xcel provides 35% of energy from wind across the eight Western and Mid-Western states it serves (and up to 67% in Colorado), he is comfortable that Xcel is not sacrificing reliability, despite the major contribution by renewable energy to Xcel's power supply. He argues that he is saving customers $billions by owning and purchasing power generated by the wind.
iii) Solar PV + batteries now cheaper than peaking gas
Above I've indicated that there is a more complex explanation for the demise of the Navajo Generating station in Arizona, with solar PV being another aspect of the story. One of the companies involved with Navajo has just announced an even more dramatic development. Tucson Electric Power, owned by UNS Energy Corporation which in turn is a subsidiary of Fortis (NYSE:FTS), has just announced a contract to provide 100 MW solar PV + 30 MW/120 MWh of battery storage at a combined cost for the power purchase agreement of significantly less than 4.5c/KWh. The solar PV component was less than 3c/KWh. This is two thirds less than a January 2017 contract for solar PV + battery storage in Hawaii (11c/KWh) , and well below the cost of a gas-fired peaking plant. This means that dispatchable renewable energy now competes with peaking gas on price. A similar story has been reported recently in Australia.
Batteries have additional benefits over a gas turbine system for stabilizing the grid, especially for preventing voltage/frequency oscillations after fast changes in load or generation. This is because batteries have a very fast response time (milliseconds) in comparison with a gas turbine (8-30 sec). For reasons explained in the link, a 10 MW battery system provides equivalent short term response to a 100 MW gas turbine.
What the Paris climate agreement says
Above I've given some examples where gas is clearly not the substitution fuel for coal, and where gas is now losing out in competition with renewable energy in supplying electricity. There is a lot evidence of this if one does some digging. This is about the battle between gas and renewable energy for a place at the table of electricity generation. I argue that gas is losing this battle.
There is another angle to the future for gas.
Gas is a fossil fuel which, when all of its contributions to greenhouse gas emissions (CO2 + escaped methane) are considered, arguably has an effect that is similar to the damage caused by coal. This isn't the story told by the oil and gas majors as they hope that they can expand their production at the expense of coal.
The world (including BP) acknowledges the need to address greenhouse gas emissions and this means exiting fossil fuels. The leaders of 195 countries are now actively engaged with implementing the Paris Agreement, whose consequence will be the exit from burning fossil fuels by ~2050. 147 countries have now ratified the agreement.
Some argue that this agreement has no credibility because this agreement involves individual countries setting their own targets that are not binding. Indeed the initial targets set by countries will not lead to the goal of limiting temperature rise to 1.5C, with a goal of less than 2C, as the initial commitments mean ~3.4C temperature increase. However, the strategy for the Paris Agreement is for countries to ramp up their targets as they engage with the process. Two of the key countries, China and India, are making great progress towards increasing their targets, with India now likely to achieve its initial target 8 years ahead of schedule.
Meanwhile the US is obfuscating about its 2020 pledge.
The point about the Paris Agreement is that there is no way that it can be implemented if BP's business plan is successful. There is simply no room for gas.
BP's portfolio mix
BP's Strategy Update February 2017 "Getting back to growth", highlights its position as 'Safer', 'Fit for the future' and 'Focused on returns'. It is all about oil and gas, especially gas.
BP does refer to "building on its strengths", which covers planning beyond oil and gas, but the summary slide in its February 2017 presentation is skinny, with reference to "new fuels lubricants and plastics", "advanced mobility" (which shows an image of an electric charging station at a conventional gas station) and "digital" (driver convenience and new channels to customers). My take on this view of the future beyond oil and gas is that it is barely thought through and is cosmetic rather than structural.
Simply put, BP has everything riding on expansion of oil and gas, and its business plan indicates that it is serious about this, with 7 major projects coming on stream in 2017 (only one of these is an oil project, the remaining 6 are gas projects) and 9 more projects under construction 2018-2021. This is a company that takes seriously its place as a major executor of big oil and gas projects. There is no sign that it sees the future in any other way.
This is a classic "Kodak" approach involving confidence that BP is the best at this and it is getting on with the job. Its senior management is steeped in the oil and gas tradition and there is no sign that they take seriously that oil and gas are under threat. Certainly alternate business models are poorly sketched out.
This is a time of dramatic change where there are fortunes to be made and lost. I've indicated for some time now that BP seems not to be taking seriously the changing times that it confronts. In a recent article I addressed the risks to its oil business. In this second article I ask the question whether gas is going to be the transition fuel as the coal industry declines. My take is that there are already strong signs that gas is going to be overtaken by renewable energy (solar PV and wind) and battery storage. Investors need to look beyond the glib phrase that gas is the transition fuel to see what is happening on the ground. My take is that not only is the dividend at risk as the oil price struggles, but its entire business plan is fragile. It is well worth thinking about where BP fits in your investment strategy.
I am not a financial analyst, but I am very focused on understanding the dramatic changes happening in the energy and transport space as the world begins to decarbonise these sectors. If my commentary helps give another perspective to your investment strategies, please consider following me.
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.