If the future is bright for natural gas, is it gas and oil now? If the future is bright for natural gas, is it gas and oil now?

By Andy Brogan

EY Global Oil & Gas Leader

Oil & Gas sector leader, speaker and industry advocate, optimist, music addict and avid traveler.

Contributors
8 minute read 14 Feb 2020
Related topics Oil and gas

In the Critical Gas scenario, oil demand peaks and capital moves toward gas-focused upstream and LNG assets.

This article is part of the Fueling the future series, examining how oil and gas companies can navigate the opportunities and risks of the low-carbon transition.

In the Critical Gas scenario, we assume that coal-fired generation decreases by an average of 5% per year globally, compared with just 1% in The Long Goodbye scenario. This rate of decline is well above the recent history. In the last five years, global coal consumption has gone down by 0.5% per year, largely due to reductions in the cost and price of natural gas and the emergence of cheaper renewables. However, the story varies geographically. Coal consumption has gone down by 5% per year in Europe and North America, increased by 5% per year in India and (contrary to conventional wisdom) been steady in China.

Critical Gas assumes zero growth in nuclear power. This compares with 2% in The Long Goodbye and Meet Me in Paris scenarios. Every megawatt-hour that isn’t generated in a coal or nuclear power plant is a megawatt-hour that needs to be generated somehow else, setting the stage for gas as either a competitor or a complement to renewables.

  • Methodology

    Of all the complex issues facing our world, the transition to a lower-carbon future may be one of the biggest. It’s not a question of “if”, but how and when.

    In our Fueling the Future analysis, EY undertook a deep dive to help oil and gas companies understand the opportunities and risks of the transition. In examining the disruptive forces impacting the industry, we developed a framework which looks at how various risk factors might change oil and gas demand and returns. We’ve distilled the possibilities into four scenarios, which range from a very gradual movement from hydrocarbons to a rapid adoption of renewables.

    Meet Me in Paris

    Technology improves rapidly; alternative energy quickly becomes cheap enough to displace existing infrastructure.

    The Long Goodbye

    Renewables take a place in the market. Oil demand peaks, but stock effects, consumer inertia and continued growth in aviation and petrochemicals keep it from a drastic drop.

    Slow Peak

    Peak oil does not happen soon, thanks to developing countries’ demand for petrochemicals, energy-intense industrial usage and aviation.

    Critical Gas

    Oil demand peaks and trails off fairly quickly as consumers migrate to electric vehicles (EVs). Capital moves toward gas-focused upstream and LNG assets.

So what happens next in a Critical Gas world?

When solar-generated electricity becomes cost competitive, there will still be a process of consumers buying (and financing) those systems and utilities integrating them into an increasingly complex power transmission and distribution network. That process will take time and may have limits.

Critical Gas depicts a lower-carbon energy world, but not a zero-carbon one. It’s a scenario that won’t get us to the goals of the Paris Agreement, but it’s moving in the right direction:  

  • EVs grow in popularity
  • developing economies are getting richer where power demand surges
  • coal is phased out, and countries are unable to stomach the risk and cost of nuclear power
  • renewable technology is cost competitive, but capital markets can’t immediately find a solution that moves power system financing off corporate balance sheets and onto consumers
  • utilities require time to find a cost-effective way to balance a power network with substantial amounts of intermittent power
  • renewables and natural gas generation grow in tandem, and as a result the demand for liquid natural gas (LNG) grows much more rapidly than anyone expects
  • gas-focused assets (upstream, midstream and downstream) are in high demand and likely to provide investors with superior returns

Advancement in solar generation, batteries, and EVs is steady. We’ve assumed that the complementarity between natural gas and renewables tilts toward natural gas because 1) in the near and intermediate term, there’s a risk that stabilizing a power system where all the new power is renewable is too costly and 2) consumers can’t or won’t finance distributed solar at scale.

Critical Gas depicts a lower-carbon energy complex, not a zero-carbon one. It’s a scenario that won’t get us to the goals of the Paris Accord, but it’s better than the status quo.

Let’s look at which figure most prominently in the Critical Gas scenario.

Coal and nuclear power

As electricity demand has grown in the developing world, coal has been the fuel of choice. It’s cheap, the technology is easy to implement, and supplies are reliable. However, if the world stands any chance of meeting its climate change goals, this cannot continue. Nuclear is a low-carbon alternative, but the cost of making it safe appears to be prohibitive. Almost every baseline forecast assumes an ongoing role for both coal and nuclear.

Electric vehicle penetration

Electric transportation is an unstoppable force. We’re close to the point where on a straight cost and performance basis, EVs will be competitive with internal combustion engine-powered vehicles as suggested in EY’s Countdown Clock model.

EV penetration is important to the Critical Gas scenario because it has the potential to drive new electricity demand and new demand for natural gas as a complement to renewables. According to the World Economic Forum, there could be as many as 2 billion vehicles on the world’s roads by 20401. We estimate that if all those cars were electric, that would increase electricity demand worldwide by just under 20%. That electricity will have to be generated somehow, and at the margin, it’s likely to be split between natural gas and renewables.
 

We’re optimistic about EVs, but there is still some uncertainty. We see three big questions:

When will EVs be fully adopted by the mass market? The cheapest models are still considerably more expensive than ICE-powered cars and aren’t available in volume.

How quickly will consumers become convinced of the cost and performance advantages? Interestingly, if a technology is perceived to be advancing, many consumers may defer adoption and push the curve out.

When will the infrastructure required to charge EVs be built at scale? There are as many charging technologies as there are EV manufacturers, and electric utilities may be reluctant to invest today in upgrades that may not yield immediate revenue.

The Critical Gas scenario assumes 41% marginal penetration for EVs by 2035. That’s slightly above the penetration we assume in The Long Goodbye scenario, substantially above the 22% penetration we assume in our Slow Peak scenario and well below the 100% market share we assume for EVs in our Meet Me in Paris scenario.

Speed of transition to renewable power

In our models, we measure the speed of transition to renewables by determining what proportion renewables and natural gas take, after we have accounted for demand growth, coal attrition and increases or decreases in nuclear generation. They are roughly 50/50 now. Meeting the goals of the Paris Agreement would require that the share exceed 100 percent: gas generation would need to be shut down and replaced by renewables.

In the Critical Gas scenario, we assume that renewables and gas will share the power generation market at the margin in 2035 and beyond. That’s roughly the case now, and it’s pessimistic as a forward-looking point of view. A recent study estimated that battery storage would have to fall to $20/kWh to make a 100% renewable power grid sustainable2. The current price is about $185/kWh. We’ll get there eventually, but no one knows when. We’re not necessarily predicting that outcome, but we consider it a plausible scenario.

Another question is financing. Today, power sector investment is almost entirely financed on government and corporate balance sheets. It’s a system that worked well, and power utilities (public and private) are among the best credit risks in the market. In an all-renewable world, we expect a large portion of that investment to shift to households. The numbers are substantial. The International Energy Agency contemplates about US$25t of investment in the power sector between 2018 and 2040 under its Sustainable Development Scenario.
 

Demand

There are many estimates of how fast natural gas demand will grow. In scenarios that are consistent with the Paris Agreement, including our Meet Me in Paris scenario, natural gas will grow very slowly for the next 25 years before peaking and declining to end in the middle of the 2040s roughly where it is now. In The Long Goodbye scenario, gas demand increases by 285 billion cubic feet (BCF) per day between now and 2050.

The Critical Gas scenario envisions a much bigger role for gas. Demand grows rapidly, increasing by more than 618 BCF per day, compared with the current demand of 370 BCF per day.

LNG Returns

Returns

One of the major findings of our Fueling the Future project is that asset returns have a predictable pattern with respect to demand scenarios and various asset classes. The Critical Gas scenario is no exception. Investments on LNG assets, for instance, show large returns, relative to other scenarios. This scenario supports, as it needs to, substantial investments in natural gas assets all along the value chain.

Summary

We know we’re on a journey to decarbonized energy, but how long a journey is unknown. The current mix is convenient for consumers in OECD countries, has fostered increased standards of living, and is enormously profitable for the industry. However, this status quo will change. Addressing climate change while delivering reliable power is imperative. The Critical Gas scenario is a story of rapid change, just in a direction slightly different from meeting the Paris Agreement goals. While we can’t plot a path with certainty, it could be the role for natural gas will be bigger than imagined.

About this article

By Andy Brogan

EY Global Oil & Gas Leader

Oil & Gas sector leader, speaker and industry advocate, optimist, music addict and avid traveler.

Contributors
Related topics Oil and gas