Transition Pulls Ahead
Monday 6 September 2021
The pace of the economic recovery slowed in late summer, extending the timeline of central bank intervention. Frankly, a moderate relaxation of demand pressure would not be unwelcome, at this point in the cycle. While job creation in the US is pressing forward, some sectors like leisure and hospitality saw demand for labor come to a standstill. That’s probably temporary, and the most recent wave of the pandemic will soon peak if it hasn’t already. All this said, the trajectory of corporate earnings growth and global GDP has now been slightly elongated, and the recovery is unlikely to peak now until well into 2023.
What’s intriguing however is that adoption of electric vehicles globally, cost declines seen in wind, solar, and storage, and the growth of clean energy overall did not slow down much during last year. And they are still not slowing. Quite the opposite. We do not yet have adequate answers as to why energy transition is decoupling (at least a little) from economic growth and supply chain constraints. But one explanation may be that its momentum was robust prior to the pandemic, and ample global liquidity of capital is now helping greatly to extend the run.
The top of the transition list surely has to be this year’s EV sales growth and in particular market share growth in both Europe and China. In The Gregor Letter, and also in The Oil Fall series, it’s been oft highlighted that once new technologies cross above the 5% market share level a take-off phenomenon is likely to unfold. China’s EV market has adhered to this phenomenon in textbook fashion, fumbling around just below the 5% level in 2018 and 2019, then finally inching above it in 2020, to reach 5.4% of sales. Now the market is soaring, and is on pace to reach 10.0% of sales this year.
But a big part of this year’s EV story in China surely has to be that the total market is flat, year-over-year, at a 25.3 million annualized pace. This produces an increasingly familiar phenomenon, in which the legacy technology stops growing as all the marginal growth swings to the new technology. China’s ICE sales peaked way back in 2017, at over 28 million units, and this year are on pace to notch just 22.7 million units. The peak in China’s ICE sales was spotted years ago, of course. But observers have been reluctant to accept the transformation is sustainable. Well, it is.
Europe’s EV uptake meanwhile is at least as impressive, if not more so, as total plug-in share soared to 16% of the market in the first half of 2021. Having put a fresh 1 million plug-ins on the road in the first half of the year, Europe’s total EV sales are actually approaching China’s annualized total of 2.5 million units. Given that Europe is roughly just 1/3 the population of China, EV penetration in the region is absolutely crushing the ICE market. And, given very high levels of wind and solar in the EU’s power system, this also means that the market’s transportation system is decarbonizing rapidly now, as the symbiosis of clean electricity and EV battery demand flourishes. For confirmation of this growth from the corporate sector, ChargePoint Holdings reported European and US sales growth notably above expectations, and raised guidance. Charging networks are as predicted growing quickly, and are tracking sales growth.
While these admirably high market share figures are impressive, they still do not prevent the growth in the total size of the on-road ICE fleet. But EV adoption does indeed apply an increasingly strong brake on that growth, with obvious implications for oil demand. Across markets more broadly you can discern the dissonance now between upward pressure on oil demand that is driven mostly by the pace of recovery (and as demand comes up from deep lows), with a growing awareness that oil demand in its totality is not likely to exceed the previous 2019 highs globally. The price of oil looks quite trapped at the moment between these two competing trends.
The commodity supercycle theory also seems to be coming under fresh examination. Iron ore and copper producers have seen their share prices pull back significantly as China’s growth comes under scrutiny. The Gregor Letter has been quite clear that rapacious demand for some commodities will be sustained for the entire decade. Lithium for batteries, rare earths, and copper are all set to see firm, strongly growing demand to the year 2030 as electrification accelerates. But it’s going to be hard to name that trend a supercycle now that demand growth for coal and oil are over, with natural gas fated to join that dead-money duo.
While it’s true that oil will remain the go-to construction fuel to build out a world of new energy infrastructure, the quantities needed are not enough to counteract the myriad forces bearing down on oil demand growth. How much oil for construction vehicles, coal for steel, and natural gas in manufacturing will be required to complete the buildout of transmission lines, utility scale solar and wind, batteries, EVs and their charging networks, and better urban design? Estimates of the construction cost of energy transition over recent years have ranged from 1% to as high as 5% of global GDP. But these estimates have come down increasingly as cost efficiencies advance. One could roughly extrapolate from these GDP estimates to assert that of the 100 million barrels per day of global consumption (the amount currently required to sustain global GDP) that as much as 1-2 million barrels will be needed each day to “fund” the global energy transition buildout. Such analysis has pitfalls of course, given that energy transition infrastructure increasingly obviates a separate volume of construction that would have taken place otherwise. And, as the decade wears on, electricity will also find its way into construction and transport more steadily, thus alleviating fossil fuel demands. Future steel production is likely to be green (using hydrogen as the input), and construction vehicles will be electrified as will global shipping. So far, energy transition is not exactly exerting a notably evident call on global commodities. Mostly, the world will simply branch in a new direction.
Post-crises periods are characterized by deep skepticism about the sustainability of recovery because most are still anchored psychologically to the profound asset price lows and devastation of the crisis itself, even as it fades monthly into the past. This time is no different, as economic strength and strong corporate earnings are greeted with warnings about their duration, and the suspicion that the “cycle” is about to complete. But we are still early cycle, not late cycle, in this recovery, with a lot of room for broadening globally. Counterintuitively, damage done to China’s internet sector by President Xi, along with the the ascent of the Delta variant, provide just enough of a growth scare to keep markets honest. Along with inflationary pressures, these concerns micro-dose the economic landscape with fear, acting to prevent the very overheating that tends to bring cycles to a premature end.
The global economy is fated to be characterized by energy transition through the end of this decade. Solid, sustainable demand from this ongoing project will drive firm demand for labor, engineering equipment, and software. The pandemic meanwhile will act like a deep psychological hole, protecting the cycle from overheating much as the great recession did, during the last decade.
Business travel is unlikely to return to previous levels. In a Bloomberg survey, 84% of businesses plan to spend less on such expenses in the years ahead. The anecdotes in the Bloomberg piece are revealing. They center on the expanding realization that tasks that previously required long, even round-the-world meetings and inspections can now be done remotely. The survey also adds to the broader theme coming into view: a non-zero portion of the global workforce, conservatively estimated at around 10%, will undergo a permanent structural change in favor of hybrid working conditions. And yes, this will impact oil demand at the margin.
Carbon trading markets continue to bulk up as new players and significant capital moves into the space. The December 2021 European Union Allowance (EUA) futures contract hit another all time high (intraday) above $62.50, and settled near $61.50 last week. According to the WSJ, global carbon markets collectively grew to about $280 billion in value last year. So obviously, we are at even higher levels today. A useful lens through which to follow these markets is through the KraneShares carbon ETF which holds European, Californian, and US contracts.
Combined wind+solar’s market share in the US electricity system continues to grow strongly, nearly wiping out growth from other sources. Wind and solar crossed the important 5% share level in 2015, and are now on pace to reach 12.8% of US electricity this year. As the EIA has increasingly pointed out, nearly all the new growth in US power generation comes from renewables. The estimate for 2021 is based on full, first-half of the year data.
China, Europe, and the US are creating all the clean electricity they could possibly need to fuel new EV hitting the road. It continues to be a frustration that so many observers do not know this, do not understand this, and are certain that “all the new EV will run on coal.” The central thesis, and subtitle, of the Oil Fall series, originally published throughout 2018, is fully on course: “How wind and solar will jailbreak the powergrid, and find their way into global transportation.” United States generation from combined wind and solar grew strongly from 403 TWh in 2019 to 470 TWh last year, and is on pace to reach 537 TWh this year. This annual growth is so very far above the new power needed for new EV, it is almost comical. The 330 thousand EV that hit US roads in 2019 required, at best, 1.32 TWh of electricity, and the 270 thousand EV sold last year required at most 1.10 TWh of power. When the US starts putting a million new EV on the road each year (and maybe that happens next year?) it will require 4 TWh of new power. But wind and solar are already smashing out growth that’s at least 15X times higher, adding 67 new TWh in each of the last two years. And the growth is going to accelerate from here. This ample coverage of new EV demand with clean electricity is even more pronounced in China. Only in Europe, where EV demand is soaring in a region where alot of strong growth of wind and solar has already occurred is the spread between new demand and new clean power supply slightly less enormous. Will we ever see a year in which new EV demand in the three main regions is not covered quite adequately by growth of new clean power? Doubt it.
Global EV sales have crossed the key 5% market share threshold, reaching 7% this year according to Wood Mackenzie. We are clearly moving into the next phase now of EV adoption if the global share can maintain the current advance. The last decade was marked by the long struggle of EV to get above 2-4% of market share. This decade, as expected, looks to be kicking off the middle part of the adoption curve. A basic projection probably sees EV taking 15-17% of the global car market by 2025, with a lot of variety within market share take from region to region.
A viral tweet claimed that California’s Mt Shasta was without snow for the first time. Not exactly true (the first time part) but the general point stands: snowpack decline in the West and glacier loss in the Cascades in particular is quite real and the Seattle Times had a very good long piece covering this issue at the weekend.
SP500 analyst consensus earnings continues to advance, even as job markets are not fully back to the previous trend. Friday’s jobs report unquestionably records the late summer slowdown, but keeps the trend alive as the global economy builds its way now towards 2022. In the world of corporate earnings, 2021 estimates no longer matter much and everything is about next year now, and the year after. Analyst consensus sees $220.39 in SP500 earnings for 2022, and $236.39 for 2023. Skeptics have been convinced all year that estimates have been too high for this year, at $201.84, only to see earnings eventually align with projections.
—Gregor Macdonald, editor of The Gregor Letter, and Gregor.us