First Eagle Market & Topical Perspective- Energy Transition: The Long and Winding Road

Key Takeaways

• Energy transitions historically have been very long-duration events, and there's no evidence to suggest the current transition from carbonbased fuels to renewable energy sources will be any different.

• As global energy consumption continues to expand with population growth and increased economic activity, especially in developing economies, the world will require greater supplies of both traditional and renewable forms of energy.

• Despite the advancements in renewable energy technologies and rapid growth of capacity over the past decade, much work and investment is needed before renewables become a large-scale, economically viable substitute for fossil fuels.

• Energy-market dynamics suggest a longer runway for fossil-fuel demand and a more crucial role for traditional energy companies than may be reflected in the financial markets.

Fossil fuels like coal, oil and gas are the largest contributors to GHG emissions, and the effort to replace these carbon-based energy sources with renewable alternatives is viewed by many as the primary path to a cleaner future. It also is viewed by many as heralding the inevitable demise of businesses across the legacy energy value chain. Given both historical trends and contemporary considerations, however, we believe the future of global energy supply and demand is likely to be far more nuanced than many appreciate and that fade risk for traditional energy companies may be mispriced as a result.

Energy transitions take time, and the staggering scale and complexity of the global shift toward renewable energy sources seems to represent an epochal event likely to occur slowly over the course of many decades. And then there's the price tag: One consultancy estimated it would cost around $275 trillion to get the world to net zero by 2050, and the recent increase in the cost of capital has further complicated the financing of these projects.¹

In short, there are no quick fixes here, and fossil fuels likely will be needed to help meet energy demand for decades to cometo the potential benefit of, in First Eagle's view, certain well-positioned legacy energy businesses in possession of scarce, vital assets. This includes majors that are the primary suppliers of liquified natural gas, like Shell and ExxonMobil; midstream companies with infrastructure essential to the processing, transportation and storage of oil, gas and natural gas liquids, such as ONEOK and Enterprise Products Partners; and service businesses helping to maximize productivity, detect and minimize methane emissions, and equip the energy industry with the latest emerging technologies, including SLB and NOV.

Change Comes Slowly

A multidecade effort by the United Nations to spur concrete intergovernmental action on climate change culminated in the 2015 Paris Agreement. More than 190 countries formally committed to reducing GHG emissions such that the global temperature would increase by no more than 2C from pre-industrial levels, while aspiring to the even more ambitious 1.5C.² In addition, many of these countriesincluding China, the US and India, which are the world's three largest emittershave set net-zero target dates by which they intend to offset all human caused GHG emissions with an equivalent amount of carbon removal.³

While these and subsequent actionsincluding the progress made at the most recent UN Climate Change Conference (COP28) held in December 2023 in Dubai are intended to create a shared urgency to replace fossil fuels with low-carbon alternatives, the data tell a different story. According to some estimates, current government policies suggest that aggregate fossil fuel production in 2030 will be 110% higher than the amount consistent with a 1.5C warming cap and 69% higher than would be consistent with 2C warming.⁴ Moreover, global coal production is expected to increase until 2030 and global oil and gas production until at least 2050.⁵ This disconnect highlights the many challenges facing the energy transition and the coalition of public and private interests seeking its implementation.

It also serves as a reminder that energy transitions historically have taken place over very long time periods, as shown in Exhibit 1. Throughout history, energy use has migrated toward sources that offered the best combination of access, efficiency and cost. Prior to the Industrial Revolution, wood fueled the world. After mining improvements in the mid-1700s resulted in lower prices and easier availability of coal, which is far more energy-dense than wood, it took more than 100 years for coal to surpass wood as the largest source of energy globally. Oil was heralded as superior to coal by the early twentieth centuryagain, due to its greater energy densitybut decades elapsed before global demand for oil surpassed that for coal.

It's also important to note that during this multi-century period, global aggregate energy demand (the blue line in Exhibit 1) grew rapidly, driven by an expanding population and rising living standards. This lifted absolute levels of demand for all forms of energyincluding such legacy sources as coaleven as the global energy mix shifted. The absolute growth in all forms of energy is isolated in Exhibit 2. If history is any guide, demand for fossil fuels is likely to grow on an absolute basis even as renewables gain share.

Renewables Have Big Shoes to Fill

Those anticipating a rapid phase-out of fossil fuels may be surprised to learn that they still account for approximately 77% of global primary energy consumption today, excluding traditional biomass like wood and animal waste; as displayed in Exhibit 3, this figure is roughly the same as it was 30 years ago despite the rapid growth of renewable energy capacity over the past decade. While the primary source mix of future consumption is uncertain, there are a number of reasons to believe there will be a substantial ongoing need for carbon-based fuels alongside renewables, including shifting global demographics, country-level concerns about the affordability and security of energy supply, and technological limitations.

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This article first appeared on GuruFocus.