What to expect in 2010 and beyond?

Around this time, it is customary to look ahead and try to predict how the New Year will unfold, particularly in terms of the major trends. IFandP’s Dr Samuel Fenwick discusses Deloitte’s latest predictions and makes some of his own.

One of the most through attempts to do precisely this has come from Deloitte, which has recently released its energy predictions for 2010. It makes the point that much will hinge on whether the economic recovery is sustained and at what pace. A “V” shaped economy runs the risk of turning into a double dip recession (“W”) if oil prices rise too quickly, while a “U” shaped recovery may be the key to more sustained growth. Deloitte raises the point that the real test of the recovery is yet to come, given that major stimulus packages are still in effect and therefore a double-dip recession can’t be ruled out, with obvious effects on both the energy sector and investment. Although Deloitte didn’t mention it in its report, a real issue will be the handling of the huge debts racked up by some countries, such as Japan and some parts of Europe, which could potentially derail the recovery if mismanaged.

The consulting firm also envisages an uptick in M&A activity across the energy and power sectors, with particular room for consolidation in the mining and independent oil company subsectors. It’s worth noting that there are two main factors at work. First, regardless of your views as to whether we will see a “W” shaped recovery, the fact remains that we are currently far off the peak in the current cycle and therefore now is a good time to go shopping for other firms. The second factor is that the panic induced by the financial crisis re-enforced the mantra that “Cash is king”. As a result, many companies have freed up significant amounts of cash and may well be looking to invest. A real limitation for those on the prowl is expected to be the lack of suitable targets, so those companies that unexpectedly flounder may be quickly pounced on.

As far as the power sector is concerned, Deloitte expects the M&A environment to become more favourable, given governments’ and regulators’ growing awareness of the scale of investment required and the resulting need for capital.

Interestingly, Deloitte expects that the smart grid sector could become the fastest growing of the new wave of energy technologies in 2010 due to large-scale investment from utilities and stimulus packages. However, the consultancy highlights that several factors might cap growth below the sector’s full potential, such as the lack of unified standards, the need for complex software and the fact that consumers are unlikely to see the benefits for some years to come.
As far as carbon is concerned, Deloitte doesn’t see the issue of coal-fired generation being resolved this year and it is easy to see why. While carbon capture and sequestration technologies are expected to continue advancing at a rapid pace, they will still be some years off from full-scale deployment. In addition, the lack of progress made at Copenhagen and the loss of a vital senator for the US Democrats in Massachusetts, makes it clear that 2010 will not see a quantum leap towards an effective US and by extension, a global carbon trading market.

While coal might be a slow burner in 2010, the same will not be said for solar and wind. With initiatives like Masdar City boldly pushing forward and oil-rich countries in the Middle East starting to realise the untapped potential of the sun, a great deal of progress could well be made over the course of this year.

Perhaps one of the most intriguing of Deloitte’s predictions, the idea of a shift towards sector wide regulation of carbon emissions, is more of a manifesto. The consultancy makes a convincing case, arguing that these could result a more balanced approach and provide the long-term signals needed for sustained and large-scale investment. However, while this does seem laudable, it is hard to envisage how such schemes would not be bogged down by politicking and arguments resulting from conflicting national interests. Any carbon emission scheme designed and put forward by major emitting industries would also have a credibility issue in the eyes of the public, making it difficult for politicians to support.

Light at the end of the tunnel?

Looking beyond 2010 and towards the coming decade, there are several key developments that will have a dramatic impact on the energy and power sector. The rise of the electric car, coupled with the growing appetite for the latest technological wizardry from consumers, will both change the way the power sector operates while dramatically boosting demand, typically outside of peak hours.

At the same time, the need to manage the issue of intermittency will continue to grow, thanks to greater use of renewables, but the major transmission projects needed to address the issue cheaply may lag behind, creating headaches for power utilities and making the need for flexible consumers and load-shedding more acute.

From a more global perspective, a truly seismic shift will occur once the focus of China’s manufacturing base begins to shift towards addressing domestic demand as opposed to its current focus on imports. This could have major implications for the economies of the US and Europe, with obvious knock-on effects for power demand. China’s appetite for US public debt is another issue and the mutually beneficial relationship between the two countries may well sour if this grows thin, particularly if the US attempts to reduce its debt by devaluation. A related issue is the growing realisation as exemplified by the recent Google fiasco that although China is getting wealthier, it isn’t softening in its attitudes to the west. This could be argued to be the result of the rapacious attitude the West adopted towards China in the early half of the 20th century, which has created a nation with a reflexive resentment to what it sees as “colonialist meddling”.

Other economic issues to be aware of is that given the sheer pace of industrialisation and development in Asia, coupled with the growing costs of oil exploration and upstream production, we may find ourselves in a vicious cycle in which rising energy prices trigger recession, followed by a collapse in the price of oil, which in turn reduce the volume of investment in the energy sector, which then sets the scene for a subsequent boom/bust cycle. Renewables, possibly in conjunction with nuclear power are an obvious solution, but changing the entire world’s energy sector before this comes to pass will require a monumental level of investment.

In terms of the upstream sector, all eyes will be on Iraq, particularly as to whether it can boost its production to the much-trumpeted 10mbpd. If this comes to pass, then in an absence of carbon-restraints, we might be looking at another decade or two of essentially business as normal. If not, then China’s strategy of locking up supplies in Africa and Latin America will become increasingly the object of scrutiny, as will the state of OPEC oil reserves. In addition, Brazil’s oil largesse will begin to make itself known towards the end of the decade and the question as to who will supply Europe with energy will become increasingly urgent, given the decline of the North Sea and the issues conspiring to limit investment in Russia.

As for the burning issue of climate change, it is fair to say that progress will be made, but it will be at a pace greatly lagging that dictated by the science. While it is hard to envisage major impacts that can be directly attributed to global warming making their presence felt so early, the mounting risks from hurricanes and powerful storms may well make infrastructure hardening a key issue. Over in the EU, carbon trading will either begin to bite in a big way or fade into irreverence. With much clamour from businesses for a stable long-term carbon price, it would be wise to bet on the former. Meanwhile in the US, even if a cap-and-trade system is introduced next year, it will be several more years before it tightens to the point where it starts significantly impacting day-to-day plant operations. Investment decisions are another matter and the tide already seems to be turning against coal. 2009 saw a large number of potential projects being canned as a result of litigation and fierce opposition from local residents and environmental groups and this coupled with the threat of cap-and-trade is going to prove a major headache for both coal-users and also the coal mining industry, which may have to redirect significant volumes abroad. Fortunately, Asia’s appetite for the black stuff is very likely to continue, as exemplified by the news today that Vietnam is expected to become a net coal importer in 2013.

In general with any forecasting exercise, its worth bearing in mind that people vastly overestimate the rate of technological progress, but at the same time, predicting the important innovations that will define the next decade is nigh-high impossible. Perhaps a lesson can be learned from of all places, martial arts. As my Sifu taught me, one does not fix one’s gaze onto one particular part of an opponent for to do so means potentially missing the bigger picture. So then, as we head into a new decade, with all the various possibilities in mind, we should still keep a wary eye out for the unexpected.

The full report from Deloitte can be accessed here

What are your predictions for 2010 and beyond? Feel free to comment on this topic below.