Future opportunities for powering growth

GDP growth prospects have suddenly been perceived as a bit dimmer in the past few months as growth in advanced and big emerging markets have underwhelmed.  But slower growth in places like China does present opportunity elsewhere. This post focuses on the power sector, where much lower fuel prices should support the economics of power generation in regions that have struggled to match its potential in the last 5-10 years.

Looking at headline projections of global energy demand and output are pretty encouraging. These data come from the recently released International Energy Outlook 2013 from the EIA (which can be found here).

Growth rates to 2020 of expansion in power generation capacity are expected to be a little quicker than what we have seen since the crash in 2009, growing at a CAGR of 2% on a global level.  Most of this is driven by the emerging world, although there is some growth in the OECD

This report may have a bad sense of timing, with many official sources dialling down GDP growth rates in the emerging world in the last couple of months.

Looking at the big picture, this may be unwinding some of the upside surprise in recent years. The chart on the left shows some of the longer term factors underlying expectations of rising energy consumption globally in the most recent EIA report.

Each line represents the path of energy consumption per capita vs. GDP per capita for the given country/region over the data made available by the EIA. The start point 2005 and the end point 2040.

The country that definitely stands out is China, with an expected exponential increase in energy consumption vs. GDP, which then flattens near the end of the forecast horizon.

Other countries by comparison are much less exciting.  Energy consumption in the OECD isn't expected to do much despite rising incomes, while surprisingly India and other Asian countries aren't expected to see anywhere near the same take off as in China, despite moving to meaningfully higher income levels.

This next chart then shows how these projections have changed since this last report was done in 2011.  While most countries are a little lower thanks to somewhat slower then expected GDP, projected Chinese power consumption is much much higher.

I think this report may have too much upward bias in relation to Chinese data. Part of this is thanks to the last couple of years, where actually data has surprised to the upside.

But while the power sector is now in much better shape margin wise thanks to much lower coal prices (with coal the dominant fuel in energy production), more recently this has been because power demand has been much weaker than expected.

This is partially due to top-down factors, but also due to an apparent improvement in energy efficient.  Historically, power generation grew pretty closely to industrial production.  But this ratio has dropped, which suggests the industrial sector is adding more value for less power (or that the numbers are massaged.)

So perhaps the EIA is getting a bit carried away with its expectations for China right at the wrong time.

Instead, the opportunities for a faster acceleration in power generation lie in Asia outside of China. This is not just centred on emerging economies, with Japan still rethinking its energy future following the Tohoku disaster in 2011.  Korea is also short of power generation capacity, with budget constrained power generators welcoming a fall in fuel costs.

In these countries, the prospect of much lower LNG will make a huge difference to the economics of power generation in these countries.  In the near term, marginal supply is still bench marked to oil as is some contractually negotiated gas from Australia in particular.  But competition from US shale gas exports should push prices for spot LNG (largely from Qatar).

This lowering of spot prices will ultimately affect contract rates for new projects, boosting utilities margins and ability to expand in power constrained markets.  But this process is still perhaps 2-4 years away.

LNG fuelled power is promising in Korea and Japan given great concerns with the environmental impact of coal. But coal is still the cheapest and easiest source of fuel for poorer countries where the growth imperative is much more important.

Coal prices have moved sharply lower in the last 12-18 months and are currently way below where most were assuming long term prices to settle.  Perhaps this is only a short term phenomenon, but it does seem likely that coal prices will be lower than expected into the future thanks to the miss on expectations in China.

This is great news for South East Asian countries where development of power projects will have been hampered by bad economics driven by China's thirst for coal. If anything, the EIA data underestimate coal fired generation capacity in the region, with even South Korea looking to install quite a lot of new capacity by 2020.

India represents the highest rate of growth according to the EIA, although projects there have been beset with contractual problems.  In particular, many mismanaged the coal price risks associated with some large plants, but the government has now stepped to ensure wholesale prices are high enough for these plants to stay profitable.

The key message is that while slower than expected growth in areas like China may weigh on aggregate economic performance, not everyone is a looser.  In particular it should open up opportunities in the power sector in those countries that have struggled to meet even modest goals in the last few years.



*this post is belatedly for David Hill at Aveva, in contra for an excellent steak @ STK