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Friday, April 25, 2014

Energy Price Deflation Coming

Yes, price deflation is going to hit the energy markets in the future. This is a long range view we've been heralding for the last few years. Now, investment bank Sanford Bernstein says solar photovoltaic (PV) is now cheaper than oil and Asian LNG (liquefied natural gas). This is great news for consumers and very bad news for those who want to keep energy prices rising.

“For these (developing Asian economies) solar is just cheap, clean, convenient, reliable energy. And since it is a technology, it will get even cheaper over time,” Bernstein writes in a newly released report.

“Fossil fuel extraction costs will keep rising. There is a massive global market for cheap energy and that market is oblivious to policy changes in China, Japan, the EU or the US.”

Solar is already eating away at the margins of oil and gas demand. Bernstein says the adoption of solar in off-grid areas in developing markets means less kerosene and diesel demand. The adoption of solar in the Middle East means less oil demand. The adoption of solar in China and developed Asia means less LNG demand. And distributed solar in the US, Europe and Australia means less natural gas demand.

While solar has a fractional share of the market now, within one decade, solar PV (plus battery storage) may have such a share of the market that it becomes a trigger for energy price deflation, with huge consequences for the massive fossil fuel industry that relies on continued growth.
The behavior from here seems clear: the solar industry will expand. Retaliatory steps from distribution utilities will increase the market for cost-effective battery storage. This becomes — initially — a secondary market for battery storage technologies being developed for the auto sector. A failed battery technology in the auto sector (too hot, too heavy, too rigid a form factor) might well be perfect for the home energy storage market with an addressable end market of 2 billion backyards.
We estimate that the solar industry would need to be an order of magnitude larger than it is today to have this kind of impact. At the point where solar is displacing a material share of incremental oil and gas supply, global energy deflation would become inevitable: technology (with a falling cost structure) would be driving prices in the energy space. But even on an aggressive view, this could take the better part of a decade.
The big oil and gas producers, and the investors that control the flow of capital, may not wait until energy prices do actually deflate, they will likely change their behaviour well before than in anticipation that it will happen.
If the downward sloping forward curve is ever accepted as permanent, rational behavior from energy producers will guarantee it is so. Sitting on oil and gas reserves for the benefit of generations yet to come ceases to be a rational strategy if that reserve represents a depreciating rather than an appreciating asset.

Bernstein points out that large energy investors, once they realize this future where solar dominates energy is inevitable, will sell fossil fuel equities and send prices tumbling. Those investors have not realized the inevitability that solar will crush fossil fuel within the decade is the only reason the sector is relatively stable in price now. Once the selling begins, it will look like an avalanche of selling in oil & gas stocks.

According to our projections, solar power should dominate the market by the end of this decade. And, by about 2027, almost 100% of our energy will be from solar.

This is why we don't really need to put a cap on fossil fuels. The market itself will force those polluting fuels to be reduced to zero simply through price deflation. When prices fall, exotic and expensive methods like fracking will be abandoned by profit destruction. The MidEast sovereign wealth funds, created by massive oil profits, are well aware that price deflation is coming and are investing more and more into solar power and storage. They can see the light at the end of the tunnel—and, for them, it's an oncoming freight train.