Practical analysis for investment professionals
24 May 2016

Energy Markets and Musical Chairs

Amy Myers Jaffe


Ten years ago, we thought the world was running out of oil, that China and other emerging market countries would have insatiable energy demand growth, and that production costs would generally rise over time.

Amy Myers Jaffe systematically dismantled those views at the 69th CFA Institute Annual Conference in Montréal. Indeed, it’s hard to emphasize enough how dramatically different the world looks today.

What’s changed? Jaffe said the peak oil theory was just plain wrong. On the supply side, technology is driving efficiency gains that are transforming the entire energy landscape. In fact, Jaffe referred to it as the Fourth Industrial Revolution. The economics of shale oil are driving costs lower and lower. Natural gas costs have fallen below $1 per 1,000 cubic feet (mcf) and will make US-based natural gas competitive in liquefied natural gas markets globally. Recently, innovations in solar and power storage technologies have driven solar costs below comparable natural gas solutions.

On the demand side, tech innovation is spurring revolutions in resource management, transportation, and logistics, among other areas. Moreover, policy changes related to pollution, mandated fuel efficiency standards, and climate change are increasingly being implemented by governments around the world, promising to curb demand further.

Ten years ago, China emerged onto the world stage as a large and perennial powerhouse, growing at more than 10% per year. Demand from China alone for many commodities rose to an eye-popping 40%, 50%, and 60% in a number of commodity markets. The idea that many of China’s 1.3 billion people would soon be converting to gas-guzzling cars, trucks, and industrial equipment was burned into the minds of many investors.

Now, in 2016, China is struggling to swallow some $7 trillion in misallocated capital. The explosion of debt that fueled its meteoric rise is now coming due and will likely weigh on its economy for some time. China is also approaching energy from a policy perspective, pushing laws and regulations to curb emissions. And the Chinese people are embracing new technologies, like ride-hailing apps, not just as modes of transportation, but as ways to meet people. So, consumption patterns are changing too.

Lastly, many players in the energy industry used to embrace the notion that the real value of a barrel of oil would increase over time. So, reserves in the ground would be more valuable simply by leaving them alone. For example, in countries like Saudi Arabia, there was an incentive to sit on reserves and only access them slowly over time. Now, that proposition has been turned on its ear.

Jaffe commented that recent solar and power-storage innovations promise to deliver energy at a lower cost than that of a comparable amount of natural gas. With very real competition from the wave of alternative energy innovations, changes in consumption patterns, efficiency gains, and the increasingly bold impact of policy, the game has changed.

And like in a game of musical chairs, many countries are now increasingly concerned about stranded assets — about being left without a seat. What does oil project ROI look like in a declining oil world? If the real price of oil drifts downward rather than upward over time, players in the energy industry have an incentive to maximize production today to extract maximum value.

Jaffe concluded her talk with a personal anecdote. She currently drives a hybrid vehicle that employs a host of sensors tracking how much the vehicle switches between gasoline to electric power. About 65% of her miles driven are powered by electric only. Of course, such vehicles still require energy production from power plants, but very few of them run on oil.

It seems the combination of technology, economics, and policy has destroyed the status quo in energy markets, creating huge new opportunities and huge new threats.

Where will you be when the music stops?

This article originally appeared on the 69th CFA Institute Annual Conference blog.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Photo courtesy of W. Scott Mitchell


Key Takeaways

  1. Technology-driven efficiency gains in resource management, transportation, and logistics are transforming the entire energy landscape.
  2. Policy changes related to pollution, mandated fuel efficiency standards, and climate change are increasingly being implemented by governments around the world.
  3. Players in the energy industry no longer embrace the notion that the real value of a barrel of oil will increase over time.


Trends and Changes in the Global Energy Markets
Amy Myers Jaffe

View the full transcript (PDF).

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About the Author(s)
Ron Rimkus, CFA

Ron Rimkus, CFA, was Director of Economics & Alternative Assets at CFA Institute, where he wrote about economics, monetary policy, currencies, global macro, behavioral finance, fixed income and alternative investments, such as gold and bitcoin (among other things). Previously, he served as SVP and Director of Large-cap Equity Products for BB&T Asset Management, where he led a team of research analysts, 300 regional portfolio managers, client service specialists, and marketing staff. He also served as a Senior Vice President and Lead Portfolio Manager of large-cap equity products at Mesirow Financial. Rimkus earned a BA degree in economics from Brown University and his MBA from the Anderson School of Management at UCLA. Topical Expertise: Alternative Investments · Economics

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