Why this is the first energy transition in history to deliver higher prices

Greg Canavan

Fat Tail Investment Research

A good part of the capital which had [been] so lavishly employed in the import trade, they are gradually diverting into that safer and infinitely more productive channel – the oil-fisheries … the whaling merchants are public benefactors, entitled to the gratitude of the whole community. They are stopping the inlets of Australian poverty, and opening those of Australian wealth.

                                                                                                                      Sydney Gazette, 18 March 1830

The Second Fleet, a convoy of six ships containing convicts, settlers and supplies, landed in Sydney in 1789. It was a notorious voyage. 25% of the convicts on board died enroute, and 40% were dead within six months of their arrival.

The private contractors who arranged transport and provisions were blamed. The authorities obviously didn’t instruct them to get their human cargo to Sydney in one piece. A reminder – if any is needed – that economics is all about incentives.

This debacle, which put the fledgling settlement on the brink of starvation, provided an opportunity for an enterprising whaling captain named Samuel Enderby.

Enderby was heavily involved in the British-American whale trade through his fleet of ships. However, following the American Revolution, an embargo was placed on exports to Britain. This included whale oil.

Before the discovery of petroleum in the 1850s, whale oil was the primary machine lubricant and preferred lamp oil in Europe and North America.

Enderby, in search of new markets, lobbied the British government to allow whalers to transport convicts to Sydney, and to then continue hunting whales in the southern ocean.

That way he could make money on both voyages. Human cargo on the way out, whale oil cargo on the way back.

In 1791, the Third Fleet left England for Sydney. Of the 11 ships that landed, five continued to hunt in the southern ocean, establishing the whale oil industry in Australia.

According to the National Museum of Australia:

Whaling became an essential part of the New South Wales economy and culture. Whalers were the most frequent visitors to the colony in its first decade.

Whaling was Australia’s first major industry with thousands of men and hundreds of ships eventually involved in the trade.

The peak of Australian whaling activity was between 1820 and 1855, with up to 1,300 men working in the industry each year. With the 1851 discovery of gold in Australia, however, sailors deserted their ships en masse to travel to the goldfields. As petroleum increasingly replaced whale oil throughout the 1850s, the industry went into decline.

An industry that had provided New South Wales with 52 per cent of her exports in 1832 provided less than one per cent by .

The prosperity that the whale oil trade brought to the colony of New South Wales wasn’t lost on the public, as highlighted by the Sydney Gazette quote above. The whaling merchants were ‘benefactors’, preventing poverty and increasing wealth.

How times have changed.

In 2022-23, Australia’s exports of liquid natural gas, coal, and oil are expected to total $225 billion. That 50% of our total resource exports (the same as whale oil at its peak).

Yet the industry is vilified and shunned. Wealthy activists and university-educated know-nothings want to shut these industries down.

They only see the world through the prism of emissions. They don’t see the other side of the balance sheet. These exports help provide food, shelter and heating for millions of people. And they pay for schools, hospitals and a bloated public service for Australians.

We’re a long way from the gratitude shown to our vital industries back in the early years of settlement. Back then, before the welfare state saw the government become everyone’s ‘benefactor’, there was a much greater awareness of what the wealth creation process was all about.

To the modern mind, the killing of whales to harvest oil is abhorrent. But back then, it was entirely acceptable.

Thankfully, technology saw the whaling industry quickly decline through the large-scale discovery of oil and its refinement into petroleum products. Moreover, this discovery made energy much cheaper.

Cheap energy (along with free markets and the rule of law) is vital for increasing living standards. The more of a nations’ wealth that is devoted to energy expense, the less wealth available for other endeavors.

That’s why this transition to renewables is so contentious. Politicians see it as a vote winner, and are ploughing ahead regardless of cost. But the more we force it to occur in an unnaturally short time frame, the greater the costs will be.

The rallying cry of the zero-carbon advocate is that renewable energy is free. Yet the more we invest in it, the higher our energy prices become. Why is that?

Making millions of non-renewable solar panels and wind turbines is not free…

Building extensive transmission lines to connect these far-flung new energy sources to the existing system is not free…

Building back up supply to support and guarantee intermittent renewable generation is not free…

Those investing in this new infrastructure will want a return on their substantial investment. And you’ll be paying for it.

At the same time, as I’ve pointed out in prior reports, here, and here, traditional energy forms have suffered from chronic underinvestment.

Technology has driven all prior energy transitions. As a result, the cost of energy has declined and contributed to the broad rise in global living standards over the years.

This energy transition is different. While technology plays a role, it’s not the driving force. Politics is. As a result, this energy transition – for the first time in history – will result in a higher cost of energy and a commensurate reduction in living standards.

It doesn’t have to be that way for Australia, but I don’t like our odds.

Australia is a net energy exporter. In 2020-21, we exported 15,420 petajoules and imported just 2,115 petajoules (see below).

Source: energy.gov.au

We stand to benefit massively from the structural rise in energy prices in the years ahead. Meanwhile, net energy importers, like the UK, Europe and Asia, will have to spend more on their energy needs.

While beyond the scope of this report, this dynamic will have huge implications for international capital flows and trade balances.

As just one small example, look at Germany. Long famed as a high value added exporter, it has built up considerable trade surpluses, especially post-reunification in 1989/90. But as you can see below, thanks to the energy crisis, its trade surpluses have collapsed.

It is now using nearly all its export wealth to pay for its energy needs. If this continues (not just for Germany but for others like it) it will have huge implications.

Source: Tradingeconomics.com

Anyway, the point is that Australia is very well placed to benefit from this energy-induced power shift. But as I said, I’m not hopeful we will invest the dividends wisely.

For evidence of this, you just have to look to Queensland, one of the most naturally endowed states in Australia.

In late September, the state government announced a $62 billion ‘Energy and Jobs Plan’. This includes a new renewable energy target of 70% by 2032 and 80% by 2035.

Currently, renewables generate around 20% of Queensland’s electricity needs. Coal provides 60% and gas 10%, with biomass accounting for the remaining 10%.

Under this new plan, all state-owned coal plants will be shut down by 2035.

What will replace this critical and cheap energy source?

New hydro dams.

Now, just to be clear. I’m not criticising adding hydro energy to the mix. But to try to REPLACE cheap and reliable energy with hydro is a big risk to energy security.

Hydro works by having two reservoirs, an upper and lower one. It generates electricity by letting the water in the upper reservoir flow through turbines (a process which generates electricity) into the lower reservoir.

One of the issues with the proposed hydro dams is that they will have just 24 hours of storage capacity. Which means they will be able to produce reliable energy for just 24 hours before the upper reservoir needs refilling. (That compares to the Snowy Hydro 2.0 product, which will be able to produce energy for seven days.)

This requires a lot of energy to pump the water back up from the lower reservoir, energy that will have to come from wind and solar (and presumably backed up by gas plants).

In 10-15 years’ time, Queensland risks having some of the highest electricity costs in the world, while remaining one of the largest exporters of fossil fuels, helping to keep other countries’ electricity costs down.

I know this is not a popular take. You may agree or disagree. But the historical record shows that governments driving investment decisions based on arbitrary targets is a recipe for disaster.

Economic growth and higher living standards for our kids comes from, in part, technological advances that LOWER energy costs.

This time around, our brain-dead politicians look like spending our energy export windfall on technologies and projects that are almost guaranteed to increase energy costs and decrease our standard of living.

But it’s for your own good…

And there’s really not much you can do about it. Despite ample evidence from Europe that renewable energy is no where near capable of powering the economy, Australia continues to panic towards net zero targets with the Mr Micawber like hope that something will turn up to make it happen.

The odds are against it. Your best hedge against political insanity on energy policy is to have an overweight allocation to quality energy stocks.

Just this week you saw the sector’s strategic value revealed by the $9 takeover offer for Origin Energy [ASX:ORG]. I originally recommended ORG to subscribers in April 2021 at $4.75 per share. I recently valued it conservatively at just over $10 per share, so the $9 offer isn’t a surprise.

Whether it gets through the regulatory hoops is another issue. But it just goes to show you there is money on the table in the gas sector. As a crucial transition energy source, it is required to ‘firm’ up intermittent renewable energy supply. That is, be ready to go when the wind isn’t blowing etc…

And the more renewables you install, the more gas you need to provide the energy.

Brilliant, isnt it?

At yesterday’s Annual General Meeting, Cooper Energy [ASX:COE] Chairman John Conde made the following comments. It’s a lengthy excerpt, and so rational and full of common sense that he’ll probably be cancelled by the mob and forced to resign within a week:

The transition to a decarbonised world must be orderly and with continued investment in cleaner energy, including gas as a fuel which enables the transition. However, for the market to transition it must do so at a pace which is realistic. We cannot just make it happen by chanting the renewable chorus. It requires planning, action and investment that is set against achievable targets – targets that include energy security and continuity of supply.

To play ‘our part’ (as Australia), the federal government has introduced a 2030 target to reduce emissions by 43% from 2005 levels, putting a mandate on emissions reduction. The scale of this undertaking and the practical challenges are immense.

Reflect for a moment on what this means in practice. Each generating unit in the base-load power stations in, for example, Eraring and Bayswater in NSW is 660MW nameplate capacity, and often operate well above that. The largest wind farm generator in Australia at the moment is 7MW. You need 100 of these wind turbines for each coal-fired generator or you need 400 of these wind farm generators to replace the four generating units at Eraring or Bayswater. In addition, one needs so called “firming capacity” to supply that energy when the wind is not blowing, and the sun is not shining.

To achieve the 2030 government target requires construction of over 1,100 new wind turbines (12 per month, every month, between now and 2030), masses of new solar farms and large-scale “firming capacity”. Is this achievable? We think not.

We need to support and enable the energy transition process AND, as I have stressed already, this needs to be based on what is achievable. Besides coal-fired electricity generation (which is slated for retirement) or nuclear (for which there seems to be little appetite), gas is the only practical source of this “firming capacity”, in our opinion. If you do not allow gas, the “firming capacity” requirements needed will be multiple Snowy 2.0 pumped storage systems or a proliferation of large-scale batteries – neither of which is possible in the timeframe.

The imperative is that there be balance in the debate about carbon reduction and energy security. Our communities, our commerce, our industry NEED gas and electricity to communicate and function. Our society will crumble if we sacrifice energy security on the altar of carbon reduction – there MUST be balance in the debate and in the outcomes, especially when we are talking about electricity supply because, I repeat, the community regards gas and electricity as an essential service.

Whether our politicians and climate lobby groups wake up to this reality or not is an open question. I have my doubts. But as an investor, it should be clear where the money is to be made.

The energy sector has had a strong run lately. So don’t buy in blindly. But a buy-the-dip mentality should stand you in good stead over the long term.

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Greg Canavan
Editorial Director
Fat Tail Investment Research

Fat Tail is Australia’s largest independent financial publisher. Greg is Editor of its flagship newsletter, The Fat Tail Investment Advisory, where he writes market commentary and looks for out-of-favour ASX 200 stocks on the cusp of a...

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