Good morning from Houston.
The US and China are talking again — on climate at least.
Stateside, the Inflation Reduction Act might have changed the economics for investing in clean energy in the US. But what happens after it’s gone?
For our first note, I spoke to private equity group Kimmeridge’s new head of low carbon investments about the long-term impact of America’s game-changing climate legislation.
The second looks at how stagnating activity in the US shale patch is beginning to weigh on oilfield services groups.
Data Drill has the latest on the outlook for US emissions. In a nutshell: lots done, more to do.
Also, check out this thought-provoking column from my colleague David Sheppard, which asks whether Russia might try to weaponise energy once again as America moves towards election season next year.
Thanks for reading. — Myles
Life after the IRA
The seismic impact of the Inflation Reduction Act on clean energy investment is hard to overstate.
As regular readers of this newsletter will know, the chunky tax cuts baked into America’s almost-one-year-old climate law have already propelled huge volumes of capital into the US and left other countries scrambling to keep up.
But while the IRA may have rewritten the economic rule book for some early stage technologies, investors are already asking what happens when it’s gone.
“I think one of the questions we’ve got to be asking — and I’m sure everyone’s wrestling with this — is to what degree are we happy to invest in a space where the economics are only made attractive by public support? Given there’s always a risk of regulatory change and . . . there’s a timeline that has a finite duration,” said Max Warburton, who is today joining private equity group Kimmeridge Energy Management to head up its foray into the clean energy space.
The IRA has upended the investment proposition for a host of green technologies, from carbon capture and battery storage to hydrogen. Companies including ExxonMobil have said that it has altered their approach to investing in new technologies, many of which now have attractive returns.
Jeff Ubben, an activist investor and member of Exxon’s board of directors, said at an event recently that the IRA could prompt the supermajor to substantially increase its low-carbon investment. The tax credits, he said, had pushed returns on some alternative investments “into double digits”, allowing the company to “defend the spend”.
Warburton, previously head of special projects at Mercedes-Benz, said investors needed to carefully consider what the economics of some technologies look like once the IRA support comes to a close.
“Take hydrogen as an example: extremely, extremely difficult technology or industry to make work. But with the IRA support, suddenly some projects make a lot of sense,” he said in an interview with ES.
“That doesn’t necessarily mean in terms of cost curve — that by funding those things and getting them going — that whenever that state support is pulled away, you have a viable energy source, or in this case, energy storage.”
The IRA’s tax credits are set to last for a decade before they expire. The hope is that enough capital has poured in at that point to scale up and cut the costs of nascent technologies that could help in the scramble to decarbonise. But for some early stage industries, there are question marks over whether that will be enough time.
A number of Republicans have also suggested they would seek to scrap the subsidies if the party regained control of Congress. Though most observers say that would be difficult to do — both politically and practically.
Warburton’s comments come as Kimmeridge — an activist investor in the shale patch, where most of its portfolio is focused — looks to bulk up its exposure to alternative sources of energy. But the group said it would be taking an incremental approach into new areas, which would initially make up no more than 10 per cent of its portfolio.
“We’ve seen a lot of people dive headfirst into the alternative energy space,” said Ben Dell, Kimmeridge founder and managing partner. “I think we’ve taken a more measured approach with a view that you actually have to figure out the economics and where the returns are.” (Myles McCormick)
Oilfield services feel the pinch from shale slowdown
A levelling-off in activity in the US shale patch has become increasingly plain as weaker prices and a mantra of capital discipline force operators to pull back the throttle on drilling.
The rig count is sliding. There are fewer frac crews out in the field. Estimates for production growth are being slashed. Indices tracking business activity have slumped.
The real world effects of that slowdown are now trickling through as it hits oilfield services providers — long seen as the industry’s bellwether — in the pocket.
Halliburton and Baker Hughes — two of the world’s biggest service providers — both warned of an impact from the shale patch deceleration as they released second-quarter earnings yesterday.
It is the latest indicator that a post-coronavirus surge in drilling — largely driven by private operators — has hit a wall. (Public companies had already laid down rigs under pressure from Wall Street to funnel cash back to investors rather than down new wells.)
On an analyst call yesterday, executives at Halliburton found themselves on the receiving end of a barrage of questions on the duration of the slowdown after the company reported a slide in North American revenues.
“Looking ahead into the second half, I expect overall market activity in North America will be slightly lower than in the first half,” said chief executive Jeff Miller. (Though he said margins would hold up).
Rival Baker Hughes — which is less exposed to the US onshore space — fared better, and insisted rising offshore and international revenue would “more than offset” any decline in is shale business.
But the company warned that as the market slackens, customers are demanding better deals.
“The environment in North America has levelled off, and we’re hearing some of the customers requesting discounts, particularly in the more commoditised markets like pressure pumping,” said Baker chief executive Lorenzo Simonelli.
However, he said any such discounts were off the table for now.
No one is expecting a return to the frenzied drilling of the early days of the shale revolution. But growing concerns that much of the best acreage has now been drilled make this latest slowdown all the more poignant.
All eyes now are on SLB, the third — and biggest — major oilfield services provider, which reports its earnings on Friday. (Myles McCormick)
The projected impact of the Inflation Reduction Act on US emissions is becoming ever more apparent. But it is still not enough for America to reach net zero, according to an outlook from Rhodium Group.
The think-tank predicts US emissions could fall 42 per cent below 2005 levels by the end of the decade under the best scenario, a meaningful revision of 7 per cent from last year’s forecast but still short of President Joe Biden’s 50 per cent emissions target by 2030.
The improved outlook is largely thanks to the IRA, which included lucrative sweeteners for US clean energy manufacturing and deployment and offered developers a 10-year window of certainty for project subsidies.
Rhodium estimates that power sector emissions could plummet 74 per cent from today’s levels by 2035, with record renewable capacity coming online. The think-tank predicts the US will need to add up to 92GW of wind and solar every year on average, triple the best year on record, to achieve its emissions forecast.
But ongoing issues such as permitting, long wait times for grid connection, and supply chain constraints threaten to slow the pace of emissions reductions, warns Rhodium. A recent report from Lawrence Berkeley National Laboratory found it took a median of five years for an energy project to be connected to the grid last year.
“It’s going to be a stretch to get to those levels [of renewables],” said Ben King, one of the authors of the Rhodium outlook. “The economics are there for wind and solar . . . It will be incumbent on lots of different governmental actors to try to ensure that we can reach as close to these levels of projection as possible.”
Aside from the IRA, there are a number of proposed regulations that can help the country inch closer to its 50 per cent emissions reduction target, said King, including the Environmental Protection Agency’s plans to regulate oil and gas methane emissions and pollution from power plants.
But emissions in some sectors — such as buildings and agriculture — show little signs of abating over the next decade as a result of lack of policy. (Amanda Chu)