Why Oil’s Fall Means Little for Solar’s Rise: Part I

15 Jan 2015


Falling oil prices will have an extremely limited impact on wholesale or retail electricity prices, which are the core economic drivers for the future of solar.

One of the most important stories of the last year was the massive collapse in global oil prices that began in June of 2014, and continues in 2015. It is a topic that comes up over a few PBRs with friends, usually framed as “isn’t this whole thing really bad for solar?” It is a fair question, and one that our industry likely examines in depth too little.

As most readers know, the short answer is oil has nothing to do with solar. Falling oil prices will have an extremely limited impact on wholesale or retail electricity prices, which are the core economic drivers for the future of solar. And yet, falling oil prices appears to be terrible for publicly traded solar companies, and over the last six months SunEdison’s stock is down almost 20%, SolarCity is down 30%, and Sunpower is down almost 40%. This is despite the fact that the fundamentals of the industry continue to improve as most analysts have made clear.

Rather than simply repeating what others have argued, this piece helps explain (1) what is happening to oil prices, and (2) why the increasing decoupling of oil and the electricity markets are a good thing for the solar industry.

Part I:  What Is the Deal With Oil Prices?

A. Rapid Collapse

In June of 2014 the Brent Spot Average, which is an average of two thirds of the internationally traded oil, was $111.80. As of this writing, the price has fallen to $57.86. This collapse will lead to a windfall for many countries that import oil and petroleum consumers generally (such as US motorists). The average US household is expected to spend $550 less in gasoline in 2015 than in 2014 and have an additional $115 billion in disposable income. Conversely, the losers will be exporters of oil with higher costs such as Russia, Nigeria, Iran, Venezuela, and those within the United States drilling for shale oil. Drilling in the tar sands of Canada, which is a rather expensive way to produce low quality oil, will also slow.

Oil prices are partially determined by supply and demand, and partly driven by expectations for future prices. Oil prices also generally spike in the winter months in the northern hemisphere, and during the summer in some countries that use air conditioning. Supply is also significantly impacted by weather, which may disrupt transportation or refining, and geopolitical activity (like recent activity in Ukraine, Syria, and Nigeria). Finally, the Organization of Petroleum Exporting Countries (OPEC) controls nearly 40% of the world market, and can act as a cartel to increase or decrease prices. Saudi Arabia, in particular, which produces 10 million barrels of oil each day on average, one third of total OPEC production, has significant influence on global oil prices.

There are a handful of primary drivers currently pushing oil prices down.

First, the United States is producing vastly more oil than now than it has in the past- enough to impact global prices. U.S. shale oil production has exploded from four million barrels of oil each day in 2009 to around nine million barrels of oil today. In 2010 the United States produced around 8.4 million barrels of crude oil a day. We now produce almost 13 million, mostly driven by shale oil. Further, although the United States economy is seeing some of its strongest growth in a decade, it is simultaneously becoming more efficient (specifically in transportation).

Second, the world is in an economic slump. While the U.S. economy grows, economic growth throughout most of Europe, much of Asia, and almost all of Latin America is anemic and has been since the global economic recession of 2008-09. When the world economy is slow, oil consumption is reduced. The global economy now uses less petroleum than it did in 2000, even as its proven reserves have expanded from roughly one trillion barrels of oil to 1.6 trillion barrels of oil, according to the EIA.

Yuri chart 1

EIA Data: http://www.eia.gov/cfapps/ipdbproject/IEDIndex3.cfm?tid=50&pid=54&aid=2

Third, as the largest producer in the world, OPEC (and specifically Saudi Arabia) is not backing off of oil production even in the face of lower prices. At a meeting in Vienna on November 27, 2014, OPEC failed to reach agreement on production curbs, sending the price of oil tumbling further. Saudi Arabia could easily cut back production, but oil price increases would only help competitors such as Russia and Iran. Because the Saudi’s can extract oil at such a low price (around $3-5 a barrel), and they have around $900 billion in reserves, they’re pretty good at playing chicken with the rest of the world…and will ultimately win.

B. How Will Falling Oil Prices Impact U.S. Business?

The shale oil industry has been a huge boon for the global oil and gas industry, with the U.S. benefiting most. At least 20% of global investments in oil production were in shale in 2013. The industry has grown by over 200% in the last five years, but is now struggling with its future. However shale oil is relatively expensive to extract, even as it becomes a more sophisticated technology.

Some experts estimate that U.S. shale oil fields can produce at $58 per barrel on average, others have argued it costs more like  $65-70. In either case, that is more expensive than current market prices for oil. Production of shale oil will not stop overnight since, once a well is drilled, oil is inexpensive to extract. But, new exploration will slow dramatically and potentially halt in many states in the U.S. Additionally, wells usually lose around 65-70% of their production after a year, and so U.S. shale oil production will almost certainly dry up unless there is a significant change in oil prices. These economic shifts have had grave impacts on the shale oil industry, and the petroleum industry more broadly.

Harold Hamm, CEO of Continental Resources, one of the largest oil players in America, is a good example. In May of 2014, Forbes Magazine named Mr. Hamm “The Billionaire Oilman Fueling America’s Recovery” and compared him to Nelson Rockefeller. In the subsequent six months, Mr. Hamm lost $10 billion of his personal wealth as a result of falling oil prices, and another $1 billion in a divorce settlement he’s now appealing because of this collapse; and Continental has halved their planned 2015 investments. Ensign Energy, another shale oil player, recently announced a layoff impacting several hundred workers, and a number of other firms are steeply curtailing their investments.

In short, the biggest domestic looser to decreasing oil prices is the American shale oil industry. OPEC’s decision to keep production constant will undermine the economic viability of shale oil investments, but renewable resources like wind and solar will be largely unaffected. More on that coming tomorrow in Part II. Stay tuned.

About Sol Systems

Sol Systems is a solar energy finance and investment firm. The company has facilitated financing for 171MW solar projects on behalf of Fortune 100 corporations, insurance companies, utilities, banks, family offices, and individuals. Sol Systems has $550 million in assets under management as of December 2014. Sol Systems provides secure, sustainable investment opportunities to investor clients, and sophisticated project financing solutions to developers. The company’s tailored financial services range from tax structured investments and project acquisition, to debt financing and SREC portfolio management. Inc. Magazine named Sol Systems on its annual Inc. 500 list of the nation’s fastest-growing private companies for a second consecutive year, ranking it No. 6 in the nation’s top solar companies in 2014. For more information, please visit www.solsystemscompany.com.

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Yuri Horwitz

Yuri Horwitz