Our energy predictions for 2021

The year 2020 will, inevitably, be remembered as the year of the COVID-19 pandemic. However, 2020 will also be remembered as a turning point for the energy industry: the year in which all parts of the energy value chain mobilised truly to recognise and react to the social and political push towards Net Zero.

As we start the new year, we set out below our predictions for different sub-sectors within the energy industry: upstream, midstream infrastructure, LNG, downstream, renewables and decarbonisation, nuclear and energy from waste.

Upstream

Mergers and acquisitions

• There will be a split in activity:
  
  • The large cap international oil companies will continue to divest assets in countries that have become less of a focus as their strategies are developing. These countries will include more emerging markets in Africa and Asia but also markets such as Australia, the UK and Norway.
  • This will present opportunities for companies that recognise that their reason for existing is to be upstream players. If the financing can be raised (see below), then there are significant opportunities now in the market for both independent and local upstream companies to acquire upstream assets in the expectation that commodity prices will increase in the medium-term.

• However, we are also likely to see further consolidation within this group of independent/local companies, with smaller or overleveraged companies wanting or needing to do deals.

Financing

• There is a growing reluctance by international commercial banks to fund upstream exploration and production activities in any developing markets (and a total exit from even developed markets in some instances).
• Development institutions and export credit agencies are also becoming increasingly disinclined to be involved in the upstream sector.
• We expect to see an increase in sustainability-linked loans as part of an effort to enhance the appeal of the sector to lenders and investors. A typical feature would be an interest rate margin ratchet according to carbon intensity key performance indicators.

Gas demand will increase

• The vast majority of future energy demand models point to gas as the transition fuel. Gas should not be forgotten by investors – it remains a vital part of the energy mix for the medium-term.
• As economies across the globe recover from the COVID-19 pandemic, gas demand will likely rise, particularly in Asia, driven by China, India and emerging markets.
• This will, in part, be driven by the continued displacement of coal (with that displacement being driven further by the implementation of longer-term policies in many countries) and this will contribute to increased gas demand growth in these countries.
• More broadly, while gas demand in 2021 is expected to recover to at least pre-pandemic levels or higher, there is likely to be a lasting impact in the short to medium-term: the IEA has predicted an average annual growth rate of 1.5% per year for the 2019-25 period, compared to initial forecasts which assumed an average growth rate of 1.8% per year over the same period.

Midstream infrastructure

• We will continue to see the trend of NOCs and large IOCs seeking to recycle capital from midstream infrastructure assets, either in the form of introducing partners through carve-outs and sales of (minority) interests, or outright 100% sales (with transportation/processing contracts back to the assets that the infrastructure services).
• Bulk storage businesses will remain attractive to infrastructure funds. However, there will be more and more focus on the products that the underlying business stores – chemicals being more investible than oil, for example (see more on that below).
• As opportunities in developed markets become less available, infrastructure funds that are able to invest in less developed countries will increasingly look at those markets for new opportunities in the midstream space.
• See also our report on The Future of LNG and Natural Gas Infrastructure and our predictions below relating to LNG facilities.

LNG

A buyer's market likely to continue

• The orthodox view is that oversupply (a function of lower demand in some jurisdictions and new liquefaction capacity in the near to medium-term) is likely to continue into the medium-term. In an oversupplied LNG market, LNG buyers will continue to have access to more favourable terms than has traditionally been the case and the emphasis on flexible supply will continue.
• The fact that we are in a buyer's market does not mean that there will be consistently low or stable prices.

LNG price volatility

• 2020 saw unprecedented swings in LNG prices, initially brought on by the fall in the oil price and spot LNG prices, which saw US LNG become relatively more expensive compared to oil linked prices: one trade of which we are aware we saw a spread of close to US$20. At the bottom end this was a result of a need to place cargoes in an oversupplied market in June/July 2020.
• The volatility has continued during January 2021, with prices for February cargoes in the high US$30/MMBtu as a result of a cold winter and reduced use of coal.
• While the record high pricing for January cargoes is not expected to continue, and the same level of LNG price volatility is not expected to be experienced throughout 2021, the year-end surge in spot prices in Asia (with some cargoes reportedly trading at over US$20/MMBtu) and the record high prices for February deliveries represent a reminder for buyers of the importance of diversifying their LNG procurement portfolio and the pros and cons of an over-reliance on spot cargo procurement.

Shorter-term LNG contracts

• With a significant proportion of traditional long-term LNG contracts expiring in coming years, and the additional consolidation of key LNG portfolio sellers and traders, the number of short and mid-term LNG contracts will continue to increase in 2021. The definition of what constitutes a "long-term" LNG contract is changing.
• To the extent that long-term or longer-term LNG contracts are contemplated, price review mechanisms will continue to be key, and the inclination of parties to use them will increase.

Increased investment in LNG infrastructure

• 2021 will see further investment in LNG import infrastructure in developing and expanding LNG markets, encouraged by gas demand growth and the availability of more affordable and flexible LNG supply under term contracts.
• LNG infrastructure business models and investor profiles will also continue to evolve, with less traditional investors becoming involved in liquefaction projects, and we may see international energy companies seeking to invest in LNG regasification projects, as well as further downstream into gas-fired power as part of their energy transition strategies.

Green LNG

• The LNG industry's focus on reducing GHG emissions across the supply chain and offsetting emissions will sharpen in 2021, and the number of green LNG cargoes (or reduced carbon cargoes) is likely to increase significantly in the coming year.
• An industry standard approach to risk and cost allocation, as well as measurement and proof of reduced carbon emissions or offsets, will likely take some time to develop: to achieve true off-sets on a consistent basis across the industry will require considerable amount of investment in off-set projects.

Downstream

Focus on investments with clear and stable markets

• Middle East NOCs are pulling back from downstream investments, especially international and/or more speculative ones, as a result of the unfavourable oil price breakeven analysis. Instead, there will be a continued focus on monetising non-core/infrastructure assets and seeking further opportunities for leveraging assets.

Old assets become obsolete

• Some older refineries across the world are becoming obsolete and we will start seeing a shift to newer refining assets which are more efficient and better able to process cheaper/lower grade crude. This will have a knock on effects of crude movements globally.

Crude oil to chemicals

• A direct consequence of the transition to low-carbon fuels in the transport sector is the fact that demand for crude oil as a feedstock for chemicals is overtaking demand for it as feedstock for transport fuels.
• As such, crude oil to chemicals (COTC) plants, which allow the direct conversion of crude oil to petrochemicals without an intermediate step (involving a refinery producing feedstock for a separate petrochemical plant), are seen as a future of oil.
• The future looks bright for petrochemicals in both the short and long-term, with OPEC predicting in December 2020 that demand for petrochemicals will "gain momentum" in 2021.
• In addition, major oil companies (IOCs and NOCs) are responding to anticipated changes to the markets for their petroleum products, as a reduction in the use of fossil fuels in transportation, and other previously difficult to decarbonise industries, gathers pace over the medium-term.

Renewables and decarbonisation

Energy transition picks up pace

• 2020 was a year in which some of the world's largest emitters of GHG committed to reductions in emissions consistent with the Paris Agreement – for the first time the achievement of the Stabilisation Goal is being regarded as achievable as China, Japan and Korea committed to net zero emissions by 2060 (China) and 2050 respectively, and the EU and the UK increased their commitments to reduced GHG emissions by 2030. See our Low Carbon Pulse Edition 1 and Low Carbon Pulse Edition 2 for more information on these developments.
• This fundamental shift is expected to continue building momentum in 2021, critically with the US re-joining the Paris Agreement under the Biden Presidency and the opportunities presented by the 26th UN Climate Change Conference of the Parties (COP26) taking place in November 2021. See also our latest Low Carbon Pulse Edition 7.
• Re-accession to the Paris Agreement of itself, and reverting to the commitments of the US in 2021 will not be sufficient. It is expected that the Biden Administration will introduce legislation to accelerate the rate of reduction of GHG emissions, including through offshore wind on the East Coast of the US, and the further development of the Sunbelt.
• This is combined with a desire by many governments to achieve economic recovery through investment in the energy transition, including re-industrialisation using energy sourced from renewable sources. Our monthly Low Carbon Pulse provides updates on international developments in the energy transition – see some recent developments in Low Carbon Pulse Edition 6.

…but some parts of the world are lagging

• The pace of change is likely to be slower in developing jurisdictions, such as much of Africa and parts of Asia, where there is a continued focus on crude oil production and/or the continuing reliance on coal for power generation and there is less engagement with the energy transition due to economic factors (including reliance of economies on oil sales) and a lack of essential energy infrastructure. However, as battery and solar technology advances, the potential for off grid solar and battery solutions is growing rapidly and developing countries might choose a micro grid solution rather than trying to develop a national grid. Equally the increasing cost competitiveness of renewables is increasing the pace of change in some markets in Asia.

More investment in offshore wind

• Given the increased GHG emissions reduction targets, countries with less land mass have looked to offshore wind (and to a much less extent offshore solar) to provide the means of achieving accelerated reduction targets. The North Sea has become a focus for Northern Europe and China and Taiwan have developed successful offshore wind programmes, with Japan and Korea also moving in the same direction. The East Coast of the US is shaping up in the same way.
• Offshore wind technology has developed in response, including by the development of larger fixed offshore projects, but also, increasingly, looking at floating projects. Given the proving up of the technology, the lower unit costs associated with scale, market certainty of off-take, and its future role in potentially producing renewable hydrogen, offshore wind is an attractive investment option. See our Low Carbon Pulse Edition 4 and Low Carbon Pulse Edition 5 for more information on recent developments in offshore wind.

Greater government involvement and support in the move towards zero emissions

• Consistent with the policy settings announced in 2020, governments around the world have recognised that new markets need to be developed to achieve emissions reduction targets, and that governments need to be actively involved in supporting the development of these markets.
• In addition to existing support around renewable energy, government support will increasingly be seen in respect of new decarbonisation technologies, such as carbon capture usage and storage (CCUS), hydrogen production and electric vehicles, and investments in these developments will require a recognition of the level of early-stage risk involved and require new, large-scale infrastructure to be rolled-out at a rapid pace.

CCUS and clean hydrogen are really moving

• After many years of studies and pilot projects, CCUS is becoming a reality in some jurisdictions. In the UK, for example, in 2021 the Government will continue to move towards finalising new business models and regulatory frameworks for CCUS, with an overall commitment to create two carbon capture clusters by the mid-2020s, with another two by 2030.
• Likewise, clean hydrogen (both low-carbon (blue) and renewable hydrogen (green)) is gaining increasing focus, with the EU and a number of other countries having published hydrogen strategies, and the UK hydrogen strategy due to be published in 2021.
• 2021 may not yet be the year when investment decisions in clean hydrogen are made at breakneck pace, but plans will be galvanised.

Corporate PPAs

For years people have talked about corporate PPAs but without much real take-up by corporates. In 2020, we finally saw a material uptake in corporate PPAs with respect to sleeving, financial and direct wire PPAs, and we expect this trend to continue in 2021.

Major corporates (including tech, logistics, industry, breweries and pharmaceutical companies) are taking ESG/CSR seriously and are looking to buy guarantees of origin certificates alongside their power supplies. Moreover, some major corporates, including Microsoft, are looking at means for achieving carbon negative outcomes for the purpose of achieving a net zero emissions outcome since incorporation.

Electric vehicles

• While there has been a gradual take-up of electric vehicles (EVs) over the past decade, 2020 is widely considered as marking the start of a decade of electrification of transport.
• In its "Global EV Outlook 2020", the IEA noted that government responses to COVID-19 will influence the pace of the transition to EVs. The UK Government response has been to set more ambitious targets for the phasing out of conventional vehicles and commit to publishing a delivery plan for those targets in 2021. Meanwhile, the European Commission published its "Sustainable and Smart Mobility Strategy" for the EU, with a target of 30 million EVs by 2030. China also upped its EV roll-out targets in 2020, as part of its COVID-19 recovery plan. The challenge, which will also present investment opportunities, is the fact that the transition to EVs will need to be accompanied with large-scale EV charging infrastructure.

Nuclear

• Whilst there is substantial debate on the role nuclear power should play in the generation mix, it is likely that given its importance in delivering high volumes of power and the number of large-scale operational facilities due to come offline in the near future, some degree of new capacity will continue to be developed.
• Not surprisingly, the greatest number of new build nuclear projects in development are in energy-hungry China and India. However, new build nuclear is also being given a fresh push in the UK: in the recently published Energy White Paper, the UK Government has committed to developing a new model for new build nuclear, potentially the Regulated Asset Base (RAB) model. This model will support at least one large-scale nuclear project, with the UK Government also committing to invest to support the development of Small Modular Reactors (SMRs) and Advanced Modular Reactors (AMRs).
• Providing low-carbon baseload generation to balance out variable renewables is not the only potential value of nuclear power in the decarbonisation pathway: there is also potential for nuclear power to be used in electrolysis to produce low-carbon hydrogen (with this variant of low-carbon hydrogen being referred to as "purple hydrogen").

Energy from waste

We expect to see:

• A reduction in enthusiasm for developing and financing large-scale EfW projects in the UK on a project financed basis, as the volume of combustible municipal, commercial and industrial waste reduces and is locked up by the existing EfW plants and those currently in construction.
• Some nervousness by sponsors and funders regarding the extension of a UK ETS to energy from waste plants and concerns about the possible imposition of a tax on carbon emissions by EfW plants, potentially dampening the appetite for new plants and making it more difficult to negotiate terms with fuel suppliers.
• Ongoing development of smaller scale energy from waste facilities focusing on specific waste streams.
• The emergence of projects which treat waste streams to produce biofuel, jet fuel and other by-products without mass combustion techniques being required.
• The development of more sophisticated waste recycling and processing plants, further reducing the volume of waste feedstock available for large-scale EfW plants.
• Increased activity for advisers in resolving disputes relating to the construction, commissioning and operation of EfW plants and projects, as there is an increase in distressed projects.
• Further M&A activity in the waste sector and consolidation as the largest waste management companies acquire small to medium players in the UK and Ireland.
• Greater up-take of EfW technology in other non-UK markets, particularly the Middle East, Asia and Australia.

Contributors: Partners Michael Burns, Antony Skinner, David Wadham, Peter Vaughan, Daniel Reinbott, Richard Guit, Michael Harrison, Julia Derrick, Huw Thomas, Anthony Johnson, Cameron Smith, Simon Moore and Matthew Wood, as well as Senior Expertise Lawyer Justyna Bremen.