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[Episode #9] – Macro Outlook for 2016


A full-spectrum romp through the macroeconomic context: Stock markets; oil and gas prices; coal's collapse; the difficult LNG export market; what commodities are telling us about the health of the global economy; trends in oil and electricity demand and electric vehicles; currency valuations and trends; the outlook for renewables; and much more!

Guest: Gregor Macdonald, Independent energy analyst and publisher of the TerraJoule newsletter

On Twitter: @GregorMacdonald
On the Web: and

Recording date: January 13, 2016

Air date: January 20, 2016

Geek rating: 6

Chris Nelder: Welcome Gregor to the Energy Transition Show.

Gregor Macdonald: Chris, it's so great to be here and congratulations on the new transition show podcast it's been wonderful. And of course Happy New Year 2016.

Chris Nelder: Thank you very much. And same to you. So before we dive into our usual debates I want to set the context a little bit by discussing oil and the macroeconomic outlook. Oil dropped briefly below $30 this week, an astonishing and supposedly psychologically important number, and a 15 percent decline since the start of the year EIA, IEA and OPEC all forecasted in December that global oil demand would rise another 1.2 to 1.4 million barrels a day this year, on top of the roughly 96 million barrels a day the world currently consumes. And so if supply didn't grow and it seems like it may not since EIA is projecting that the decrease in non-OPEC and the increase in OPEC's supply will basically cancel each other out this year, then that would probably be enough to rebalance the oil market which is thought to be oversupplied by a little more than a million barrels a day. But I am very skeptical of that number. China has been the main driver of global demand growth for many years. It was China's weakening demand growth that kicked off the oil price decline in the summer of 2014 and we are still in the position where nobody has trustworthy numbers on China's economic activity. But we all know that it's slowing as evidenced by the weak demand oversupply and falling prices of all commodities across the globe. So I think it's important to see oil's price crash in this context which looks to me like a broad deflationary environment that has driven down the prices of all commodities to levels that we haven't seen in over a decade. I mean normally that kind of pricing would only happen in a deep recession or depression. So when prices fell to 2009 territory last July I was tweeting up a storm about how we would likely see stock markets fall again to close the gap with commodities and that now seems to be finally happening. U.S. stock markets have gotten off to their worst start to a year ever. The S&P is down 7.5 percent on the year already the Shanghai Index is down 17 percent already this year. And although the Fed decided to raise its interest rate by a token quarter percent a few months ago mostly I think to try to retain some semblance of credibility, everything still looks very, very weak out there. And finally I will note that unlike some observers who never got off their deflationary soapbox even during the post-2008 recovery, I only came back to that point of view about 18 months ago. And that's in fact when I started warning about a crash in the very week that U.S. stock markets peaked. So with my sincere apologies my friend for that long preamble. What's your take on the global macro picture at this point and the outlook for the year?

Gregor Macdonald: Well I'm kind of glad we're starting off with oil and I know that our conversation will interweave through all the various energy resources and especially renewables. In my most recent issue of I wrote that it's really unfortunate that the global oil supply complex increased supply so significantly in 2015 now when I say significantly you know something like 2.3 percent, but there was as you said in your introduction, there was actually a fairly strong signal in 2014 on the demand side. Demand rose maybe 0.75 percent in 2014. And we really didn't get the supply response that the market needed. As you also pointed out it looks like we're we're actually going to finally get the kind of supply response that the market really needed last year. Looks like we're going to get something like that this year. Although to have this supply response in 2016 that you needed in 2015 if just as you said, it sounds like you and I have roughly the same forecast, on non-OPEC declines might get cancelled out by OPEC supply. And so maybe we're heading into a year where global supply is flat. But, unfortunately the market may need a bigger supply response than that. Now of course oil, it remains a pretty good barometer of the global economy but we'll get into this somewhat, as you know oil's role in the global economy has come down by a fairly solid amount since the year 2000.

Chris Nelder: Well, I do want to get into that but not just yet. Just for now I want to talk about an oversupply of oil. A glut of oil that has yes materialized from both supply and demand factors. But I think the demand side of that has really been under appreciated and we can have, and we will have likely some supply destruction for the high cost oil, tight oil in the U.S., Canadian oil sands, deepwater that sort of thing this year. But it's really the weakening demand in China that I think needs to focus our attention this year. And I do feel that we are struggling against a deflationary undertow. And I do see oil as a signal for that. And I just wonder if you would agree on that point.

Gregor Macdonald: I do. I guess from a more broad standpoint the global energy complex seems to be possibly suffering kind of an over-supply shock across the board. I mean coal has been in the penalty box for a couple of years now.

There's a really interesting market in which you've got this very high level of dependency but you've got no growth. And one idea that might be helpful here that I kind of like is just this idea that commodity markets are not only sensitive at the margin. They're just sort of tragically sensitive at the margin and when demand for commodity markets begins to tail off and flatten even for short periods of time it really shows up in price quite strongly. And I you know having watched oil for so many years I'm always hesitant to make any big pronouncements say about the move in oil over the past four weeks. But the move in oil over the past 18 months is what really is concerning. And I agree with you that the world has possibly been fighting deflationary impulses for a number of years, maybe even since the year 2000.

Chris Nelder: And I think China's growth has really masked that.

Gregor Macdonald: Yes, China's growth was this wonderful gift to not only developed countries but especially the non-OECD countries who were commodity producers. That Industrial Revolution in China dumped capital into the hands of so many citizens and an emerging middle class and many commodity producing nations from South America to Southeast Asia. And of course the commodity countries like Canada and Australia where you had the signal of housing booms in places like Sydney and Calgary, and of course Sydney and Calgary housing markets are cracking now.

Chris Nelder: Yes in fact I read an article this week about you can get nice high quality downtown office space in Calgary right now for $0 dollars a square foot.

Gregor Macdonald: Yeah that doesn't surprise me. I mean I'm sure the people haven't left just yet. But as you're probably aware of these low oil prices as damaging as they are to the U.S. independent oil and gas industry they're even potentially more damaging to the tar sands industry. But again back out to this deflationary notion, you know at an investor conference in San Diego this autumn's October Fest which is put on by Howard Lindzon...

Chris Nelder: Of StockTwits fame.

Gregor Macdonald: Yeah, there was a good conversation about the oil sector's role in the economy and you know a number of us sort of looked at the more benign take which was that a decline in the price of oil would simply be a happy transfer of capital from the oil and gas companies to consumers. A number of us who've watched the return of the oil and gas sector post-2009 very capital intensive, very investment heavy, very heavy equipment oriented. We watched the industrial cities of the Midwest, you know the Akron's, and the Milwaukee's and the Cleveland's, and so forth they really thrived on the return of oil prices after the Great Recession. And so this oil price environment is clearly not merely a happy transfer of capital from the oil and gas companies.

Chris Nelder: OK. So we definitely agree on all that that we are in fact looking at a deflationary signal in what's been happening in oil. And I think we would agree that that's also the signal that we're getting from equity markets.

Gregor Macdonald: Yes, and I am cautious about making any prognostications about how nasty the current winds will take global equity markets this time around, we are still in a ultra-low interest rate environment. Stocks still provide a better prospect for return over the long term. But you know there are some voices out there saying that the bond market could actually go through another big rally cycle driving interest rates even lower around the world and that's certainly a possibility.

Chris Nelder: OK. So basically we just continue down this path until we hit some sort of a bottom. Is that the idea there? We keep shrinking and declining?

Gregor Macdonald: You know what's really surprised me is the fact that the non-OECD economies haven't really bounced back. You know over the past few years I mean yes in 2011, 2012, 2013 but they really haven't come back and of course there are other things going on in important non-OECD economies. In China, you have this difficult transition to a consumption oriented economy, in India you have a kind of domestic energy revolution that's going on. It's a revolution of domestic supply and it's a big, big policy push to bring a lot of people onto the power grid who've never been on the power grid. So you've got some things happening in non-OECD nations, the big ones, and it's as though those good things that are happening have not sparked any sort of broader recovery in the non-OECD, and that just personally that's really surprised me. As someone who has been very patient over the past few years waiting for recovery. I'm very surprised that the United States has once again found itself sort of an island of economic growth in a world that's very, very sluggish and of course that asymmetry that can't last forever. You know we've gone through that before.

Chris Nelder: Right. So before we talk about that I'm really glad that you brought the conversation to this point, because it is that broad lack of vigor in the global economy that I think really is something that we ought to be paying attention to. So it seems to me that we just have too much supply of everything but nobody is willing to cut back on production. You probably saw this quote, where at a recent coal trading conference Energy Venture analyst President Seth Schwartz said the problem with this industry is nobody will close a goddamn coal mine. Noting that the owners of Patriot Coal were planning to actually increase production this year even while coal prices are in the basement. And basically they're hoping that their competitors over at Walter will close their minds. You know this is after Arch Coal just became the 49th coal producer to go bankrupt in the U.S. since 2012. And it's the same problem we see everywhere, most of the world's oil producers, nearly all the producers in the U.S. and Canada are losing money at these prices, and they're all hoping that the other guy will close down. I mean this war for market share is hurting all producers and it's becoming a war of attrition. And now we have Saudi Arabia murmuring about putting up some of its assets for sale under an IPO to raise cash while it's burning $100 billion annual budget deficit every year. And now we're seeing oversupply everywhere in key industrial metals, grains, soft commodities and so on. And I wonder if it isn't time however unpopular the notion may be, to dust off that old Limits to Growth playbook here, Gregor and start thinking about a future where economies and demand for energy and commodities actually shrinks from year to year.

Gregor Macdonald: Well there's a couple of things there. You know an issue that fewer people have paid attention to but that some folks have actually started to pay attention to is what's happening in global fertility rates and fertility rates come down for different reasons and not to get into the weeds on that, but we have some fairly notable trend changes over the past 15 years in global fertility rates. And again I don't want to put it all on a factor like that. A lot of what's happening right now is that that China industrial revolution lifted world GDP and it created this very awesome call on global natural resources and we're definitely in the hangover period of that, I mean you mentioned coal. I recently did an issue on coal at and actually did an open post at my web site on just the very unusual position that the global coal market finds itself. Here we are having supersized coal back to use or consumption levels that the world has never seen before. Coal now provides a quantity of energy to the world that's roughly equal to the quantity of energy that oil provides. And yet the coal market has received, to use a financial term, a sudden stop -there's been a sudden stop in the global coal market. Consumption levels aren't declining on a global basis but they're clearly no longer advancing and so into that environment we've got new natural gas that's being exported from Australia and the United States and that's probably for the power grid. We've got renewables which I know we'll talk about. And wow, I mean the next five years in wind and solar supply are pretty darn impressive as well. I mean we're getting to an area now where where wind and solar, I've got some data I'll share with you today and some forecasts. You know wind and solar alone is coming into that marginal part of the global power market in many domains and it's saying hey I'm here too and I'm here to help.

Chris Nelder: Yeah, I recall some years ago you actually thought that coal would continue to grow. And I think I think we've both been impressed by how rapidly renewables have just sort of taken the place of coal and supplying any new low growth. You know even just what, a year ago, we were still hearing about China's building another coal plant every week or whatever. Now we see China's coal consumption actually declining. And I think the only place where there might actually still be a growth market for coal is potentially India. But as we've discussed, that's even looking less likely every month. Renewables there are also just sort of winning the race.

Gregor Macdonald: India's coal growth of domestic coal production supply sort of offers the worst of both worlds to the climate community and the global coal industry. It means that India is going to burn more coal. But it also means it's not going to import any more coal and Piyush Goyal who is the India Minister of Energy teamed up with Prime Minister Narendra Modi. They are very serious about getting those 350 to 400 million people on the power grid and they're not going to do it exclusively with coal. Absolutely not. But they are very proud, just for example, I mean Piyush Goyal has been tweeting out hurrahs the last couple of months because for the first time in years there's no shortages of coal at the mining head or on the railways or at the coal burning power stations. So India is definitely going to go through a revolution. And then of course if you're a creator, or an excavator, or extractor of energy somewhere else in the world you're wondering how much India will call on you for your energy supply or your services. There's a real uncertainty but you're right Chris that there's been a sudden stop on a global basis of coal consumption. I did think it would go probably another five to seven years. The big surprise has been China. China - the Beijing leadership is clearly freaked out by the last few years of air quality. They're still building some new coal fired plants. It's not actually clear that they'll actually run them. But of course on the other side of the ledger on the wind and solar side of the ledger. Wow. I mean the gigawatt capacity additions are just astonishing.

Chris Nelder: So I'd like to just return briefly to this concept that I was talking about before about revisiting the old Limits to Growth playbook. And I agree that fertility rates do give us some hope on that. And I recall Jeremy Grantham's piece where he really focused on fertility rates as sort of humanity's last best hope for dealing with resource overshoot and climate. In fact I'll link to that in the show notes because I think some people haven't had a chance to read that it really was a great essay. But do you see, as I'm suggesting here this weak demand for commodities sort of across the board as an indication that we just really can't keep expanding the way that we have been.

Gregor Macdonald: Well you know the framing used to be that we couldn't keep growing because energy supply would be geologically or technologically constrained,and then that would be expressed in price, and that the price level would be too much for the workers of the world to afford.

Chris Nelder: I know somebody who used to think like that.

Gregor Macdonald: And of course some of the backward looking hindsight criticism of the Limits to Growth model from the 1970s if I recall, some of that has been a little cute because there was so much that happened between the 1970s and now and I do think that one of the things that happened that would have been difficult for anyone to model is that in my view it's very clear that human beings are both constrained by their environment and resource availability. They also have the ability to shift their behavior if they get hit over the head often enough. And fertility rates are clearly in my view a response that has been sort of a long rolling unfolding of fertility rate responses that have occurred of course in the shorter term...

Chris Nelder: Well yeah fertility rates. There's a signal that makes it self evident over 10 year, 20 year cycles. We're talking about something that's happened over an 18 month cycle here. So...

Gregor Macdonald: Yeah, in the shorter term the OECDs consumption of oil was probably at its highest peak, I just did the data the other day maybe 2003, 2004 but I think of the Limits to Growth question as a long time line question. And one that doesn't fit so easily into the shorter view. But I guess maybe I would answer it this way. For the past 10 to 12 years we've been bumping up against various ceilings and then kind of coming back down again and then bumping up against various ceilings again.

Chris Nelder: And that's exactly what I'm talking about.

Gregor Macdonald: You know there has been that pattern and it's a little difficult to describe because the ceilings are a little bit different as you go from region to region. We kind of bounced off that ceiling of that oil price shock of the last decade.

Chris Nelder: 2008.

Gregor Macdonald: Yup. And that created some somewhat moderate new demand patterns for oil at least in the OECD. Not so much in the non-OECD, the non-OECD was not as price sensitive as they were becoming new users and their user base was expanding. I must admit Chris, I am confused now about where the non-OECD is in oil adoption. I'm not confused that they've largely industrialized on the back of power and electricity, you know as China's industrial revolution was manufacturing built on the back of the power grid. But there they were adopting oil as new users of oil, oil found a new user base in China for a number of years. Look at some of the more recent data on automobile sales. And I wonder what Beijing will do in terms of policy with regards to internal combustion engines, so I don't know what the future prospects are for oil. Did oil hit the non-OECDs as well? I'm actually unclear on that.

Chris Nelder: Well, I think we all are mainly because the most important signal within the non-OECD is China and nobody knows what data to believe with them. But let's return to the concept of world demand in the OECD. So you've been pretty firm in your view that oil consumption in the OECD peaked about 10 years ago, and that it won't be growing again. This is one of our sort of long running debates, and the data does in fact show as you say that OECD oil demand has not bounced back to say 2006 levels yet but the OECD, I really wonder if that's the right framing because it includes the sick men of Europe you know the so-called PIGS. And if we just look at the U.S. I mean Gregor demand for gasoline and diesel in the U.S. hit a new all time peak in 2015. New all time high at 13.1 million barrels a day. The old high being 12.8 in 2007. And so I still have to think that oil and economic growth are still very much coupled, and that if the countries of Europe had rebounded as strongly from the 2008 crash as we did then the entire OECD probably also would have hit a new high in gasoline a ditillate demand last year. So I don't think it's a question of decoupling more as one of being sort of economic health.

Gregor Macdonald: So that's pretty strong data that there's no growth. That definitely goes to dependency. So you know like in global power grids, we've done so much to try to start to decarbonize. And it shows you that in the United States you know I think U.S. oil consumption is maybe around 9 to 11 percent below the highs. And I think the data you just cited was that there'd be about 2 plus percent growth over what seven or eight years. So that's sort of not growth but it really illustrates to me the dependency. I mean I was looking at some data this week on rail ridership, rail ridership has soared in the United States over the last 10 years. It's up 40 percent from 2005. And you know a lot of the little thing that never used to matter like public transportation, I remember snickering at these small tiny improvements in the mileage performance of vehicles, well you know over the last 10 years we've put on what maybe four or five miles of improvement on vehicles in the United States.

Chris Nelder: Up until 2014.

Gregor Macdonald: And then now we are doing all backsliding now. Yeah, so let me try to frame this this way. My view is that we're going to get to the year 2020 and we're going to have much better than expected decarbonization progress that will have occurred in global power grids. I think even people who are moderately optimistic will say, 'wow the world really accomplished a lot' and then I actually think we're going to have much worse progress than expected in global transportation. And this almost rigid calcified dependency that we have on oil for transportation despite a lot of really excited talk about autonomous vehicles and I've been doing a lot of research on this recently and electric vehicles. Despite all that excitement, that data that you just cited about the gasoline really to me and I've been thinking about growth stories versus dependency stories, really shows that dependency and there is that portion of the U.S. economy, and you know I've looked at how the proportion of oil in the U.S. energy mix of course has declined like it has elsewhere in the world and natural gas has risen up. But let me say this Chris, non-OECD oil consumption has after its peak it's been traveling along at a bottom actually for the last three to four to five years. It's not going up, but it's not going down either. And it sort of reminds me of what I wrote a couple of weeks ago on my blog about coal. You know people are very excited that there is no longer coal growth, great. We've got a big new coal mountain. You know people will get up tomorrow morning and they'll go to work in the coal industry to supply the coal that the world uses. The industry isn't hiring. OK, but people will get up tomorrow morning and do that job. And you know even in the OECD you wonder if that's where oil is right now, are we down to those harder to dislodge levels.

Chris Nelder: Yeah and you know speaking of path dependency, I was sort of startled yesterday to come across some quick little tweeted out pilot data from Charles Lane, a writer over there at the Washington Post. He was giving out the percentage of all new U.S. car sales that were electric cars 2011 - 0.13%, 2012 - 0.36%, 2013 0.63%, 2014 - 0.75%, 2015 - 0.67%,I mean for the last five years we have not even gotten above three quarters of one percent per year in electric car sales. And this last year 2015, the US sold a record 17.5 million vehicles and most of those were lower efficiency vehicles. Again as we were saying the total fuel economy sales weighted average per year has actually fell in 2015. So we just deployed a whole lot more new Ford F-150s than we did EVs by a big margin. And that bakes in a certain structural demand for another at least 10 years right or as long as people keep their vehicles.

Gregor Macdonald: I just feel sad hearing you cite the data.

Chris Nelder: Well I think we all do.

Gregor Macdonald: Of course. I'm... and I think you were as well. I was cautious about the prospects for the rate of EV adoption back in 2010, I'm more positive actually about it now. But it's so bracing as you say the Ford F-150. I've done a fair amount of traveling the last year. Boston, New York San Diego, Seattle and I see new Ford F-150s everywhere.

Chris Nelder: Oh, it's been the best selling vehicle in America. Year after year after year.

Gregor Macdonald: Yeah. What's really sad to me is that the EV market missed this cycle. I mean I just remember so well, you come out of the Great Recession automobile sales have been hammered. Everyone who looks at this market understands in order to adopt something new You've got to have the turnover and there we were ready for fleet turnover. I mean it was like the stars were aligned and...

Chris Nelder: And we're selling 10 million vehicles a year.

Gregor Macdonald: Yeah. And finally when the automobile sales come back, the EV market's not even taking a percentage point. Very depressing.

Chris Nelder: Right. So this brings us I think conveniently to probably our longest running debate Gregor about the interaction of oil prices and the global economy. So just to try to quickly recap, I have generally held to the peakist point of view in which all prices act as a brake on the economic activity and I think that's what happened I think you do at least partially as well in the crash in 2008 and I think that's part of what has led to the current slump. In fact I'd argue that if we hadn't had this unprecedented central bank interventions and effective zero interest rates in the wake of that crash the tight oil boom might never happened, and the economic recovery that we've had since 2008 probably wouldn't have happened either because oil was just too expensive to fuel economic growth. You I think originally share that point of view and then began to see or maintain that oil was losing its importance to the global economy, that it didn't have that kind of correlation that there was some decoupling now between GDP and oil demand. And that by switching loads to the power grid, the world might still achieve economic growth even with oil prices holding firm over $100 a barrel and that world GDP would continue to increase. Fair enough? Fair characterization? OK. So let me open with this question. If your position is right then is it just a coincidence that the global economic growth ex-China was anemic throughout the $100 oil era and that it has tapered off since then in most of the world apart from China and the U.S. or is that just a coincidence. And why have we essentially had flat demand for grid power in the developed world for most of the past decade, if we are as you've put it rebounding to the grid?

Gregor Macdonald: Yeah. Good questions. So it's not a coincidence. Even though oil was nearly 50 percent of the global energy mix in the 1970s and was still almost 40 percent of the global energy mix coming in to 1999-2000 was about 39 percent. Now that oil's share of the global energy mix is down towards 31 percent. What I really want to say is I just want to moderate the idea of oil being kind of like this reliable toggle that either creates or reflects what's happening in the global economy. Obviously a 31 percent share is still very important and it should be added that the kind of work that's done with oil is unique and you can do certain types of work with oil that you can't do with other types of energy. That said, some of the ideas that I was critical of 10 years ago. I'm less critical of now. So for example the declining oil intensity of global GDP, I was critical of that view in 2005. I'm less critical of that view now. I was critical of that view back then because I more typically saw the global economy in industrial terms, and in terms of stuff that got moved around and things that got built. Now 10 years later I accept that a larger portion of what happens in the economy tends to be digital goods and information technology. So I've capitulated to the idea that we're going to mark the GDP figure in the Excel column as having grown even when either all energy consumption is flat or even if oil's share of the global energy mix is in decline. And yes, it is worth noting that the growth rate of electricity generation in the world the last 10 years has exceeded the growth rate of oil consumption every year of the last 10 years. There is something notable about that. And part of it is that you know the non-OECD they came to power more heartily than they came to oil. So they skew the data a little bit. That might go a little bit more towards your view. So yes.

Chris Nelder: That is an interesting point.

Gregor Macdonald: Yes, you and I know it's not an either or situation. I really like evolution as an idea. We can't be talking about the world today the way we were talking about it in 2005. Some of the changes are really dramatic in the way energy is used and traded. And the share mix that various energy sources have. Here's one way to look at it. One thing that may have been lost is oil as a reliable indicator of what's happening except at the tail ends. You know. But in the middle where oil prices are not doing something either extreme as like the pulse of what's happening. It must have been an easy world to do macro back in 1975 when oil was providing 50 percent of the energy to the world.

Chris Nelder: That's an interesting point.

Gregor Macdonald: You know it's just harder. It's sort of like what we were talking about before. Again I was surprised when people thought in 2014 that lower oil prices as you quoted recently, or you've mocked the quote actually on alloyed good for America clearly.

Chris Nelder: Oh it's alloyed alright.

Gregor Macdonald: People haven't gotten up to speed on the fact that we'd become an oil producer. So yeah we're in a very different world today than we were just 10 years ago. The oil shock was a real shock and the world has responded to that. And it is branching and growing along the lines of electricity and just as a platform. You know I think what's really encouraging from a climate standpoint is that the visibility on how we will start to decarbonize global power grids is really clear, in fact I wrote another recent post at just saying it looks to me like OECD emissions have peaked and that peak is looking more secure. If you asked me because when you look across the OECD and what plans we have for how we'll use energy over the next five years, I just don't know what kind of net growth opportunities there are for fossil fuels in the OECD.

Chris Nelder: So let's move on to LNG. Speaking of fossil fuel growth. And this is sort of another one of our long running debates I've been skeptical as you know about the future of U.S. LNG exports mainly because I have not been convinced that shale gas production in the U.S. would hold up at current high levels for the decades that would be needed in order for billions of dollars of investment in LNG export facilities to make sense. Conversely, you've been very bullish on U.S. LNG exports seeing the U.S. exporting around 9 billion cubic feet per day I think it was or around 12 percent of U.S. gas production by 2020. So now it seems the market has been intent on making fools of both of us because the prices for LNG have crashed around the globe, even in Asia now landed LNG prices are under $7 per million btu. So once you factor in the U.S. Henry Hub gas prices that are around 240 right now plus $5 for liquefaction shipping and gasification, shipping LNG to Asia right now is a money losing proposition. And Cheniere, the first company to get an LNG export facility up and running in the U.S. has kicked its visionary CEO to the curb. So now I get the argument that would be exporters make that gas prices will rise again and over the next 20 years or so they'll be back in the money. But I also look at the new expert capacity coming online in Australia, in Qatar and then I think again about the deflationary scenario and I'm just not at all sure about that. So what's your latest view on U.S. LNG exports?

Gregor Macdonald: Yeah good questions. And let me just preface to say that a lot of this talk and conversation will turn on what happens to natural gas prices over the next, certainly the next five years but really for investors, ten years as you and I know, fossil fuel extraction operations tend to look at a 10 year investment timeline. So just to refresh the data since I do have it in front of me, there are currently seven projects that have been approved and I mean full approval by the United States government and the various agencies, the seventh just was approved before Christmas. So the six that have been approved and are under construction would amount to 10.6 Billion cubic feet per day which compared to 2015 dry gas production would be about 12 to 13 percent. And then if you add the 7th project that's just been approved, and it's not under construction yet, that would bring us up to 12.82 Billion cubic feet per day which compared to 2015 expected production would be 17.3 percent. The natural gas futures market clearly cares not one whit about the about the coming wave of LNG exports from the United States doesn't care about it and is completely unconcerned. Natural gas futures markets quarterly unconcerned on the supply side. However as you point out, natural gas prices are going to have to rise at some point here for all these projects to make good on their investment. And of course this is happening in a context in which Australia, Australia has also come on with supply. In fact if you combined Australia and the United States the world was looking at an extra 20 billion cubic feet of natural gas in LNG form coming onto the market that it didn't have before the year 2015, 2016 by the year 2020, and now we're up to 22. with this recent project. So I don't know what the U.S. natural gas industry is going to do. I know what they need. They need for all this LNG to be taken up steadily over the next five years presumably by China. I know that China has LNG import infrastructure at the ready. I know that China is starting to consume natural gas from a very low base but it's not just the global LNG market that they can source natural gas supplies. They can source it by pipelines which are either under construction or will be under construction across Asia. As for North American supply, yes I remain sanguine on future North American supply of natural gas. I think it's actually scary for this industry how much natural gas is being produced and the rate at which the supply has expanded even in this crushing low environment is just insane. And so obviously here is another market where somebody has got to go first. Someone's got to shut down a natural gas drill. You know, right?

Chris Nelder: Well I mean the drills are getting shut down, but you know I think we will see declines in shale gas production this year along with the tight oil. Because, I mean that the two are so intimately connected. I think what is it about a third of us gas supply right now is actually coming from tight oil operations as associated gas, so...

Gregor Macdonald: But just briefly on the supply with looking at the supply growth. 65.8 billion cubic feet per day of production in 2012. 74.5 billion Cubic feet of supply a day in 2015. 1,2,3 years from 65 to 75. Wow.

Chris Nelder: That is impressive.

Gregor Macdonald: In fact if you just start that in 2013 it was 66 in 2013. So it's almost ten extra cubic feet a day in just two years. That's just crazy growth and the price reflects that.

Chris Nelder: And so much of it produced at prices that by any legitimate accounting would lose money for producers. Which is the craziest part of all. So I think a big part of and an under appreciated part of this whole macro picture has been the ongoing strengthening of the U.S. dollar, particularly over the last 18 months while oil prices have been falling. So the concern over the Euro was widely reported for the past several years. But since oil prices started crashing the Russian Rouble the Brazilian Real, lots of other currencies have been losing value quickly including the Chinese Yuan and the South African Rand and so in fact I happened to catch our friend Paul Kedrosky on Bloomberg Television last night explaining how the recent rush of Chinese money into North American assets everything from Vancouver real estate to a stake in the smartphone app Grindr is really about capital flight which echoes a lot of other stories I've heard recently about capital flight from other countries particularly those in Asia and those dependent on natural resource exports. So what's your view on the forex markets right now and what do you think happens next?

Gregor Macdonald: Yes, so the dollar is strong for all the reasons that you mention. And from an energy standpoint looking for the dollar I'm not making a call on where the dollar's price level goes but the pressure, the upward pressure on the dollar is going to continue because the energy balance sheet of the United States has been undergoing reconstruction. We're we're still consuming a little bit less energy than we were 10 years ago. Most of this energy, there's been a huge shift in the source of the energy that we're consuming. And you know we're producing more oil we're consuming less oil. We're producing more and consuming more of our natural gas. We're exporting natural gas to Mexico. Here come new exports of natural gas to the world. We've been exporting huge quantities of petroleum products and of course now here comes the export of crude oil to add to the petroleum products and then we've got a wind and solar revolution underway and that goes under the part of the ledger of homemade energy. So we're taking the net balance of the U.S. dependency on foreign sources of energy when you net the exports and imports. And from a financial standpoint that's just going to add further pressure to the dollar. So I just continue to think that the dollar has basically done all the tightening that the Fed ever needed to do. And this quarter point that they did recently just really felt like monetary theater and I would say that what we're going to hear, I think we're going to see the Fed be unable to make the case that they've got to do too many rate rises because that inflation reading is going to be under severe pressure in the first half of 2016 and the dollar, the dollar is going to continue doing the Fed's work for them.

Chris Nelder: So, no reversal of course on that. So if the dollar remains strong or God forbid it even strengthens further from here. We certainly have I think reasonable expectations that certain currencies are going to continue to weaken against the dollar right now I mean for example the Canadian. Yes that's definitely under pressure. So if this continues to be the case then that only adds more pressure on oil prices. That only adds more pressure on natural gas exports that only adds more pressure on pretty much all the things we've been talking about today.

Gregor Macdonald: That's right. People like to dismiss the fact that U.S. exports are quote a small portion of U.S. GDP. But I don't think 9, 10, 11, 12 percent, yeah its not 88 percent. But you know you start hammering away at that and you're starting to nip chip away at one of the legs at the stool of U.S. GDP. You know its not 25 percent, it's 10-11 percent so I agree with you. I was talking to an investor in Toronto last week and he was actually looking at the Loonie and what's happening to the Canadian oil and gas sector and he was actually wondering if things would get kind of a little out of control up in Canada. You might have a banking crisis in Canada.

Chris Nelder: Yeah. I mean I've seen forecasts that it could actually hit an all time low against the yen.

Gregor Macdonald: Yes in fact the hot conversation over the last 48 hours has been a sudden spike in Canadian food prices at the supermarket. That looks very unpleasant.

Chris Nelder: And to think that it was kind of at current levels back in what was it 2000 or thereabouts and then actually got up to parity with the US dollar. So really really big effect there that I think still sort of remains under appreciated and it's kind of a tie under the whole dynamic of the macro situation. So maybe now we should move on from the macro stuff at this point and kind of get back to the theme of this show. So you've been doing some work lately to really focus in on energy transition in your Terrajoule newsletter particularly on the outlook for renewables. So what are your latest thoughts on that?

Gregor Macdonald: Right. So in 2014 the new generation from wind and solar power provided kind of an astonishing about 40 percent of all new generation, it provided 117 new terawatt hours out of 350 as I guess that's about 30 percent. And in 2015 something similar occurred. In 2016, we're still traveling along about 34 percent. But again I think what's really important here is that if wind and solar power are able to come in and provide a full third of whatever new power generation from all sources is coming online in the world that's a real cap on fossil fuel growth. That's clearly part of what's starting to happen in China. That's very much what's happening here in the United States. You know the coal retirements of course here in the United States are spectacular. And we're just one country, we're not the world. And of course some of those retirements are replaced by in part by natural gas. But this extension of the investment tax credit and the wind production credit. I think the market was going to do well even without those. But it's actually going to smooth the next five years instead of having like a big spike this year of new capacity and then a drop off the following year. Now that the industry can sort of smooth its way and you know we've got cost declines that are acting as a tailwind. Chris, I've actually started asking myself what feels like kind of a wild and radical question. I've started asking myself how much fossil fuel growth is going to occur on a net basis in the world just in global power grids.

Chris Nelder: In power grids alone?

Gregor Macdonald: Yeah, in power grids alone. Because you've got wind and solar and I'm not tracking hydro and nuclear right now. I'm really tracking wind and solar but you know just two years ago my projection was that the world in a really nice scenario would wind up with 500 gigawatts of solar capacity by the year 2020. I mean I've been progressively raising that about 700 gigawatts of solar capacity globally by 2020. That's a pretty big deal. And so I actually think that folks in the climate community they don't want to let up the pressure. But I think that they should really start to feel quite encouraged that at the margin something is really beginning to happen, and the visibility on what will happen in global power grids is pretty clear. Again reaching back to what we talked about before though transportation solving the problem of cars with cars is sort of my snarky way of saying I'm bullish on BP. And if EV were to take off, electric vehicles were to take off that offers a lot of nice opportunities for storage and demand and getting this thing going a little bit faster. But I think that we're not moving fast enough in terms of global transportation. There's a real asymmetry opening up now between the great progress in power grids and just not much happening in transport.

Chris Nelder: Yeah. No I absolutely agree Gregor. I am very interested in EVs and I think there really is some potential there. But right now I mean it just remains a potential. It amazes me how many times people say to me you know this whole decline in oil is ultimately all about vehicles and I just have to say no it isn't. It isn't now. It could be, but we don't know when that'll be. It isn't right now. It has nothing to do with oil right now. And to the extent that we have actual economic growth going on to the extent that we have bonafide economic activity it has to happen with gasoline and diesel. It has to. There just isn't enough rail to really move the needle on that. And I continue to believe that long term passenger traffic especially replacing airline flights under 500 miles ought to be done with rail. Even in the United States. Well that's a topic for another day, anyway Gregor, I'm glad to hear that you've been working on the outlook for renewables. I think that's really an interesting target right now for your work.

Gregor Macdonald: Thank you. Yes I'm shocked at what I'm seeing. The cost declines are steady and very encouraging. And the fact that the United States has just, alone, the fact that the United States is going to wind up with more solar and wind in 2020 than we thought maybe just six months ago. That's going to feed into the cost decline that everyone's going to enjoy globally.

Chris Nelder: And we're just going to replace coal. And no one's even going to notice.

Gregor Macdonald: Well you know what I will keep you updated on the point where we actually see coal capacity globally go into decline. We're not there yet. And unfortunately the problem with the existing coal capacity in the non-OECD it's sort of a big thing that we're going to have to grapple with for a while.

Chris Nelder: Well it is. But I'd also point out that the load factors have been falling.

Gregor Macdonald: Sure, sure of course.

Chris Nelder: And there's definitely a threshold there. You know if your load factors get too low pretty soon it just doesn't make sense to even keep the asset around. It doesn't have to go anywhere close to zero before they shut it down.

Gregor Macdonald: I agree Chris. And actually this is you know one of the super themes that I keep taking fresh swipes at in my publication is this rather large macro idea that the total cost of fossil fuel extraction, fossil fuel transport, fossil fuel combustion and fossil fuel combustion infrastructure that entire sort of supply and combustion chain is a set of infrastructure that is really quite enormous and costly when compared to the technology of capturing energy and not burning it but simply capturing it. I think Mark Jacobson of Stanford who's done a number of studies on this. He's really helped me understand the difference between combustion and capture. And I don't think that's a asymmetry of cost and ongoing future risk that many really understand yet they see solar and that it captures diffuse energy. They see these large installations that go up. But what they're not thinking about is you know you stand astride a half a gigawatt solar plant in the California desert. No pipelines, no Caterpillar shovels, no ships ferrying stuff, no combustion architecture.

Chris Nelder: No rail lines going in and out.

Gregor Macdonald: No rail lines. All that steel is just not needed and that those two worlds are so different from each other is something that everyone really needs to think upon.

Chris Nelder: I agree there could be actually, how do we put this sort of a deceptive price effect when you're moving into this new domain of generating assets that have a high upfront capital cost and then a zero marginal cost. And then you get 10-15 years down the road with those assets and all of a sudden you find yourself in a totally different world.

Gregor Macdonald: That's right Chris. That's exactly it.

Chris Nelder: All of a sudden it's like not having to pay rent anymore.

Gregor Macdonald: Exactly. Exactly.

Chris Nelder: Or paying off your house. It's like oh wow I have another thousand dollars a month in my checking account all of a sudden.

Gregor Macdonald: That's right. The pay off at the back end to solar and renewable energy is solar in particular is amazing just to me. Whereas at the back end of fossil fuels your costs skyrocket.

Chris Nelder: Or skyrocket and crash and skyrocket and crash.

Gregor Macdonald: There we go.

Chris Nelder: And the volatility alone as we've discussed is damaging. It just makes your capital planning so difficult. Well Gregor thank you so much for your time. I think we've covered plenty of ground today and we'll definitely have to have you back on the show.

Gregor Macdonald: Thank you so much Chris. It was great to have the conversation with you and to go back and forth on these things.

Chris Nelder: As always my friend we will continue this conversation.

Gregor Macdonald: OK Chris. Bye.