Old ideas can be surprisingly powerful when used in new or different areas. This is the case of the “liquidity trap” business dilemma of Keynesian economics. The liquidity trap implies that lower prices will not trigger higher demand or substantially reduce supply. It also signals important structural changes. What about the energy market?
Energy supply is now ample following a massive investment cycle and yield improvement in the past years. Transactional liquidity is high and unconstrained because of competition and deregulated markets. Demand forecasts are being downgraded due to a drop in economic growth and improvements in technology-driven marginal energy intensity. This is a market “trap”.
The combination suggests that low energy prices are likely to stay for a number of years. To illustrate, with global economic growth at 3%, marginal energy intensity at 0.7, and conservation in the existing stock at 2%, demand is now barely moving. The supply-side marginal yield improvement is 3% per year, and efficiency enhancements and step-outs in existing fields effectively balance decline rates, giving a virtually unchanged supply for several years ahead, even with exploration activity halved in the past year.
The classic view is that low oil and energy prices will rapidly stimulate economic growth, gaining strong momentum after 10-15 months. The lower marginal energy intensity may now have broken this link. Only the most extreme seasonal weather and unforeseen events will shake energy prices substantially. The classic liquidity trap.
The liquidity trap highlights why companies need to review strategies in the deepest way. Among fuels, coal is particularly vulnerable, being an energy resource of last resort. Glencore and Alpha Resources illustrate how coal companies now struggle. The outlook for natural gas is better, since gas tends to be a favored fossil fuel and can experience growth in a stagnant market.
Radical new company strategies are already being forged as a consequence of these changes. The liquidity trap suggests that that new strategies should not be based on growth assumptions and prices of the past decade. In its wake, it is likely that strategies will lead to a dynamic round of innovation in energy over the next decade.