Defining the supercycle
Singh defined the energy supercycle as price volatility arising from a persistent imbalance between energy supply and demand. He sees the supercycle taking place over an extended period, during the transition from a global economy primarily running on fossil fuels to one in which the dominant source becomes renewable energy in all of its forms, including solar, wind, geothermal, hydropower, hydrogen and nuclear. He said it could take 10 years, at a minimum, for the supply of renewable energy to be sufficiently high and reliable enough to replace fossil fuels.
The transition could take even longer because investment in — and the output of — fossil fuel infrastructure is trending lower. Most acquirers of production and refining capacity currently are financial buyers whose goal is to generate as much revenue and profit as they can from existing facilities rather than to provide energy security, Singh said. As a consequence, the cash flows from such assets are no longer as certain or sustainable as they used to be given the general lack of investment in such facilities.
Singh noted that the conditions leading up to the supercycle have been developing for decades. For example, the most recent construction of a new U.S. oil refinery with large production capacity — at least 100,000 barrels per calendar day, or b/cd — was in 1977. In addition, the Energy Information Administration reported that U.S. refinery capacity has dropped about 5% from 2019 pre-pandemic levels to 17.9 million b/cd.
The likely result is an extended uptrend in the prices not only for fossil fuels, such as oil and natural gas, but also for the raw materials critical to the production of renewable energy — particularly lithium, cobalt, nickel, manganese and graphite, all of which are in scarce supply. “The world ultimately will have a much sturdier foundation for strong and stable economic growth, but we’ll have to go through the supercycle to get there,” Singh said.
The geopolitical angle
While geopolitics always has played a major role in the supply and pricing of energy, Singh argued that its influence is currently greater than at any time in the modern era. He pointed to several important factors:
China, which explicitly seeks global supremacy in multiple dimensions — i.e., economic, technological, militarily — is aggressively maneuvering to control access to the critical materials for renewable energy;
The disruption from Russia under President Putin to wield its vast fossil fuel and mineral supplies as a political and economic weapon; and
Countries that are large producers or consumers of energy, such as India, Brazil, Indonesia, Turkey and South Africa, are potentially hedging their bets as the competition between the U.S., China and Russia plays out.
“This is the most intense great-power competition the world has experienced in the past 70 years, with two main implications,” Singh said. “One is that the potential for cross-border coordination of the energy transition is lower than it would have been in the past, especially between the U.S. and China, which are the two largest energy consumers. Second is the ongoing risk that the world’s finite energy supply will be weaponized as a geopolitical lever because fossil fuels are only produced in a few places on earth.”
Downside risks
As compelling as the case for the supercycle is, Singh acknowledged that it might not play out as he expected. Several variables could exert downward pressure on energy prices.
The first is the combination of climate change and rising global inflation. “Given that ‘necessity is the mother of invention,’ rarely has there been a stronger incentive for energy-consuming countries to make transformative investments in the production of clean energy, which is more reliable and secure than fossil fuel infrastructure. If these investments are made at scale and produce the desired outcomes, fossil fuel prices would undoubtedly fall,” he said.
Another variable is the extent to which energy consumers could successfully use their aggregate bargaining power to keep energy prices down or, at least, limit the scope of price increases. The G7 nations, for instance, have agreed to cap the price of Russian oil at a level close to the marginal cost of production, a move that the European Union is also considering.
Singh calls this “a game of chicken” between energy consumers and producers. It presents a material risk “that energy producers like Russia and OPEC Plus react to the price cap simply by lowering their output to maintain high prices. This could either shorten the supercycle or increase its length and intensity,” he said.
The final major variable is the risk that energy producers take a unified stance to keep prices high, even as the global economy slows or falls into recession. This could truncate the supercycle if high energy prices help to foster a global recession — which could be self-defeating for producers as demand and prices fall accordingly.
Implications for economies and markets
If the supercycle lasts for at least a decade, in line with Singh’s prediction, the implications for economies and most financial markets are decidedly unfavorable. “There would be higher energy prices across economic cycles,” he said, “as well as higher headline inflation, and less-anchored inflation expectations, driven in part by more fiscal support to provide a cushion for our citizenry against higher energy bills.”
“All of this points to a higher steady state for policy rates and interest rates across the yield curve,” Singh added. “The global redistribution of income from energy consumers to energy producers would also have a meaningful impact on where current account deficits and surpluses rise and fall, where foreign reserves are accumulated and depleted, how capital flows evolve, where financial vulnerabilities emerge and, ultimately, where geopolitical leverage accrues.”
What investors should do
All else being equal, institutional investors will face more volatile markets and rising risks as this supercycle plays out, Singh said. Higher interest rates would translate into higher discount rates and risk premia on any cash flow-producing asset, including equities and fixed income. Any risky asset class, for that matter, would probably fare poorly. Pension plan shortfalls could increase as asset values decline.
Based on PGIM Fixed Income’s analysis, plan sponsors should consider raising their allocations to renewable energy commodities, which would be the clear winner in the supercycle scenario. These would include key minerals used in renewable energy, such as lithium, cobalt, nickel, manganese and graphite.
“In the environment that we expect, having exposure to renewable energy commodities is a prudent portfolio decision,” Singh concluded. “It hedges against geopolitical risks and against central banks’ likely posture during the supercycle period — and it prepares for a clean-energy transition that is absolutely needed and inevitable.” ■
