Big Debates: The State of the Energy Transition

In the latest edition of our Big Debates miniseries, Morgan Stanley Research analysts discuss the factors that will shape the global energy market in 2025 and beyond, and where to look for investment opportunities.

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Michelle Weaver: Welcome to Thoughts on the Market. I'm Michelle Weaver, U.S. thematic and Equity strategist at Morgan Stanley.

Devin McDermott: I'm Devin McDermott, Head of Morgan Stanley's North America Energy Team.

Mike Canfield: And I'm Mike Canfield, Head of the Europe Sustainability Team,

Michelle Weaver: This is the second episode of our special miniseries, Big Debates, where we cover key investment debates for 2025. Today, we'll look at where we are in the energy transition and some key investment opportunities.

It's Monday, January 13th at 10am in New York.

Mike Canfield: And 3pm in London.

Michelle Weaver: Since 2005, U.S. carbon emissions have fallen by about 15 percent. Nearly all of this has been tied to the power sector. Natural gas has been displacing coal. Renewable resources have seen higher penetration. When you look outside the power sector, though, progress has been a lot more limited.

Let me come to you first, Devin. What is behind these trends, and where are we right now in terms of the energy transition in the U.S.?

Devin McDermott: Over the last 20 years now, it's actually been a pretty steady trend for overall U.S. emissions. There's been gradual annual declines, ratcheting lower through much of this period. [There’s] really two primary drivers.

The first is, the displacement of coal by natural gas, which is driven about 60 percent of this reduction over the period. And the remainder is higher penetration of renewable resources, which drive the remaining 40 percent. And this ratio between these two drivers -- net gas displacing coal, renewables adding to the power sector -- really hasn't changed all that much. It's been pretty consistent even in this post COVID recovery relative to the 15 years prior.

Outside of power, there's been almost no progress, and it doesn't vary much depending on which end market you're looking at. Industrial missions, manufacturing, PetChem -- all relatively stable. And then the transport sector, which for the U.S. in particular, relative to many other markets and the rest of the world, is a big driver transport, a big driver of emissions. And there it's a mix of different factors. The biggest of which, though, driving the slow uptick in alternatives is the lack of viable economic options to decarbonize outside of fossil fuels. And the fact that in the U.S. specifically, there is a very abundant, low-cost base of natural gas; which is a low carbon, the lowest carbon fossil fuel, but still does have carbon intensity tied to it.

Michelle Weaver: You've also argued that the domestic natural gas market is positioned for growth. What's your outlook for this year and beyond?

Devin McDermott: The natural gas market has been a story of growth for a while now, but these last few years have had a bit of a pause on major expansion.

From 2010 to 2020, that's when you saw the biggest uptick in natural gas penetration as a portion of primary energy in the U.S. The domestic market doubled in size over that 10-year period, and you saw growth in really every major end market power and decarbonization. There was a big piece of it. But the U.S. also transitioned from a major importer of LNG, which stands for liquefied natural gas, to one of the world's largest exporters by the end of last decade. And you had a lot of industrial and petrochemical growth, which uses natural gas as a feedstock.

Over the last several years, globally, gas markets have faced a series of shocks, the biggest of which is the Russia-Ukraine conflict and Europe's loss of a significant portion of their gas supply, which historically had come on pipelines from Russia. To replace that, Europe bought a lot more LNG, drove up global prices, and in response to higher global prices, you saw a wave of new project sanctioning activity around the world. The U.S. is a key driver of that expansion cycle.

The U.S. over the next five years will double; roughly double, I should say, its export capacity. And that is an unprecedented amount of volume growth domestically, as well as globally, and will drive a significant uptick in domestic consumption.

So that the additional exports is pillar number one; and pillar number two, which I'd say is more of an emerging trend, is the rise of incremental power consumption. For the last 15 years, U.S. electricity consumption on a weather adjusted basis has not grown. But if you look out at forecasts from utilities, from various market operators in the country, you're now seeing a t...