Just as natural gas has beaten coal in less than five years, solar power is already beating gas, so betting on LNG exports or even fracked methane for domestic power is a bad investment. These are some implications of a new Citi GPS report.
The switch from gas to solar is already happening in Germany and in the U.S., according to Citi GPS in Energy Darwinism: The Evolution of the Energy Industry, October 2013, page 9:
…moreover, solar steals the most valuable part of electricity generation at the peak of the day when prices are highest. This effect has already caused the German utilities to release profit warnings, with some gas power plants in Germany running for less than 10 days in 2012, all of which makes some utilities reluctant to build new gas plants given fears over long term utilisation rates and hence returns.
And not just in Germany; see page 84:
This is not a ‘tomorrow’ story, as we are already seeing utilities altering investment plans, even in the shale-driven U.S., with examples of utilities switching plans for peak-shaving gas plants, and installing solar farms in their stead.
Wind is also beating coal; page 9 again:
Wind is already overshadowing coal in the second quartile. While wind’s intermittency is an issue, with more widespread national adoption it begins to exhibit more baseload characteristics (i.e. it runs more continuously on an aggregated basis). Hence it becomes a viable option, without the risk of low utilisation rates in developed markets, commodity price risk or associated cost of carbon risks.
By no “commodity price risk” they allude to wind requiring no fuel. And that’s also true of solar, as they spell out on page 90:
Renewables have a negligible variable opex, while nuclear has a large fixed opex component
See also page 14, and 15:
Added to these cost benefits is the lack of pollution which is also becoming a key driver in markets such as China, where the preponderance of coal-fired generation is having a noticeable impact on air quality.
Solar’s negligible opex is not just no fuel: it’s also no emissions. Given how fast the climate is changing here in the southeast, including droughts and pine beetle infestations, less greenhouse gases through solar power is important.
And solar costs less to install than wind, coal, and nuclear; page 88:
Nuclear: Not suited to competitive uncertainty
Solar costs less to install than any other power source, and then requires no fuel. And no 500-mile gas pipe gash through the countryside.
Plus solar is learning much faster, by which they mean increases in deployed solar capacity make solar prices drop even faster; back on page 9:
Perhaps most importantly is the evolution of each of these industries, fuels and technologies. Solar is exhibiting alarming learning rates of around 30% (that is for every doubling of installed capacity, the price of an average panel reduces by 30%), largely due to its technological nature. Wind is evolving, though at a slower ‘mechanical’ learning rate of 7.4%, and gas is evolving due to the emergence of fracking and the gradual development and improvement of new extraction technologies. Conversely, coal utilises largely unchanged practices and shows nothing like the same pace of evolution as the other electricity generation fuels or technologies. Nuclear has in fact seen its costs rise in developed markets since the 1970’s, largely due to increased safety requirements and smaller build-out.
The most the report says about gas learning rates is it’s “gradual”. Sure, fracking came on quickly and swatted down king coal. But that was a one-time technology innovation, and it’s done. While solar keeps learning. Implication: solar is going to beat gas even faster than gas beat coal. And that’s already started. No wonder that’s “alarming” to the fossil fuel industry.
They hint at how fast in their definition of learning rate:
We use learning rates in the context of this note to describe the speed at which technological or manufacturing improvements reduce the cost of electricity from a particular type of generation (e.g. solar) relative to the cumulative installed base of that generation technology. In this context, a learning rate of 10% would mean that for every doubling of installed capacity, the average cost (or price) of that capacity would decrease by 10%.
They base their learning rate on doubling of capacity. And solar doubles installed capacity in the U.S. in less than two years at its current 60+% annual additional capacity rate. Which would mean that at a 30% learning rate, solar prices should drop by 60% in less than two years. Which is what’s actually happening. And the real current learning rate isn’t 30%: it’s 40%.
Let’s look at the report’s first paragraph, on page 7:
While the world of energy is constantly evolving, we believe that the last five years has seen a dramatic acceleration in that rate of change and, more importantly, that the pace of change is set to at least continue if not accelerate further. Simplistically, we believe that certain power generation technologies are evolving — most notably gas via the shale revolution or solar via technological and manufacturing advances — while other technologies such as wind are evolving much more slowly, with some such as coal showing more limited evolutionary change. Given the long term nature of investments in these technologies and fuels, we believe that the pace of change will have a profound impact on the returns of both upstream and generation projects. A case study of Germany where the generation landscape has been radically altered in just the last five years shows this is not a ‘tomorrow story’ — it is happening now, and while it will take longer to impact emerging markets, it will impact an increasing number of industries and countries going forward.
Solar is already at grid parity (see pages 49, 50, and 54), and learns far faster than any other power source, so why would anyone with any responsibility for public policy, balance of trade, or environmental conservation, bet on LNG exports? Or natural gas as a long-term domestic power source, for that matter? Tearing up our southeast woods, wetlands, farms, and back yards to feed gas plants in Florida or LNG export terminals for short-term profit by a few industry executives and investors is not something any responsible local, state, or national government should support.
The report tries to spell this out in what amounts to very blunt language for a report such as this, on page 10:
Given the long term nature of upstream fossil fuel and power generation projects, this substitutional process and the relative pace of evolution is vitally important to understand. The sums of capital being invested are vast; the International Energy Agency (IEA) forecast that $37 trillion will be invested in primary energy between 2012 and 2035, with $10 trillion of that in power generation alone. Clearly the value at risk from plant or the fuels that supply them becoming uneconomic in certain regions, both in terms of upstream assets and power generation, is enormous.
This analysis of ‘Energy Darwinism’ as we have chosen to call it highlights the uncertainties and hence the risk inherent in upstream projects at the upper end of the gas cost curve, in the coal industry overall, for utilities, and for the power generation equipment manufacturers. These changes and risks will affect any investor, developer, owner, producer or consumer of energy which, given the sums of money involved, makes it of paramount importance to understand.
Translation: if you bet on shale gas for longterm power generation, you’re going to lose your shirt, and it may not take a long time for you to lose it.
Oh, wait: Citi GPS provided that translation at the end of the report, page 99, “Key Insights regarding the future of Energy”:
…We are currently in the midst of a more balanced energy mix but as conventional fuels become gradually more scarce and expensive and as new technologies improve, the long term transformation becomes more inevitable.
What do they mean by “long term”? Look at their main summary on page 85:
In summary, we believe that the global energy mix is shifting more rapidly than is widely appreciated, and most importantly that consumers face economically viable choices and alternatives in the coming years which were not foreseen 5 years ago. Accordingly, we believe that long term investment into some conventional fuels must be considered in the context of at worst the risk of substitution, or more likely lower demand than might otherwise be expected, with implications on prices and hence returns of those upstream projects. Moreover, the further up the cost curve conventional fuels are, the higher these risks associated with that investment. Investing in a project with an assumed 25 year life, when new technologies will be competing with that fuel in the first quarter of that project’s life entails significantly more risk than we believe is widely recognised. There will always be more subjective choice factors involved such as fuel diversity and energy independence that may offset cold, hard economics, but investors, companies and governments must consider the sea change that we believe is only just beginning.
A quarter of 25 years is 6.25 years, and they repeatedly refer to the changes that just happened in less than 5 years. So the “long term” they’re warning about is as soon as the next five years or less.
Back to page 99:
Infrastructure spend has been centered on “conventional” technologies (coal, oil and gas) keeping risks to upstream projects lower. / Energy substitution away from conventional towards renewables and the pace of evolution is vitally important to understand as the value at risk from a plant or the fuels that supply them becoming uneconomic in certain regions — both in terms of upstream assets and power generation — is enormous.
Citi GPS says it’s “inevitable” that renewables (solar and wind) will win, and understanding how fast is “vitally important”. And they’re just talking about economic consequences for energy companies. It’s even more vitally important for those of us who have much more immediate and local risks.
Why should we bet our property, environment, or communities on somebody else’s very short term profit?
As the report says, page 84:
getting a choice of fuel or technology ‘wrong’ could have dramatic consequences
And yes, local, state, and national governments can affect all this; page 99 again:
The impact of energy decisions taken by corporates and governments in power generation will have an impact on the upstream providers of the fossil fuels on which these plants will (or won’t) run, affect the demand for these commodities, as well as the price and the likely returns on upstream investments.
Make it harder for gas pipes to come through here and their pushers will find them uneconomic and pack up and leave.
Even more than that, this is an opportunity to lead; page 84:
Even small swings have profound financial implications across the energy industry
We right here in Georgia, Florida, and Alabama can refuse to invest our land and communities in a bad bet gas pipe and invest in solar power instead. That small swing could change the whole power industry.
Make it mostly distributed rooftop solar plus conservation to multiply the change; page 74:
50% reduction potential in volumes sold by traditional utilities through energy efficiency and more distributed energy
Distributed solar and energy efficiency both spell jobs right here where we need them, with reduced electricity bills and clean air and water.
No pipeline. Solar now for the sunny southeast!