By Tom Nelson - Head of Natural Resources
Deirdre Cooper - Portfolio Manager
Graeme Baker - Portfolio Manager
The fast view
- Human kind has harnessed the power of wind, water and sun for centuries. Wind-wheels and windmills have been used since the 7th century AD to grind corn and pump water, while the earliest recorded wind turbine for electricity generation dates back to 1887 in Scotland.
- The rise of renewables has been accelerated by the urgency of addressing climate change and the rapid improvement in the marginal economics of solar and wind powered electricity generation. Solar and wind today provide around 7% of global electricity generation.
- Subsidies do play a role – across all energy classes – and their impact on renewables is lessening as they become cheaper and more effective. In fact, the cost roadmap on renewables means that renewable electricity is cheaper than any other form of power in most parts of the world.
- While unpredictable weather patterns are a major challenge, the answer is more effective storage of generated capacity through better and cheaper batteries.The rise of renewables has been accelerated by the urgency of addressing climate change and the rapid improvement in the marginal economics of solar and wind powered electricity generation. Solar and wind today provide around 7% of global electricity generation.
- Neither nuclear nor Carbon Capture and Storage (CCS) are likely to be cost-competitive in the future. Nuclear still faces challenges around safety, public perception and technology.
- Our energy transition model highlights the major task of staying within a 2 degrees carbon budget. We believe the current pathway is inadequate and the potential ramp up in renewable energy is often underestimated.
- For asset owners there is significant risk and opportunities to integrate into portfolios reflecting the transition to renewable energy and electrification.
In, ‘Burning the midnight oil: What can history teach us about energy transition?’, we looked at the historic evolution of the world’s energy system, from wood to coal to oil & gas. And as stated in the lessons from history, the transition occurs between the dominant energy sources, though previous sources persist. And one of the most persistent energy sources is renewables.
Human kind has harnessed the power of wind, water and sun for centuries. Wind-wheels and windmills have been used since the 7th century AD to grind corn and pump water, while the earliest recorded wind turbine for electricity generation dates back to 1887 in Scotland.
The French scientist Edmond Becquerel is credited with discovering the photovoltaic effect in 1839 while experimenting with an electrolytic cell made up of two metal electrodes placed in an electricity-conducting solution. Water has powered human activities for centuries, with the first hydroelectric facility built in the US in 1882, with Canada building a plant in Quebec three years later. Indeed, in 2017 hydropower generated approximately 20% of the world’s total electricity.
Renewables – our current status
Primary energy sources, renewable or non-renewable, are energy sources before they undergo a human engineered conversion process to secondary sources, such as electrical or mechanical energy. Conversion of primary energy sources including fossil fuels and renewables into electricity currently represents 20% of the world’s usage of primary energy. The other major uses for primary energy sources are transportation, industry and heating for residential and commercial buildings. Looking specifically at the primary energy sources used to generate electricity, solar and wind power have rapidly gained 7% of the electricity market, while hydroelectric power remains the largest renewable contributor.
Use of primary energy | 2018
Source: BNEF New Energy Outlook, 2018 & Investec Asset Management, 2019
But while windmills and hydro dams dominate the historical narrative – other factors have brought us to this point.
Renewable energy first began gaining ground as concerns grew about diminishing reserves of fossil fuels and the security of energy supplies. However, the rise of renewables has been accelerated by the urgency of addressing climate change and the rapid improvement in the marginal economics of solar and wind powered electricity generation.
The cost deflation in both solar and wind power since the 1970s has been nothing short of remarkable, as shown below.
The price of a crystalline silicon photovoltaic (PV) module has fallen by more than 99% since 1976
Source: BNEF New Energy Outlook, 2018
Solar and wind are set to dominate
According to Bloomberg New Energy Finance (BNEF), a leading research firm, solar module costs are down 84% since 2010 and are forecast to decline by another 52% by 2025 as manufacturers improve efficiency across the production chain1.
Elsewhere, wind turbine costs have fallen 32% since 2010, with a further 40% fall by 2030 and almost 60% by 2050. Battery technology is also seeing enormous improvements and cost deflation, with an estimated 79% drop in battery costs since 2010 and a further 67% forecast by 20301. This represents industrial cost deflation on an almost unprecedented scale and partly explains why analyst estimates for installation of solar and wind generation capacity have consistently been too low, notably in the solar sector since 2005:
Annual solar additions outpace all estimates (LHS) & Cumulative solar installations beating predictions (RHS)
Source: IEA World Energy Outlook, 2018
This remarkable chapter of the energy transition story is not without jeopardy. What might get in the way of solar and wind power dominating market share over the decades to come? We consider four questions that investors frequently ask when considering renewables:
- Surely subsidies are playing a major role in the growth of renewables?
- What happens when the sun isn’t shining or the wind doesn’t blow?
- Will there be a resurgence in nuclear technology?
- Could advancements in carbon capture and storage slow growth in renewables?
Surely subsidies are playing a major role?
Subsidies do play a role – across all energy classes – and their impact on renewables is lessening as they become cheaper and more effective. In fact, the cost roadmap on renewables means that renewable electricity is cheaper than any other form of power in most parts of the world.
It is important to compare the cost of producing electricity from a range of different primary energy sources – because each incurs markedly different costs.
To determine the cost of energy generated by a new power plant, we typically look at the levelised cost of energy (LCOE). This is the sum of electrical energy produced over a plant’s expected lifetime, divided by the sum of the costs over that lifetime (typically between 20 and 40 years) – including the return on capital, which is effectively the power price needed to deliver a required return. This gives you an LCOE figure – usually expressed in units of currency per kilowatt-hour or megawatt-day.
According to BNEF, the LCOE of renewable energy is now cheaper than fossil fuel generated electricity in most parts of the world and will crossover in regions with higher financing costs in the near future.
2017 vs 2024 average cost of electricity production ($ per MWH*)
Source: BNEF New Energy Outlook, 2018
* Countries shown (China, Germany, India, United States) account for 50% of global electricity demand
What is worth emphasising, is that renewable electricity is cheaper than fossil electricity because the vast majority of its cost is upfront capital expenditure. In such scenarios, investors are not typically willing to commit debt capital without certainty on the power price – and so governments will continue to play an important role in facilitating and accelerating the growth of renewable energy.
Turning back to subsidies, and the viability of renewable energy technologies without subsidy support, there are two overarching facts to consider:
- While there are different tariffs, taxes and subsidies for different renewable energy technologies in different countries all over the world, in the main, subsidised support for renewables is being withdrawn as its LCOE comes into line with non-renewable sources of power generation.
- Second, subsidies are not unique to renewable energy. The fossil fuel industry has been supported by subsidies on a far larger scale for far longer. The International Energy Agency estimates the value of global fossil-fuel consumption subsidies in 2016 to be around $260 billion – and that figure has come down in recent years. Oil subsidies accounted for 40% of the total, or nearly USD 105 billion, covering an estimated 11% of global oil consumption. Natural gas subsidies were also significant, amounting to around $50 billion, affecting the price paid for 22% of gas consumption.
Looking more closely at the relative economics by technology and by region for renewable energy sources, the direction of travel is clear: increased scale, cheaper raw materials, improved efficiency and technological progress are enabling wind and solar in particular to displace traditional sources of power generation.
Source: Investec Asset Management, 2019
What happens when the sun doesn’t shine or the wind doesn’t blow?
While unpredictable weather patterns are a major challenge, the answer is more effective storage of generated capacity through better and cheaper batteries.