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What can history teach us about energy transition?

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:

  1. Surely subsidies are playing a major role in the growth of renewables?
  2. What happens when the sun isn’t shining or the wind doesn’t blow?
  3. Will there be a resurgence in nuclear technology?
  4. 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:

  1. 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.
  2. 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.

Regional snapshots:


China

In China, which is the biggest single-country market for both wind and solar, onshore wind is already at cost parity with new coal plants on a LCOE basis at $57/MWh. The BNEF analysis estimates that in 2019 solar PV in China will also be cheaper than new coal plants1.

China needs to move away from coal rapidly for us to stay within the 2°C scenario 
Use the buttons below to toggle between 2018 vs 2050


US

In the US, onshore wind is already the cheapest source of new bulk electricity generation, at $38/MWh, and solar PV is expected to arrive at cost parity with combined-cycle gas in 2020 at around $40/MWh1.

Solar & Wind moves from 10% to 61% replacing Coal & Gas in our 2°C scenario
Use the buttons below to toggle between 2018 vs 2050


India

In India, onshore wind and solar PV plants are the cheapest sources of new bulk power generation: BNEF estimate the benchmark price for onshore wind to be $39/MWh (having halved over the last 12 months), while they see solar PV at $43/MWh, with aggressive competition having significantly lowered costs. At the same time, the cost of new-build coal in India is moving higher as tougher regulations on pollution control take effect, while gas-fired generation in the country remains expensive owing to a shortage of cheap domestic gas supplies and low capacity factors.

India has a huge challenge to move away from coal
Use the buttons below to toggle between 2018 vs 2050

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.

The enormous investment by automotive manufacturers in battery capacity will be very helpful in bringing down the costs of short-term generated electricity storage. But while lithium-ion batteries are ideally suited to managing short-term spikes in voltage and demand, they are not particularly well suited to managing longer term inter-seasonal peaks, particularly in markets with no tolerance for power outages. This challenge must be addressed by a range of different solutions, working in tandem.

These include more sophisticated demand response from energy users (itself facilitated by increasing factory automation – where activity is tuned more to efficient use of energy supply and less to the human working day), complementary renewable output (with wind at night and solar by day) and much smarter and more robust grids.

It may also need gas back-up. How much depends on how steep the renewables and battery cost curves are and therefore how expensive it is to build peaking power plants, or in other words, power plants that generally run only when there is high demand. Aurora, the Oxford-based energy consultancy, estimates that the investment costs of an 80% renewable grid in Europe would be 30% more expensive than a 60% renewable grid, and a 100% renewable grid would be 60% more expensive. The consultancy is effectively saying today it is more cost effective to build a gas powerplant to back-up periods of high demand, but it sees significant room for those numbers to decline if wind, solar and battery costs fall more quickly.


Will there be a resurgence in nuclear technology?

Nuclear fission energy, once the future, has suffered a devastating loss of confidence thanks to high profile, high impact disasters at Three Mile Island in 1979, Chernobyl in 1986 and Fukushima Daiichi in 2011. New facilities face political risk, public hostility and high and escalating costs.

For operators, the safety requirements for nuclear fission power plants have become much tighter after the Fukushima disaster – when a tsunami triggered events that led to a nuclear meltdown and the release of radioactive material. Now, ‘generation III reactors’ employ better fuel technology and more enhanced safety features.

But they are also costly. In South Carolina, construction to upgrade the Virgil C Summer nuclear generating station was abandoned after $9bn of sunk costs. In the UK, with energy provider EDF constructing two nuclear facilities at Hinkley point in Somerset, a National Audit Office recently observed the most recent LCOE of new build nuclear-generated electricity sits an extremely high level, between £82/MWh and £119/MWh2.

Such high and rising prices, when the cost of energy from renewable sources continues to fall, essentially nullify nuclear as a viable option.

Of course, there is the perpetual promise of scientific breakthrough in generating significant amounts of energy through nuclear fusion – but there is no certainty that anything workable will be available in scale in the limited timeframe available. The environment cannot wait.


Could advancements in Carbon Capture and Storage or NETs slow growth in renewables?

Carbon Capture and Storage (CCS) essentially sees a coal fired power plant capturing the carbon it creates and storing it in the ground. Long proposed as part of the solution to catastrophic climate change, the costs in carbon capture and storage remain extremely uncompetitive. In 2017, the Kempner Project – a Mississippi-based carbon capture project – was forced to revert to burning natural gas in the face of runaway costs, forcing its sponsor, the Southern company to take a $6bn write down.

Even more challenging are negative emissions technologies, or NETS, which seek to remove CO2 from the atmosphere. In the recent landmark IPCC report, only 9 out of the 90 scenarios investigated stayed below 1.5C, the other 81 all required NETs to remain within the carbon budget. The NET with the biggest potential is bioenergy with carbon capture and storage (BECCS). Plant matter is burned to generate electricity. The CO2 is captured and stored underground. More plants are then grown, absorbing CO2 from the air – this is burned, taking more CO2 underground and so on.

However, just to tackle one third of global emissions from the global energy sector, some 380 Mha of land would need to be given over to growing plants for BECCS facilities. To put this into perspective this is more than two times the total agricultural land in India. Growing energy plants sufficient to have a material impact on CO2 emissions would likely be in competition with land currently used for food production. What government would willingly reduce the availability of food for its population by allocating land to biofuels instead? Who would gamble on the future of tackling climate change by prioritising expensive and unproven technologies over the cost-effective, cheapening and proven? It is hard to see this type of technology playing a part in a ‘just energy transition’, which will not place the cost burden of the transition on those can least afford it. There are many examples, most recently in France, of misguided environmental policy creating the unintended consequence of social unrest.  


What further technology gains might we see in solar and wind?

If the threats to solar and wind are present, but are significantly overplayed and in some cases diminishing, both energy sources can offer positive news in future.

The size of wind turbines has been growing and will continue to do so. Larger blades, sweeping through greater vertical airspace can harness more wind, and can therefore generate more capacity – and if the tower is taller, the blades have more opportunity to harness the predictable winds that prevail at altitude.

This not only increases the potential energy that can be created but decreases the unpredictability of wind energy. The forthcoming GE Haliade-X turbine3, expected in 2021, stands almost 260 metres tall with blades over 100m in length.

Turbines could grow beyond this – with the only constraints being the materials to safely manufacture them and the infrastructure to transport and install the turbines.

Source: https://www.vox.com/energy-and-environment/2018/3/8/17084158/wind-turbine-power-energy-blades, 2018

The solar industry continues to see improving economics, through economies of scale and increased cell efficiency which, as with larger turbines, reduces balance of system costs. For example, a 500watt panel uses the same amount of glass and steel as a 200-watt panel but generates significantly more power. We would expect the solar learning curve to continue in the future.

A model for the future – the rise of renewables

With solar and wind increasingly dominant in the evolving energy system, we have produced a bottom-up global model of the world’s remaining carbon budget in a 2 degrees scenario.

We began work in 2016, drawing on a detailed view of the existing energy system, including the unique technical, social and economic parameters, in each country. We have since updated the model with Dr Daniel Quiggin, an expert in renewable energy systems.

The model features a large number of complex variables (not least the assumption that the initial carbon budget is correct) and it necessarily has a high margin of error. However, the output gives us an idea of what might be required in the future if we are to prevent temperatures rising above levels that will damage our planet and societies.

Carbon budget for global warming projections until 2100

Source: Climate Action Tracker Project, 2017, *UN IPCC estimates, 2016 – 2035, https://www.climate-kic.org/news/no-more-excuses-financing-1-5c, 1 The VaR represents losses of US$7trn at 5°C of manageable financial assets as calculated in 2015 by to the Economist Intelligence Unit, 2 The VaR from current policies is estimated at US$4.2trn, as calculated in 2015 by to the Economist Intelligence Unit

There are many potential pathways for the planet. Our model assesses how the carbon budget can be used to keep us within 2 degrees of warming by the end of the 21st century. This is the basis for the output and forecasts presented below.

Change in electricity generation consistent with a 2 degrees scenario

Source: Investec Asset Management, 2019

The model shows that we must move aggressively away from fossil fuel energy sources, especially coal, and further into renewable energy generation.

This can be supported by rapidly falling battery costs, demand response, energy efficiency programs and smart grid technology – allowing us to consume more renewable energy relative to fossil fuel electricity generation.

By 2050, the majority of renewable energy capacity installed will be wind and solar – with the aggressive move from coal happening in the 2020s and the addition of, on average, over 600GW of solar and wind per year.

The model assumes that electricity grows by 1.3% per annum (with assumed annual efficiency improvements of 0.7%).

To put the scale of the task ahead of us into context, in 2018 we added approximately 109GW of solar and 53GW of wind. This equates to an annual required growth rate in electricity generation of 10.3% and 7.2% for solar and wind respectively out to 2050.

To achieve this, we will need to invest almost $25 trillion in new power generation projects by 2050. Solar PV and wind will require over $16 trillion of investment, particularly in Asia.

Moreover, and in addition to the rapid greening of our energy system, the demand for electric vehicles will also need to grow. We see battery EV sales growing from the current 1mn/year going to over 600mn sold in 2050 – an annual growth rate of 16%.

Investec Energy Transition Model

There are several models available to asset owners, particularly BNEF and IEA, and our model is designed to complement this established work. It differs from incumbents in a number of areas, which include:

  • Carbon capture and storage and NETS are unproven technologies and we are not convinced they can be made viable given the scale and speed of the climate challenge. We exclude them.
  • Based on historic deployment rates, future scale up (the s-curve dynamic) could be achieved far more quickly.
  • Inclusion of emerging markets. Most of the growth for energy will come from developing countries – which is especially important when looking at carbon budgets that cover the next 88 years – and we believe a global approach provides a more accurate model to assess risk and opportunities.

We also think it is important to look holistically at electricity, transport (including heavy transport) and heat, and to calculate emissions based on life cycle analysis of products, from raw material extraction through to disposal or recycling.


These results highlight the mammoth task of staying within a 2 degrees carbon budget – and the huge responsibility now resting on governments and the private sector to act.

The current pathway is not enough and the potential ramp up to renewable power is underestimated by many. For asset owners there is significant risk and opportunities to integrate into portfolios reflecting the transition to renewable energy and electrification.


Potential 2°C scenario for renewables in 2050
Use the buttons below to toggle between 2018 vs 2050


Source: BNEF New Energy Outlook, 2018 & Investec Asset Management, 2019

 

1Source: BNEF New Energy Outlook, 2018
2National Audit Office, ‘Hinkley Point C’, page 20. https://www.nao.org.uk/wp-content/uploads/2017/06/Hinkley-Point-C.pdf
3https://www.vox.com/energy-and-environment/2018/3/8/17084158/wind-turbine-power-energy-blades


 


Important information

This content is for informational purposes only and should not be construed as an offer, or solicitation of an offer, to buy or sell securities. All of the views expressed about the markets, securities or companies reflect the personal views of the individual fund manager (or team) named. While opinions stated are honestly held, they are not guarantees and should not be relied on. Investec Asset Management in the normal course of its activities as an international investment manager may already hold or intend to purchase or sell the stocks mentioned on behalf of its clients. The information or opinions provided should not be taken as specific advice on the merits of any investment decision. This content may contain statements about expected or anticipated future events and financial results that are forward-looking in nature and, as a result, are subject to certain risks and uncertainties, such as general economic, market and business conditions, new legislation and regulatory actions, competitive and general economic factors and conditions and the occurrence of unexpected events. Actual outcomes may differ materially from those stated herein.
All rights reserved. Issued by Investec Asset Management, issued February 2019.

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