The Future of Energy Investment

The idea of using canaries in coal mines to detect noxious gases is credited to John Scott Haldane. He was known as “the father of oxygen therapy”. His research on carbon monoxide led him to recommend using the birds, as they were more sensitive to the gas than humans. If the bird became ill or died, that would give miners a warning to evacuate. The last canary retired in 1986 to be replaced by an electronic smell detector (incidentally the last pit pony was only retired in 1999). Will the coal mine now follow its one time employee, the canary, down the road of redundancy? The direction of travel in renewable energy is clear. Substantial gains have been made in the productivity of solar panels and wind energy. Recent developments in other fields, such as battery energy, re-affirm these developments. What is becoming increasingly clear is that our model of dependency on oil-based consumption will change. This will have a dramatic impact on the investment world and the small changes that are taking place now will become commonplace in the next 10 to 20 years. Wind and solar energy are disrupting a century-old market in providing electricity. The huge increases in productivity that were brought about during the Industrial Revolution in the UK, by the use of steam power and its underlying asset coal, are now drawing to an end. Energy Revolution The Industrial Revolution might just as well have been called the Energy Revolution. The advances that were wrought from being able to harness the energy within coal transformed humanity. The world’s population, which was 720 million in 1750, and had over the previous 1,000 years grown at a rate of 0.13%, started to shoot up. The growth rate peaked at 2% in the middle of the 20th century, leaving the world’s current population at 7.6 billion. In Germany, where the installation of solar panels has been encouraged by subsidy, the fall in demand for conventional electricity has caused dramatic changes to the domestic energy market. Germany’s two biggest electricity companies, E.ON and RWE, have been forced to separate their renewables and grid business from their conventional business. In total, it is estimated that utilities across Europe wrote off €120 billion worth of assets relating to the grid business between 2010 and 2015. A similar situation is evident in Australia where disconnections from the grid, due to huge investments in local solar infrastructure, have left fewer active consumers able to pay for its upkeep. Theoretically, if renewables were to make up 100% of the market, the wholesale price of electricity would fall to zero. In parts of southern Australia, grid upgrades have doubled network costs since 2008-09. Despite cuts to subsidies, Australian PV installations are expected to triple over the next decade. Australia has shut ten coal-fired power stations over the past seven years, yet coal still generates about three-quarters of its electricity. The challenge for investors is clear. Direct energy investments markets that sell commoditised kilowatt-hours need to be transformed into markets where consumers pay for guaranteed services. This is similar to the phone market where, in the past, the pricing model was based on price per minute. Consumers now pay a monthly package with their necessary services included. Future Markets In 2015, renewable sources accounted for only 7% of electricity generated worldwide. Over 80% of the world’s energy still comes from fossil fuels. However, 40% of new investment into energy is through renewable sources. By 2040, Bloomberg estimates that wind and solar will make up almost half of the world’s installed generation capacity, up from just 12% currently, and account for 34% of all the power generated, compared with 5% currently.. Large technology companies have invested heavily in this market and are continuing to do so. A recent fundraising for Noon Home, a digital light switch company, raised $50 million. In addition, approximately 22 million households in the US are now smart homes. In a similar vein Tesla has been remarkably successful in promoting its battery energy packs, which can store the electricity when there is no sun or wind..California has raised its goal of generating one third of its power from renewables by 2020, and has proposed raising the target to 60% by 2030. Germany’s goal is to become 80% renewable by 2050. Meanwhile, the pace of solar installations in China is likely to slow, following a record 34GW installed in 2016 (this equals 19% of Germany’s total current capacity). This is because the cost reductions are being matched by a drop in the subsidy in the feed-in-tariff that China pays to solar-power generators. Nonetheless, Bloomberg again estimates that from 2016 the amount of new renewable energy capacity in China is likely to have started exceeding new fossil fuel plants. It expects the same to happen in India from 2018. The main bulk of new investment in renewable energy will be in Asian markets. China and India will be at the forefront of new investments for some considerable period of time to come. Solar installation costs in these markets have reduced by 15% since 2015 and by over 80% since 2010. Solar costs now rival the cost of new coal power plants. It is estimated that China and India will represent a $4 trillion investment opportunity for the energy sector. China will account for 28% and India 11% of total regional investment between 2017 and 2040. The main driver for all this investment is the more than 80% drop in the cost of solar panels since 2010. Technological innovation may be tailing off but solar costs can now compete with coal and other fossil fuels on a level playing field. Conclusion The technological changes that are disrupting the world’s energy markets will lead to impacts at many levels. Large energy importers such as Japan will have to radically rethink how they provide energy to homes. The changes to employment markets will also be profound. Mining is a huge employer in many countries and re-training these workers will not be easy. Utilities in many countries face a death spiral, unless a shift in the pricing model is permitted. The challenge for investors will be to judge the appropriate time to invest in renewables as their installation price keeps falling, and at what stage (surely inevitable) regulators will permit a change to the pricing model. The energy intensity of many modern products is also reducing and it is conceivable that energy consumption in some developed markets will start to fall. In addition, political tension in some parts of the world may be reduced by the fact that more countries start to become self-sufficient and have less need to rely on neighbours for energy resources. As the growing ranks of Tesla drivers in the Grand Duchy would no doubt agree, the future is renewable. Enda Fahy Enda Fahy is Director of Alternatives at FundRock. Keeping a close eye on markets and industry trends is crucial to us being able to guide our clients. For any fund structuring / AIFMD queries please contact Enda.