By now, we’re all well versed on the subject of Amazon disrupting retail, Aldi disrupting supermarkets and fintechs disrupting banking (admittedly to a significantly lesser extent). However, the most significant disruption is occurring right under our noses without us really noticing.
While disruption is just another buzzword for ‘change’, which has always been with us, there is no escaping the profound impact it has on old technology, incumbent businesses and legacy revenue models. It is important to understand the virtuous cycle that accelerates usage and revenue trends in technology.
When a technology advances, bringing down its price, it opens the technology to new markets. Increasing utilisation reduces the price further, opening up still newer markets, increasing demand, reducing the price further and so on … until of course another newer technology replaces it.
Keep that cycle in mind as we examine global developments in energy generation and supply. Energy is a commodity and the winner will be whoever can supply energy most cheaply.
Irrespective of your politics, it is vital to understand the trend in prices that wind is delivering. An exponential plunge in wholesale wind power prices was caused by generator rotor surfaces increasing, with their height increasing from 15 meters in 1990 to an estimated 150 meters in 2020. This change has resulted in more than 1000% growth since 2002 in global installed energy capacity from just 31 gigawatts (GW) to 487 GW at the end of 2016. In 2016 alone, a record 55.6 GW of wind power was installed. The average price of wind power contracts signed in the US wholesale electricity grid has fallen more than 95% per unit since 1980.
The tipping point for solar energy may now have been reached after which it becomes and remains the cheapest source of energy, without subsidies, in sunny parts of the world.
Improvements in technology and efficiency, and an increase in supply, has seen the average retail price of solar-generated energy plunge from US$77 per KWh in 1977 (according to some analysts such as Ramez Naam) to just US36 cents today. That represents a 200-fold fall in price.
To put the current prices in perspective, a new natural gas plant in the US costs about US5-6cents per kWh to build. A coal plant in India costs US4-5 cents. In China’s Gobi Desert, an unsubsidised solar array has been built for US5 cents per KWh, while last year, First Solar sold contracts to Berkshire Hathaway at US3.9 cents.
India is an enormous market for many manufacturers, and what happens there will have an impact on global manufacturers elsewhere, including Australia. In India in April 2017, the Rewa Ultramega solar power plant was put out to tender and the low bid came in at US4.5 cents per KWh, including labour, frames, modules, and land. The price represents a three-fold decline in just four years. This marks a tipping point according to many observers, making solar power the cheapest unsubsidised source of new energy.
Clean energy is the cheapest
If clean energy is becoming the cheapest source around the world, partly helped by record low interest rates, the utilisation rate of technology that relies on it will also accelerate. As it does so, the prices decline. As prices decline, new markets open up, penetration increases and prices decline again in a virtuous cycle that usurps and ultimately replaces old businesses models entirely.
All-electric vehicle cars will dominate India by 2030. China’s electric vehicle subsidy scheme may see any vehicle sales growth above the 2016 base line entirely filled by electric and hybrid vehicles. Volvo has said it will only make fully electric or hybrid cars by 2019. Car manufacturer announcements reveal that by 2021, there will be at least 143 electric vehicle models on the road compared with just a handful today. Norway has set a target of only allowing sales of 100% electric or plug-in hybrids by 2025. Some states in Germany are considering a 2030 phase-out of fossil fuel vehicles and France’s Macron has announced that France will ban the sale of diesel and petrol cars by 2040. But, if India reaches its target by 2030 and 100% of additional growth is mandated to be electric hybrids, there will be no petrol or diesel cars for France to ban by 2040.
In modeling the take up-rate of electric cars in Australia and what it might mean for Caltex or Santos, keep an eye on what is happening in India and China. It will not be Australians determining which cars are sold here, and trends in Australia will not determine what businesses survive.
A US company owned by Google, Nest, is working with the utility Southern California Edison to convince 50,000 of its customers to agree to install Nest thermostats which automatically reduce the amount of energy used during peak grid times. Nest could make wind and solar work better together, alleviating some of the concerns about base load power for utility companies and other industrial users.
Until recently the problem with energy independence for consumers has been storage. But Tesla recently took US$1 billion of orders for its battery technology in one week. Although Tesla-branded powerwalls are actually Panasonic batteries, it is the three-fold increase since 1990 in battery energy capacity per gram and the ten-fold drop in prices that has made storage viable. Tesla says batteries represent one-third of the cost of manufacturing an electric vehicle and the cost will fall five times in the next five years.
Impact on incumbents
The impact on incumbent energy companies may be a death spiral. If their customers are obtaining even 50% of their power needs independently, prices will rise, accelerating the emigration from their services. A small house with solar cells and a Tesla powerwall unit can have 70% of its power needs met, and that is a house in Germany with a relatively short summer. In Australia and India, much more of a household’s energy needs could be met off grid.
Battery prices are now dropping at a rate faster than wind and solar. Lithium Ion batteries, which deplete after 1,000 charge/discharge cycles, are quickly being followed by new technologies that will not deplete for 10,000 cycles. Demand allows scale, bringing costs down further, opening new markets and accelerating that virtuous cycle. Deployment of the technology will be exponential.
In the US, the four largest coal companies, including Peabody Energy, have fallen into bankruptcy in the last four years. Coal and thermal powerplant utilisation is declining in all major markets including the US, India, China and the EU. If the market for a commodity declines, there’s no escaping the outgoing tide for suppliers who are price takers with high fixed costs. Oil is not running out but is being replaced with better technology.
Watch the virtuous cycle of disruption
The speed at which the virtuous cycle of disruption takes hold is vital for legacy companies, and the impact on energy markets transcends business and economic cycles. For example, Australia’s stock market will not be as heavily-weighted towards fossil fuel energy and resource companies in future as it is today. Your financial security hinges on how quickly you spot and respond to these changes.
Roger Montgomery is Chairman and Chief Investment Officer at Montgomery Investment Management. This article is for general information only and does not consider the circumstances of any individual.