2023-12-21 07:35:00 ET
Summary
- The final installment in the 4-part Energy series. "Alternate" energy has been growing as a source of U.S. energy and especially electric generation.
- Solar and wind have been growing fastest but may be running into roadblocks.
- Because solar and wind are intermittent sources, we will almost certainly need one or more "base load" type sources to grow as well (candidates are small-scale nuclear, geothermal, and hydrogen).
- Reasonable projections confirm that we will continue to use a large amount of natural gas to generate electricity until 2050 and almost certainly well beyond that date.
Co-authored with Philip Mause.
This is a follow-up article discussing the macroeconomic forces at play in energy that have influenced our stock selection in the sector. There has been a shift for the U.S. from being a net consumer of energy to a net producer. This means opportunities for income investors like us! Part 1 of the series laid out an overview, Part 2 covered Natural Gas, and Part 3 focused on Oil. Today's final article of the series will cover "Renewables" and "Alternate Energy."
We have chosen the neutral title "Alternate Energy" because phrases like "Clean Energy" presuppose a conclusion (that the energy described is actually "clean") that may be debatable and are, in that sense, self-congratulatory like the phrase "health food" which presumes that the food to be described actually improves health.
Alternate energy includes wind, solar, wood, other biomass, hydro, geothermal, and emerging technologies (deep geothermal, nuclear fusion, small nuclear, and anything else on the horizon).
Looking at the issue from afar, mankind sits in a sea of energy from the sun, from the center of the earth, in the form of wind, locked in atoms, etc. The amount of energy that mankind uses and needs to use in the future is trivial in comparison with the energy that surrounds us. In a real sense, then, the energy problem is a technology problem - harnessing the massive energy around us in a safe and structured manner to do the work we need to get done. Thus, "alternate energy" should - as time passes - play a larger and larger role in solving the energy problem and promises enormous returns for properly targeted investments.
Oddly enough, alternate energy includes some categories that have not been growing much at all in the relevant period (2007-2022), e.g., hydro, and others that have been growing very rapidly (wind, solar). For some of these technologies, there is a raging debate about whether they can truly be described as "clean." Thus, wood pellet technology has grown considerably in terms of U.S. production while consumption takes place primarily in the EU or Japan. This is probably due, in part, to a debate about whether it is sufficiently (or at all) effective in reducing carbon dioxide emissions. Similarly, although ethanol is one of the leading sources of alternate energy, there is still a debate about the degree to which it actually produces less carbon dioxide on a net basis than gasoline. For this and other reasons, its growth seems to have stalled.
The table below provides the BTU equivalent production levels (in trillions of BTUs) for each technology in 1990, 2000, 2007, and 2022. For electric generating technologies, including solar, wind, and hydro, we calculate the number of kilowatt hours produced and multiply by 10,000 (a common heat rate for fossil fuel plants) to produce a "fossil fuel equivalent" BTU production level. Biofuels include ethanol and biodiesel, geothermal includes both geothermal electric and the geothermal energy used in "ground heat" heat pump systems, and solar includes solar thermal as well as solar electric.
Solar | Wind | Hydro | Geothermal | Wood | Biofuels | |
1990 | 168 | 33 | 2997 | 189 | 2216 | 111 |
2000 | 207 | 57 | 2820 | 207 | 2282 | 233 |
2007 | 171 | 354 | 2535 | 273 | 2089 | 970 |
2022 | 2283 | 4452 | 2682 | 366 | 2122 | 2511 |
We can see that Hydro and Wood have reached pretty much a steady state. There is some potential for further increase, but there are some issues. Wood pellet technology permits the burning of wood in power plants to produce electricity (it can be mixed with coal), but there is controversy as to whether it is really "green." Hydro has plateaued as the best sites have been used already. Biofuels had a big increase largely due to ethanol, but it seems to have hit a plateau around the middle of the past decade due in part to a limit on how high a percentage of ethanol engines will tolerate before running into maintenance issues as well as the issue of how much of our corn production we want to use this way.
Geothermal has had some increase due to ground heat. Geothermal electric has potential but has not yet materialized in a big way.
Solar and Wind have increased enormously and are generally considered the favorites of the green community. In the last year or so, they have run into various roadblocks. Although wind output has generally increased considerably each year, data from the first seven months of 2023 shows a year-over-year decline in output. What is going on?
The Rising Cost Curve Due to Siting
With respect to both solar and wind, there is enormous variation in terms of the desirability of siting locations. Some sites have better exposure to wind or solar resources. Some sites are closer to existing grids which can accommodate the additional generation of electricity with less expenditure on transmission lines. Some sites are in locations that are unlikely to provoke popular opposition. Adding all of these factors together, there is an enormous variation in the economic attractiveness of different sites.
Not surprisingly, the better sites tend to be utilized first. This is, of course, dramatically illustrated with Hydro, where the best dam sites seem to have been used up, resulting in a no or low growth situation. With respect to wind, some of the areas with the best wind resources are far from load centers and may require the construction of long and massive transmission facilities. Offshore wind appears attractive, but it has generated considerable opposition.
Adding up all of these considerations, it is highly likely that certain costs and delays will increase as we move up the siting cost curve. They may reach the point at which growth slows or stops. Of course, it is possible that technological advances will increase unit output or decrease deployment cost and thus will at least offset the higher costs associated with moving up the siting cost curve. That appears to be what has been happening, but there is no assurance that it can continue forever.
The Tilted Playing Field
In the United States, the legal and political systems are often tilted in favor or against various outcomes. For example, in many large cities, landlord/tenant law is heavily tilted against landlords, creating all sorts of roadblocks to the eviction of tenants.
As a general matter, our legal system has become tilted in a way to impede the construction of large projects of any kind - local autonomy favoring NIMBY movements, liberal "standing to sue" rules, requirements of environmental impact statements, protections for endangered species, preservation of historic artifacts, and many other provisions, create a rich toolkit for those opposing large projects of any kind. Local and national opposition groups can wage tenacious and imaginative warfare in court and in politics against big projects. These battles are often characterized as having a "David vs. Goliath" aspect as the press paints a picture of impecunious local groups of neighbors mustering against omnipotent corporate opponents. In fact, in the United States - a "nation of lawyers" - it is almost always possible for the opponents of projects to retain top-notch counsel - often on a pro bono basis. The tilted playing field creates innumerable opportunities to throw up roadblocks in opposition to projects. In many of these battles, victory is not necessary; it is often the case that a lengthy delay is enough to kill the project without any final decision on the merits.
For a long time, this tilted playing field empowered environmental groups and gave them the weapons to stop energy projects. Now, it is very ironic that this weapon system is beginning to be used against "green" energy. Solar and wind development requires not only the solar and wind facilities themselves but also - in many cases - massive storage facilities to manage the fluctuations in solar and wind production and, perhaps more importantly, huge transmission facilities, which must, in many cases, cross territory that will not directly benefit from the solar and wind resource. All of these facilities are vulnerable to the arsenal of legal weapons described above. We must bear these factors in mind when undertaking the difficult task of predicting the future path of alternate energy.
Future Prospects - "Stable AE"
In this category, we include the Alternate Energy sources, which do not seem to be experiencing a great deal of growth - wood, hydro, and ethanol. It would seem that this pattern will continue. There is a significant potential for importing hydro energy from Quebec but the latest attempt to gain approval for a transmission line through the State of Maine failed. It is always possible that it will be revived, but that is not likely. There is some potential for more development in the U.S., but it would meet with opposition and not be cheap.
Ethanol has experienced huge growth this century, but since the middle of the last decade, it has flattened out. One issue is the use of massive amounts of corn and competing needs for the use of corn as animal feed and human food. Another problem is that when the ethanol content of gasoline exceeds a certain percentage, it creates engine maintenance issues. Given the likelihood that there will be a shift in powering the vehicle fleet to electricity, there may also be less "room" in the future for ethanol as vehicular fuel. The Green movement has not unanimously embraced ethanol, so there is not likely to be a massive push for its expansion from that direction.
Wood production as an energy source has been growing because of the pelletizing of wood and its use as an electric generating fuel - often mixed with coal in coal-fired power plants. This qualifies as "green" in Europe, but there has been a considerable amount of controversy as to whether - when the full cycle is analyzed - the use of wood this way really reduces carbon output. I think there is potential for more wood production in the U.S., but it seems that the wood will most likely be used in the EU, UK, and Japan.
Future Prospects - "Exotic" AE
Given some of the issues with wind and solar and the limited prospects for expansion in "stable" alternate energy, there is considerable interest in new or emerging alternate energy technologies. Most of these are in relatively early stages of deployment or development so predictions of future use are difficult.
Small-scale nuclear has gotten considerable attention, and there are plans for deployment. While it has the advantage of being less obtrusive and expensive on a per-plant basis than large-scale nuclear, it would take a number of small-scale facilities to generate the amount of electricity that a single large-scale plant can generate. This could require multiple siting disputes and perhaps multiple transmission line construction disputes. The jury still seems to be out on the issue of economics and public acceptance of this technology.
Geothermal electric has considerable theoretical potential because of the enormous amount of heat energy under the surface of the planet. Certain locations are much more attractive for the deployment of this technology, and many of them may not be near load centers, so the technology might require massive transmission line investment. Geothermal electric - like small-scale nuclear - has the advantage of providing comparatively reliable energy and thereby obviating the need for massive investments in storage. There have been encouraging developments in accessing geothermal energy through horizontal drilling, and it may be that this will become an important source of electric generation.
Hydrogen is often mentioned as an attractive technology, but discussions usually focus on its use as a storage or transmission vehicle, and this does not really reduce carbon output. In this regard, electricity produced by solar or wind (or other sources), which might otherwise be wasted due to inadequate transmission or demand, can be converted through electrolysis into hydrogen and stored or used as vehicular fuel. It can be a useful way of storing or transmitting energy produced by intermittent sources, but it will not reduce the need for those and/or other actual sources of energy.
In addition, methane reformation can achieve the conversion of methane into hydrogen and capture the carbon; the hydrogen can be burned without the production of any additional carbon. There are other technologies for capturing hydrogen that are in various stages of development. The economics and other energy use associated with these technologies have to be taken into account, but some of them seem to be very promising as "clean" or at least "cleaner" technologies and are potential sources of clean energy.
On the other hand, there is an emerging technology of "natural hydrogen", which has the potential to be a clean energy source. Hydrogen, which has been produced by chemical reactions under the Earth's surface and is trapped beneath an impermeable rock, can be accessed with proper drilling techniques, brought to the surface, and used as a source of electric generation. This is already being done in Africa, and although we are at an early stage, there may be considerable potential for natural hydrogen as an energy source.
There are other "exotics" - nuclear fusion, tidal energy, methanol from plant waste, and others - that also have potential, but with respect to which the overall potentials are very hard to assess. Although the future is hazy, it is very likely that - due to the intermittent nature of solar and wind - one, or a combination of more than one, of the "exotics" will have to play a major role if we are to achieve a massive reduction in carbon emissions.
Future Prospects - Wind and Solar
Before getting into specifics, it is useful to look at a "big picture" projection generated by the "reference case" (assuming no policy changes) calculations of the DOE's EIA. The table below shows 2022 electric generation by source in billions of kilowatt hours and projections for 2050. The numbers are for total electric generation, including generation not going through the grid.
natural gas | coal | nuclear | hydro | wind | solar | geothermal | wood | total | |
2022 | 1685 | 849 | 772 | 276 | 440 | 205 | 16 | 40 | 4321 |
2050 | 1209 | 256 | 625 | 285 | 1218 | 1828 | 37 | 43 | 5520 |
The table that appeared earlier in this article showed that wind and solar had each grown by a factor of roughly 13 between 2007 and 2022. The EIA projections suggest a slowing down of percentage growth but still factor in a great deal of growth. A recent WSJ article points out that costs for solar, wind, and batteries have come down enormously during the period of recent growth, and this has contributed to growth at a higher-than-predicted rate. The EIA projections for total growth in demand for electricity seem reasonable. If the entire gasoline-burning vehicular fleet switches to electricity, that alone adds roughly 1000 billion kilowatt hours per year of demand, so that a 1200 billion kilowatt-hour increase may even be a conservative number.
Energy projections have had a horrible history of being wrong. As noted above, there is a possibility that one of the exotics will play a much bigger role than suggested in the EIA projections. Still, it is reasonable to assume that we have reached the point at which we can project major continued growth for wind, and - most likely, more so - for solar over the next 20 to 30 years.
The EIA projections in the above table are consistent with some of this article's observations. Hydro stays pretty stable, as does wood and nuclear. Coal declines a great deal. The overall growth in electricity output necessitates a continued large role for natural gas. And solar and wind increase enormously.
On the other hand, recent developments have raised some doubts about the trajectory for wind. The KWH production from wind for the first seven months of 2023 is below 2022 statistics. This is a sharp departure from the trend but appears to be primarily due to less wind volume due to El Nino weather patterns. While this may be true, it illustrates another issue associated with wind energy - the potential for not only hour-to-hour fluctuation in production but also significant year-to-year variations.
In recent months, there have been some project cancellations in the offshore wind sector. There has also been a chill created by higher interest rates. For solar and wind projects, a very high percentage of all of the cost associated with electricity generation is in the form of first or up-front costs. This requires advance financing, which is very sensitive to the level of interest rates. Projects which were attractive 3 or 4 years ago have become less attractive with current interest rates. This will probably restrain development as well as lower profitability for projects that are actually developed.
This year has also been a bad one for alternate energy stocks. Enviva (EVA), the leader in wood pellet technology, has been taken out to the woodshed. Hannon Armstrong (HASI), a funder of many projects, is doing badly. Atlantic Sustainable (AY) is down considerably. Green energy ETFs - Invesco Solar (TAN), Global Clean Energy (ICLN), Direxion Daily Global Clean Energy Bull 2X (KLNE), and Fidelity Clean Energy (FRNW) are all down considerably from recent highs. Some of these stocks seem to be forming a bottom. We do not have any recommendations in the sector at this time, but we are going through the rubble pile and may find some hidden gems ripe for a rebound.
In that connection, distributed solar (solar collectors on residential or commercial building rooftops) may be the most attractive target area. It generally does not attract the opposition associated with big projects, and it does not require the construction of massive transmission facilities. Electric utilities can stop distributed solar by enacting discriminatory rate structures, but that is a battle that the consumers may win. Distributed solar appeals to the American sense of rugged individualism and self-sufficiency. A solar system combined with storage in an area with a strong solar resource can also protect the customer from the impact of brownouts and blackouts. It appears that distributed solar may offer some attractive investment opportunities. We do not have any recommendations at the current time, but - again - we are sifting through the debris of the recent bear market in this sector.
In terms of the macro background to investment decisions, there are reasons to think that solar growth will continue to be very strong with costs declining and less NIMBY opposition than there will be against wind. Wind should also grow, but the EIA is projecting much slower growth for wind than for solar, which may be due to the exhaustion of optimal sites and/or increasing local opposition. One interesting aspect of the EIA projections is that - even with conservative projections of growth in demand for electricity - natural gas will continue to be a very large source of electric generating fuel.
I nvestment Implications - Fossil Fuels
The above considerations suggest that we are likely to continue using fossil fuels at a high level for a considerable time. The oil companies have become more reluctant to respond to price spikes with massive increases in capital expenditures on exploration and production. There is strong reason to believe that the natural gas part of the fossil fuel sector may benefit from increased electrification to the degree that the Green Movement persuades people to buy electric cars but is unable to meet the additional demand with green energy power plants, natural gas is likely to pick up the slack.
This reinforces our recommendation of conservative, well-situated fossil fuel stocks - namely Antero Midstream (AM) yielding 7%, Energy Products Partners (EPD) yielding 7.5%, and BlackRock Energy & Resources Trust (BGR) yielding 6.3%. We may soon have some future recommendations in the alternate energy area, as those stocks have declined substantially and may have descended into our strike zone.
For further details see:
The Massive Increase In U.S. Energy Production - Its Investment Implications (Part 4) - Alternate Energy