Emerging Markets’ Desperate Need for Renewables

In our October 28, 2013 commentary (“An Early 21st Century Narrative: The Age of Renewables“), we asserted that–due to increasing domestic crude oil production and the ongoing adoption of renewable fuels–U.S. energy independence on a national level is a foregone conclusion. The Energy Information Administration (EIA) chronicles that last year, as much as 84% of total U.S. energy demand was fulfilled by domestic sources, the highest level in 30 years.

Exhibit 1: U.S. Energy Production at 30-year High Relative to Consumption

domesticproduction2013

Interestingly, 10% of our domestic energy production now comes from renewables (including hydro, solar, wind, biofuels, and thermal). We believe government agencies in general are too pessimistic regarding the trajectory of the increasing impact of renewables on U.S. and Developed Markets’ energy production. For example, Germany (a country not known for its sunshine) recently generated over half of its electricity from solar for the first time, while Great Britain’s installed solar capacity doubled over the last year–none of which anyone has foreseen. Because of the rapid adoption of renewables, as well as the ongoing shale revolution, we continue to believe that U.S. energy independence on the national level is a foregone conclusion.

What we are more interested in–as investors and global citizens–are two more ambitious goals: 1) energy independence at the community or household level through microgrids and a “smart,” decentralized distribution system, and 2) bringing electricity and heating to more undeveloped areas of the world. The International Energy Agency (IEA) estimates that 1.3 billion people today are still without access to electricity, while 2.6 billion people have no access to clean cooking facilities.

This is a glaring social problem not just in Sub-Saharan Africa but in other developing countries/regions, such as India, China, and Developing Asia. e.g. The IEA contends that as much as 25% of India’s population today have no access to electricity. A country where a vast segment of its population is disenfranchised is both a significant impediment for future economic growth and social harmony.

According to the IEA’s 2014 World Energy Investment Outlook, global policy makers and corporations are projected to invest $40.2 trillion into our energy production and transportation infrastructure from now till 2035. 59% of these funds will be used to maintain current production, while 41% will be for new development. Two interesting trends are expected to continue over the next 20 years:

  1. There is a decisive trend towards investing into renewables and efficiency programs in both developed and emerging market countries;
  2. The role of public policy makers in shaping global energy policy has been on the rise, and will continue to rise for the foreseeable future as governments set goals for renewables adoption (e.g. California’s 33% renewables goal by 2020) and new efficiency standards.

Within the developed world, these two trends are driven by environmental and domestic energy security concerns. Within Emerging Markets, however, these are driven by more fundamental concerns. For example, economic growth and the rising cost of energy has led to a significant deterioration of China’s and India’s trade accounts in recent years. The rising cost of energy (combined with significant gold imports) was instrumental in causing India’s financial crisis last summer.

Exhibit 2: Oil Import Bills of Net Importing Developing Countries on the Rise (source: IEA)

oilimportbillEMSince 2011 (the IEA’s last study on Emerging Markets’ energy imports), energy dependence in countries like China and India has continued to rise. In fact, China’s oil imports are projected to rise above that of the U.S. sometime this year. As such, investments in renewables in both China and India are not only necessary due to environmental concerns, but national security concerns as well.

Finally, as discussed above, there is also a dire need to empower those who currently have no access to electricity in many developing countries, including India. This is crucial to sustain high economic/productivity growth, as well as for long-term social cohesion (having electricity inherently increases access to education, knowledge, and healthier lifestyles). The IEA estimates that an additional $641 billion in investments is needed to achieve universal access to electricity by 2030, $135 billion of which is needed in India. In light of the $40.2 trillion of projected investments in the global energy sector over the next 20 years, $641 billion is achievable. However, the IEA also stresses that much of these investments would need to be made in rural areas with little or no access to any existing infrastructures (e.g. power lines or even paved roads). Since the costs of building a centralized grid (or expanding the current grid) to rural areas are prohibitively high, the only alternative is to install microgrids or roof-top solar in such undeveloped rural areas. The age of renewables will thus not only bring U.S. energy independence, but increased energy access to the rest of the world as well.

 Exhibit 3: Additional Investment Required for Universal Access to Electricity ($billion in year 2010 dollars; source: IEA)

energyaccessforpoor

An Early 21st Century Narrative: The Age of Renewables

Brazil recently auctioned off the rights to its giant Libra oil field, and practically no-one attended the party. Any American under the age of 25 cannot imagine a world where half of the population lived under the follies of central planning; and any American under the age of 20 cannot imagine a world without the internet or instantaneous global communications.

Similarly, any American born in the year 2013 would not be able to imagine a world where there is even a debate on the viability of renewable fuels vs. fossil fuels. To them, it is a foregone conclusion that renewable fuels will be the main lifeblood of 21st economic growth and prosperity. We assert that much of the early 21st century narrative–particularly the years 2014-2020–will be driven by the “coming of age” of renewable energy sources, particularly solar, wind, battery storage technologies, and eventually, bio-fuels.

We have kept track of the energy industry since the end of the dot.com boom, when I worked as a natural gas & oil analyst in Houston, Texas. In an August 29, 2004 commentary (when WTI traded at $45 a barrel), I argued that WTI could be trading at $80 to $100 a barrel, while U.S. gasoline prices could top $4.00 a gallon over the next five to six years. The study of renewable fuels is an extension of this–the study of the evolving energy regime is important as energy forms the lifeblood of any modern economy, and to this day, still dictates much of global geopolitics. But more important, we believe renewable fuels will drive much of the growth in U.S. and European energy production from now until 2020. Power grids will become more decentralized while households will be subject to less power interruptions. U.S. energy independence at the national level is a foregone conclusion–what we are trying to achieve is energy independence down to the community or neighborhood level. This may be a more difficult feat given the entrenched interests of U.S. utilities, unions, and the amount of capital costs required to construct microgrids across the country. We also believe that this boom in renewable fuels production/infrastructure growth will coincide with the next secular bull market in venture capital and public equities.

Energy historians (e.g. Daniel Yergin–his Pulitzer-prize winning book “The Prize” is a must-read ) in 2020 will look back at the disappointing auction of Brazil’s Libra oil field as a watershed event in the global energy regime. The failure of the Libra field in generating much excitement heralds the beginning of the end of the “Age of Oil,” and not coincidentally, the shift of economic power from the “BRICS” and OPEC countries back to the United States as the latter, especially the state of California, invest substantial amounts in renewable fuels technology and infrastructure. Sure, the commercialization of the Libra oil field has been beset by political and ownership disputes, as well as overshadowed by the commercialization of U.S. shale. But the collective yawn by energy analysts and the U.S. population would have surprised me just a few years ago, when Petrobras’ stock price was still riding high.

Today, we are no longer as surprised. A recent (which I would label as conservative) study by Citi Research projects that $9.7 trillion of infrastructure investments will be made in the global power industry from now till 2030. Over 60% of this new power generation will come from renewables, including wind, solar PV, biomass, and hydro. As shown in the following charts, the majority of renewable investments would be in Developed Markets (U.S., Germany, the UK, etc.). In fact, Citi Research expects 40% of all incremental Developed Markets’ energy consumption during 2015-20 to originate from renewables (excluding hydro).

Citichart1

There is already plenty of evidence suggesting this projection may be conservative–the U.S. shale boom notwithstanding. Within the U.S., there is still an ongoing chorus to drill for more shale, including the Monterey Shale in California (if all of the Monterey Shale is commercialized, California’s oil production will surpass that of Texas). But this chorus is being gradually displaced by a broader movement to commercialize alternative energy sources across the world–e.g. the broader support for Tesla and its planned build-out of super-charger stations across the country, rooftop solar panels on new homes in California, and–as Citi Research points out (see below chart)–the displacement of peak generation by solar in Germany.

CItichart2

The penetration of wind and solar in Germany is expected to double in three years. This means in three years (and some of this may occur by summer 2014), wind and solar will “eat up” the vast majority of Germany’s baseload power generation during the middle of a sunny Saturday or Sunday afternoon. Installing battery storage technologies (Arizona is beginning to do this) will eventually allow German households to consume solar-generated power in the evenings as well.

We have come to a turning point in how our world (especially in Developed Countries) view, produce, and consume energy. We have detached ourselves from nature in every aspect since the beginning of the First Industrial Revolution in the late 1700s. Individuals no longer witnessed how we produced our energy on a daily basis. Points of production and power grids became centralized–dominated by giant corporations and sovereign entities. This too, shall pass. The Age of Renewables will usher in a new age of harmonization–driven by a secular bull market in cleantech and technology venture capital.

The New Energy Regime: The Diffusion of Power

While the civil society is often relegated to the back tier of social life … it is the primary arena in which civilization unfolds. There are no examples that I know of in history where a people first set up markets and governments, and then later created a culture. Rather, markets and governments are extensions of culture … The civil society is where human beings create social capital, and which is really accumulated trust–that is invested in markets and governance. If markets or governments destroy the social trust vested in them, people will eventually withdraw their support or force a reorganization of the other two sectors.” — Jeremy Rifkin, author of “The Third Industrial Revolution” and “The Hydrogen Economy.”

40 years ago this Wednesday, OPEC instituted its first embargo on countries (the U.S. and Netherlands) that supported Israel during the Yom Kippur war. WTI crude prices shot up by 400%. The 1973 OPEC Embargo represented a watershed in the global energy regime in two important ways: 1) It made clear to the world that America’s hegemony on oil policy and prices has ended. The “oil weapon” was successful in that it heralded an irreversible shift of oil policy and price setting power from the Texas Railroad Commission to OPEC (at its peak, the TRC controlled over 40% of U.S. crude oil production; ironically, the TRC’s prorationing model served as a blueprint for that of OPEC); 2) It made clear to the Nixon Administration that a coherent national energy policy is needed–made all the more urgent as U.S. crude oil production peaked in 1970 (although we won’t know that for some time).

Ever since the 1973 and the 1979 OPEC oil embargoes, the U.S. leadership has sustained the country’s energy needs through a combination of drilling more wells, better drilling and extraction technologies (e.g. horizontal drilling and shale fracking), importing more oil, and–at various times–experimenting with alternative sources such as wind, solar, biofuels, and even geothermal energy (California is the leading source of geothermal energy). In other words, there has been no national, coherent policy (aside from massive fuel-switching from oil to natural gas by U.S. utilities during the 1980s) other than continuing the old oil-based energy regime. The forays into what we called “alternative energy” have been half-hearted–in many ways, a gimmick to satisfy the growing chorus of Americans demanding cleaner energy and self-sufficiency. The fact that many of these technologies were not economically efficient did not help either.

This chorus grew louder as U.S. oil imports and crude oil prices continued to rise–peaking at over 10 million barrels/day in 2005 for the former, and nearly $150 a barrel in summer 2008 for the latter. The constant calls for a new energy regime is more than just a yearning or a tactical business decision for more efficient energy production.  Yes, as financiers, we need to be cognizant of economic returns and protecting our investors. And, for the first time ever, CB Capital is seeing sound investment opportunities in various “clean technologies” areas that are already or soon-to-be economical (more in latter blog posts and research reports). Rather, this ever-louder chorus–which began with a group of highly-committed “green” minority in the wake of the OPEC crisis and environmental movement–has turned into a broader social movement occurring in significant parts of U.S. civil society (in particular, the best-educated and most collaborative, the Gen-Ys). To paraphrase Jeremy Rifkin, the civil society–which is the foundation of our present form of government and dictates how our market functions–is setting the stage for the complete transformation of how Americans think about energy, and consequently, how we produce and consume energy in the future.

We contend that the 1st Energy Regime lasted from the beginning of recorded human history to the beginning of the First Industrial Revolution (1760 to 1780). Humans derived much of our energy sources from the sun–whether it is directly or indirectly (photosynthesis) through the consumption of plants or the burning of wood. Humans were more or less harmonized with nature on a daily basis. Societies that did not respect nature or who consumed resources in a non-sustainable manner simply disappeared (e.g. the Rapa Nui people on Easter Island). The 2nd Energy Regime–which began with the adoption of the steam engine and the replacement of wood by coal as a primary energy source–transformed how societies thought about and produced/consumed energy. Humans and societies became more disassociated and de-harmonized with nature. We no longer witness on a daily basis how our energy was produced (or how our cattle is slaughtered). We know that the production of fossil fuels has brought with it an environmental price–but as they say, out of sight is out of mind. We also became de-sensitized to wars and conflicts fought in the name of energy and oil security. It is also sheer madness that the U.S. is still deriving much of our crude oil imports from oppressive regimes and areas whose collective consciousness are still stuck in the pre-Enlightenment Middle Ages.

The U.S. is now ready for a 3rd Energy Regime–driven by both American civil society and sound economic principles. This 3rd Energy Regime has been 40 years in the making. By its 50th anniversary, we expect the U.S. energy infrastructure to have been completely transformed. We have in the past discussed the ongoing U.S. Energy Renaissance driven by horizontal drilling, fracking, and Lower Tertiary drilling; as well as more efficient energy consumption through the commercialization of additive manufacturing, self-driving cars, better battery storage technologies, and the eventual commercialization of the quantum computer. In ten years time, I expect a much-higher adoption of renewables (California is on its way to sourcing 33% of our energy through alternative sources), which would include solar, wind, and perhaps the re-introduction of hydrogen fuel cell vehicles into our auto fleet. While companies such as Google are continuing to make substantial investments in solar (over the last three years, Google has invested over $1 billion in solar generation), the largest clean tech investors are companies such as GE (which is known for only investing in high ROE projects), and interestingly, traditional fossil fuel companies. According to the Cleantech Group, three of the top ten largest corporate investors in clean tech are traditional fossil companies (see below table).

corporate clean tech investment

More importantly, commercializing technologies such as rooftop solar, more efficient battery storage, and smart grids would transform the U.S. power grid from a centralized to a decentralized one (see below diagram). In other words, power would literally flow back to individual family households. The Jeffersonian ideal and myth of the American self-sufficient yeoman farmer will thus come closer to realization.  We have argued that part of the 21st century narrative is a diffusion and democratization of power from governments, institutions, and corporations back to the individual–as long as said individual utilizes the tools and global networks available to him. The diffusion and democratization of power began with the Internet Revolution in the late 1990s. The commercialization and adoption of alternative energy in the second decade of the 21st century–what we call the New Energy Regime–will not only provide a more sustainable source of power and lifestyle to Americans, but will further empower the individual. We believe the concept of U.S. energy independence is not a pipe dream. In fact, U.S. energy independence is not good enough. We believe we could achieve energy independence down to the individual community or even household level as the energy grid is decentralized–as long as the American civil society continue to embrace renewable energy sources.