The Impact of New Energy
James Henderson
December 2017
Temperature targets and the Carbon Budget
• Generally assumed that the 2 degree target will only be met by restricting the
overall carbon budget to 1000Gt
• However, the range of estimates is quite wide, adding to uncertainty and
possible lack of commitment
Probability of temperature change versus carbon
budget
Global policy coverage
• Global policy cover on environmental regulation is extensive, but
implementation is the key issue
• COP21 provided no binding targets – companies are struggling to plan in an
uncertain environment
Security of Supply argument for Renewables
• Many countries are keen to reduce reliance on imports of fossil fuels
• Renewables can provide a growing source of indigenous energy
• They bring their own security of supply risk (intermittency) and arguably
make the long-term supply of other fuels more risky
Domestic economies can benefit from jobs in a new sector
• Number of jobs in renewable energy is rising rapidly – 6.5 million in 2013,
7.7 million in 2014 and over 8 million in 2015
• Meanwhile employment in oil and gas fell by 18%
Decarbonisation trends are key to energy economy outlook
• The global strategy for decarbonisation is the most important factor in the
future of the energy economy
• Changes in the power sector, transport and final energy demand will shape the
future of energy companies for decades
• The rise of renewable energy, and the increase in non-fossil fuel demand by
end-consumers, will force energy companies to adopt new strategies and
corporate structures
Global CO2 emissions reductions to reach 450 scenario
• Energy efficiency will be a vital component in reaching temperature goals,
essentially reducing energy demand
• The growth in renewables will be equally important, with other
technologies making minor contributions
Share of global energy consumption covered by energy efficiency
regulation
• Global energy intensity improved by 1.8% in 2015, twice the average of the
past decade and helping to halt the rise in CO2 emissions
• Mandatory efficiency regulation now covers 30% of global final energy use,
across all end-use sectors
• Low prices can undermine reform, though, reducing the economic incentive to
invest in efficiency (e.g. large cars in the US)
• Energy taxes (especially a CO2 tax) could offset this problem, but many
countries have been reluctant to impose a levy
European carbon price has collapsed
• European allowances for carbon were introduced in a traded market (the ETS)
in 2006
• Unfortunately, the economic crisis in 2008 led to an oversupply and the price
collapsed
• Adjustments are set to be made in the 2020s, but until then the price is
unlikely to have much of an impact on fuel use in Europe
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Europe Carbon Price (2012-2017)
The UK has its own system, which has demonstrably worked
• The UK government has introduced a carbon-floor price, which essentially
mandates a “top-up” payment above the EU ETS
• It is planned that the price should rise consistently to 2030, although this may
ultimately be subject to political and economic forces
• In 2016 coal use in power generation plummeted dramatically as a direct
result of the new tax
Continuous improvement expected
• The IEA expects energy efficiency to increase by 1% p.a. in its base case
scenario, helped by a global move away from heavy industry
• Electric motor use is set to rise dramatically, and efficiency regulation is
expanding in this area, covering 90% of new motors
• $300 billion is expected to be spent on efficiency in this area to 2040, although
this would be offset by a $450bn saving in new power generation requirements
• Most efficiency gains will be made in non-OECD countries as their energy
economies mature (China could improve by 3.5% p.a.)
Global Energy Demand Growth To Slow
• Overall conclusion is that global energy demand growth with slow
• In a world where GDP growth averages 3-3.5% p.a. energy demand growth is
likely to be closer to 1%
• The key question is how much of this growth will be accounted for by
renewables?
Power sector leading the way with renewables
• Power generation is currently the most advanced in terms of introduction of
renewables
• The heat sector in buildings will become vital post 2030, while industrial
decarbonisation will also be key to meeting climate goals
Electricity consumption is set to rise
• Electricity demand is likely to rise as part of a decarbonisation strategy
• As a result, the focus of the energy economy will be on how power stations are
fuelled, with the assumption that renewables will grow
• Key question for fossil fuels – how fast will the decline be?
The Electricity Sector Value Chain
• Electricity sector is a mixture of regulated and unregulated segments
• As renewable energy is introduced, and as demand patterns change, the
complexity for energy companies in all parts of the chain increases
Generation - Competition
End-User Supply -
Competition
Transmission and Distribution –
Regulated
Stylised merit order for power generation
• Historically generating companies have competed on the basis of a merit order
of generating costs
• The market price is set at the marginal price, which is paid to all power
producers who are called upon to dispatch electricity
The key players across the power generation sector
• Implications of renewable intermittency, decentralisation of power and grid
integration felt across the value chain
• Fossil fuel providers of fuel input face a much more volatile and uncertain
future
Global electricity generation by source
• Renewable energy currently accounts for 23.5% of global electricity output
• However, most of this is accounted for by hydro, which tends to be a very
controllable source of electricity
• Wind power is the largest source of new renewables
• There is no doubt that the future must contain more renewable energy, and
that it will change the structure of the global energy economy
Renewable power capacity and annual growth rate, 2000-2015
• Growth in renewable energy accelerated in 2015, to 9.3%, adding 154GW of
capacity
• Majority of additions in wind, solar PV and hydro, with the former two now
growing faster than the latter in absolute terms
• Since 2012 renewable additions have exceeded non-renewable
• By the end of 2015, renewable capacity reached 1,811GW - 28% of the
global total (of which hydro accounted for 58%, wind 23% and solar 12%)
Investment in renewables is growing, especially in Non-OECD
• Share of investment in Non-OECD exceeded 50% of total in 2015
• China accounted for 36%, as it expands it production capability
• Will there be a step change in energy output in Non-OECD that by-passes
fossil fuel transition?
Shift in the Power Sector Business Model
• Electricity sector participants are facing a major shift in their business model
• Previous status quo is being challenged and companies are having to adjust
dramatically – e.g. E.ON and Uniper split
• Changes will accelerate as technology continues to improve
Source: IRENA
Turning policy into action – the ultimate challenge
• The key question for incumbent suppliers is whether action will follow policy
statements
• Countries have committed to change, but specific actions are less clear
• Companies are being forced to bet on outcomes that may be the default
result of governments failing to achieve goals
Barriers to renewable energy deployment
Cost of Wind and Solar falling over time
• The costs of both wind and solar power have declined rapidly in a very short
period of time
• At the lower end of the spectrum cost competitiveness without subsidy is
possible in some countries
Levelised Cost of Electricity for Utility Scale Power (2010 and 2016)
• The cost of renewable energy is falling fast, and is getting very close to the
range of fossil fuel generation
• Once subsidies are no longer required, a tipping point could be reached
• Key question revolves around the cost of intermittency and the need to
provide back-up capacity
Capital cost reductions expected as capacity additions rise
• Cost reduction trends are expected to continue as synergy benefits increase
• Onshore wind has least far to fall because it is already competitive
• Solar is expected to benefit from the opening of new regions of the light
spectrum
Solar PV Auction Prices around the World
• The price of power at Solar PV auctions suggests that real cost savings are
being made
• Prices in the Middle East and South America emphasize the competitiveness of
solar energy in regions where the sun shines
Solar PV Installed Capacity and Potential Growth to 2030
• The growth in solar PV capacity has been dramatic, but is expected to
continue to be rapid
• Under some scenarios solar could account for around 40% of global
generating capacity by 2030
Source: IRENA
Solar PV Outlook – a variety of projections
• There is a wide range of scenarios, however, underlining the huge
uncertainty involved in the development of the global energy economy
• To an extent policy makers appear to be relying on the Bill Gates axiom:
– “We will always overestimate the change that will take place in the next two years and
underestimate the change that will occur in the next ten.”
Source: IRENA
Wide Range of UK Electricity Demand Scenarios
• Electricity demand scenarios vary significantly depending on progress
towards decarbonisation goals
• Electrification can be a key objective if renewables come to dominate
the power sector
Source: National Grid
UK Generating Capacity Outlook Uncertain Even By 2020
• Renewable generation will certainly increase, and coal should fall, but the
outlook for gas producers is much less clear
• How do gas producers and power generators invest with this uncertainty?
Source: National Grid
UK Fuel Inputs for Power to meet Carbon Targets
• If the UK is to meet its carbon targets then nuclear will play a much more
important role, coal will disappear and gas will rely on CCS
• Renewables will obviously be a large share of the total, with wind leading
the way
• This could all change, though, if nuclear becomes less popular – what is the
alternative, and who will invest for it?
Source: National Grid
Impact on gas demand could be very profound
• Gas demand could fall very sharply in a green scenario
• However, if there is less renewable progress, then gas is seen as the
default fuel
• This could create major security of supply issues
Source: National Grid
The Scissors Effect on European Utilities
• The change in the electricity sector is having a dramatic impact on utility
companies in Europe
• Wholesale prices for electricity are falling thanks to the low marginal cost of
renewables
• Costs are rising because of low capacity utilisation of non-renewables
• Consumer prices are rising because of renewable subsidies, dampening
demand
Breakdown of levelised costs for different power technologies
• The cost breakdown of renewables is very different from most fossil-fuel
and nuclear technologies
• High capital costs necessitate government support via subsidies to ensure
a rate of return for the developer
• Low operating costs mean that short run marginal costs are very low, so
that a low price can be bid for dispatch
• Effectively, when the wind blows strongly or the sun shines brightly the
price of excess renewable energy can be zero or even negative
Capex
Renewables and the merit order effect
• Renewable energy has guaranteed dispatch, and so moves all higher cost
supply out
• The wholesale price declines as demand is satisfied at a lower level
Introduction of renewables alters supply curve
Share of hours in year with Electricity Price at Zero
• To date sub-zero prices have only occurred in Germany, the UK and the US
• However, as the volume of low cost generators rises they will become
increasingly prevalent in highly decarbonised economies
• The levels shown above rely on demand side management and storage, and
would be much higher in an “energy only” market
• Zero prices create a clear problem covering power system costs
Renewables create over-generation risk
• Net load (total electricity demand less generation from wind and solar PV)
varies dramatically according to weather
• As renewable generation increases, so low point gets lower, increasing the risk
of having too much base load capacity
• In a worst case scenario curtailment is required, undermining project
economics
The California “Duck Chart”
Hours of effective operation by Gas-Fired Plants in Spain
• The Spanish market provides a good example of the impact of renewables of
fossil fuel generation
• Gas-fired plant utilisation has fallen to below 20% on average, and many
station have been mothballed of shut down
• Low coal prices have also encouraged a renewables-coal mix, which has also
been seen in Germany
Prices declining while costs are rising
Storage options are likely to increase
• Multiple storage options are being explored to reduce volatility of
renewables
• A breakthrough in battery technology is the “black swan” for fossil fuels
Source: IRENA
Expansion of decentralised power in Germany
• Germany is a prime example of decentralisation in action
• Centralised power generators and distributors are left with reduced overall
demand but the potential for big spikes when the sun does not shine
• Who pays for the back-up capacity?
Source: IRENA
Intraday price curve has flattened as storage and demand-side
management improves
• During specific periods the weather can create huge volatility
• However, renewables can also smooth the demand curve on an intra-day
basis, especially when combined with demand side management
• This reduces the volatility in prices that provides one of the few
incentives for generators who are no longer base load
USD/MWh
Electric vehicles could have a big impact in the transport sector
• Total EV sales reached 0.8 million in 2016, up from 0.5 million in 2015
• Compound annual growth has been 75% since 2011
• China is now the largest market, with a CAGR of 100%
• EVs accounted for 14% of the total growth in the car fleet in 2016
EV impact on car sales growth
• A key argument for fossil fuels is when
the tipping point for growth is reached
• Electric vehicles can provide a good
example: at what point will EVs account
for all incremental growth in car sales
• At a 60% growth rate it could be as
early as 2020
Share of EVs in incremental growth
Year of tipping point
Total EVs at different growth rates
If EVs grow at 50% per annum, car manufacturers and oil producers
have some serious thinking to do
• Once the growth in ICE vehicles comes to a halt, vehicle manufacturers will
accelerate production and development of EVs
• This will create an unstoppable momentum towards an electric world of
transport
The car market if EVs take off
Incrementalgrowthincarfleet(mmcars)
Shareofincrementalgrowthincarfleet
Some infrastructure and technology issues
• Battery prices have been falling at 21% p.a. since 2008
• They could reach $100/kwh by 2020, at which point a car battery would
cost around $6,000
• Charging infrastructure has also expanded rapidly, doubling every year
since 2010
• Policy plays a key role – China has plans to build 5 million charging points
by 2020
Battery prices ($/kwh) Charging stations worldwide (‘000)
Behavioural economics could suggest rapid growth
• Consumer adoption will be vital to the success of electric vehicles
• If consumers start to think of EVs as an attractive and superior technology, then
historical analogies suggest a rapid growth trajectory
• A key element in the decision will be cost, and the debate therefore centres on
battery technology
US household penetration of new technologies EV share of sales and fleet, end of period
Optimistic longer term scenarios see dominance by EVs although the
variations in outcome are wide
The impact on oil demand could be very significant
• A loss of even 5 million bpd would be huge, given that oil demand has
historically grown by around 1mmpd per annum
• However, would a price collapse slow the switch away from oil?
Demand and change in demand for fossil fuels
• Oil, coal and gas continue to dominate the energy mix, and will do so for
the next two or three decades
• However, the incremental change in energy demand is increasingly being
filled with alternatives – when demand stops growing a tipping point is
reached and producers may start to panic
Source: BP (2016)
Total global energy demand grew by 127mtoe in 2015, of
which fossil fuels accounted for 65%
Marginal demand growth for fossil fuels could end as early as 2020
• On the assumption that global energy grows at 1% per annum and that
solar and wind maintain existing growth rates, renewables could account
for all marginal growth in energy demand by 2020
• There is clearly flexibility around this date – if global energy demand grew
at 2% and renewables by 10% the tipping point would be 2046
• However, given the increased focus on energy efficiency and the global
policy switch to renewables, sooner rather than later seems likely
Marginal supply of energy (mtoe)
Examples of Change in the UK Energy System
The UK provides some good examples of rapid shifts in energy use due
to new technology
Energy Consumption for Lighting
New energy sources had very small market share when “old” energy demand peaked
The Example of Coal – as a fuel dies its price collapses
Coal demand peaked in 2014…
…but the price has been falling since 2010
European Electricity sector is another example
• The European electricity sector is another example of ongoing change
• Demand for fossil fuels peaked in 2007, prices peaked in 2008 and the major
utilities have now had to undergo major restructuring
• Total demand is only 5% off its peak, but the combination of a slight
slowdown and a radical change in the mix has caused major turbulence
European electricity supply by source
Various scenarios for coal and gas in the power sector
• In the status quo scenario, demand for both gas and coal grows sharply to 2040
• However, in a decarbonising world, the opposite is true
• When will we know which scenario we are on?
• And how will producers react when we do?
Coal projections Gas projections
Differences of opinion on energy outlook
Estimates of growth in Wind and Solar Power Estimates of growth in Fossil Fuels
• There are numerous outlooks for world energy, all produced by bodies with
different vested interests
• However, one thing is clear – the level of uncertainty over the outlook for the
global energy economy has rarely been higher
• Timing, rather than direction of travel, is the key issue
ExxonMobil Outlook presents an Oil Company view
• Presented as a realistic version of the likely outcome – nothing will happen as
fast as expected, despite policy objectives
• Oil and gas demand continue to rise, coal demand peaks and renewables grow
rapidly from a low base
• However, climate targets are missed by a long way
What else could a major
oil & gas company say?
IEA scenarios show an alternative vision based on keeping
temperatures down
• The IEA presents an alternative view, contrasting existing policies with a 2
degree temperature growth scenario
• Overall demand grows much more slowly
• The contrast in coal, gas and oil shares is stark – all are in decline by 2040
• However, fossil fuels still account for 58% of the mix in 2040, even in the “450”
scenario
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2040 (450)
Coal Oil Gas Nuclear Hydro Bioenergy Other Renewables
Sharp capex cuts in oil and gas industry in 2016 and 2017
• Lower oil price and uncertainty over future leads to cuts in spending
• Short-term risk of under-investment and resultant supply shortage
• Companies struggle to balance long-term investment projects with short-term
demand requirements
• Price spikes could be an inevitable consequence if supply does not keep up
with demand
• Who are the main short-term winners and what are the implications for
security of supply?
How will oil and gas companies use their money?
• The managers of oil companies have some key questions to ask about how
they use their diminished operating cashflow
– New investment
– Pay down debt
– Dividends for shareholders
• A key question for shareholders and directors is what is the purpose of oil and
gas companies going forward
– Growing corporate entities?
– Dividend paying utilities?
Oil company sources and uses of fund (2016-2020)
Source: IEA
Annual investment in renewables must double to meet targets
• Investment in renewables fell to $227 billion in 2016, caused by removal or
reduction in subsidies in some countries
• Solar and wind continue to receive the most capital
• Overall investment must rise to $450 billion p.a. to meet temperature targets
• Furthermore, the balance of investment must move away from Europe and
North America towards the developing world
Innovative financing is starting to emerge
• To date asset financing has been the most prevalent source of investment
(loans backed by collateral)
• As subsidies are gradually removed / become less necessary, more innovative
forms of financing will be required
• Private equity and venture capital have played a role, and green bonds have
been introduced as a more general form of debt for a wider investor base
Differing investment requirements depending on policy outcomes
• IEA scenarios highlight the key issue – where to put investment dollars
• Annual investment in fossil fuels collapses in “green” scenario, but when will
we know what to spend – decisions need to be made in the next few years
• Even green investments carry longer-term risk – will they be overtaken by
new technologies
Conclusions
• The direction of travel is clear, the speed is not
• There is a long-term future for oil and gas, but at what price and with what
levels of volatility?
• Investment decisions with a long-term timescale need to be made soon,
when the view is very unclear
• The result could be a lack of short-term investment that could cause
greater price volatility
• Fossil fuel companies and banks are very unsure how to invest capital –
should it just be returned to shareholders?
• For renewables, the key issue is financing in a world where subsidies are
still needed but can be withdrawn at any time (e.g. UK)
Impact of decarbonisation on merit order of generation (2015-2040)
• As renewable energy sources grow they start to push other power
sources down the merit order
• When renewables is operating it is effectively first choice for generation
because of its low marginal cost
• If demand growth is also curtailed, the scope for alternative fuels is
further diminished