What the past can tell us about the green energy future
December 14, 2020
Peteris Celms,
BlueOrange Portfolio Manager
A concept often presented as a critique of the system, especially in the context of today’s push for sustainability, creative destruction is the process of industrial transformation that continuously revolutionizes the economic structure from within, dismantling long-standing practices in order to make way for new methods and technologies. In essence that constant innovation leads to obsolescence.
Creative destruction is best exemplified by the constantly evolving information technology sector. The most recent example of this phenomenon is the accelerated, widespread adoption of Zoom, Microsoft Teams and other videoconferencing and collaboration tools during the pandemic. It would be difficult to imagine that a year ago, next to nobody knew what Zoom was and now it’s become an indispensable tool for communication. That sort of accelerative change is phenomenal, but whether or not these tools “revolutionize” the way we do things (i.e. change from where we work, eliminate business travel, etc…) as some proclaim is not the point. Rather, it is the fact that their introduction and use by a large enough group of people will result in those same people finding other productive uses for those tools that have not yet been conceived of, and render obsolete the old methods that were in their place.
This is true for the internet in general, and most every sector of the economy, but its role in the energy sector is often an afterthought.
It shouldn’t be.
Modern civilization is what it is because of continued innovation in energy. And it’s been that way since the beginning.
Early industrial processes and the growth of industrial cities required ever-increasing amounts of firewood. As the costs of transporting timber from sites further and further away became more prohibitive, other solutions were sought out. This problem was so acute, that in Britain, it resulted in the forced adoption of coal to replace wood. The Industrial Revolution, and many of the innovations that followed were driven by the availability of coal.
First used for heating and powering steam engines for early industrial processes, continued innovation brought the invention of the coking process necessary for the wide-scale production of cheap iron. With time, new processes were developed to make cheap steel from this iron and create even more powerful machinery powered by steam, and so on. All that was needed was a little crisis to put that revolution into motion.
In the late 18th century, another fuel was coming of age: sperm whale oil. The British and Americans began sperm whaling because of its importance for public lighting and as a lubricant. A whole industry was made on the back of hunting these animals, only to collapse within 100 years. Pressured by the positive feedback loop of how lucrative the business was and high demand, excessive hunting decimated the whale population. At the same time, early oil drilling was beginning, another lucrative business in feeding the growing energy appetite. Add in innovations in chemistry that led to kerosene, and the days of sperm whale oil were always numbered. And so were those of kerosene, as electricity eventually replaced that too.
History teaches us many lessons, but here are just two:
1. When pressed to do so, inquisitive individuals find new ways to innovate to meet pressing needs
2. The consequences of these innovations are often far reaching, enabling the process of creating destruction
Impacting investments
In retrospect, it seems logical that an energy transition that upends the existing infrastructure of the economy and starts a trend of innovation across industries would be correlated with an upturn in the long-term business cycle.
For one, each new fuel-source has not only been more powerful than the last, but over time has become more efficient at generating greater and greater amounts of energy to feed the world’s increasing demand for it. And at the same time, energy abundance has been a push factor for the development of new machines to automate processes, reflexively increasing the demand for energy. The cheaper energy becomes, the more we want to consume it.
Secondly, in order for these transitions to happen, there is a prerequisite for enormous infrastructure investment to disperse that energy. This has downstream effects of putting a large number of people to work in the development of the necessary technology, the construction of the necessary infrastructure and sourcing of the necessary materials, ultimately having a positive rippling effect on the economy as a whole. And where there is money to be made in energy, investment will follow. Just look at the Middle East.
Historically, energy transitions have taken 50-75 years, as a change from one energy system to another requires going against the inertia of an increasingly embedded existing system, but it’s usually been a question of when rather than if that new energy source will spur a new wave of investment and economic development. But ultimately if a new fuel source is more efficient at meeting energy needs and costs less to do so, it is only a matter of time.
That is why, for example, the coal industry’s long decline has not been because of environmental concerns, but thanks to natural gas and super-efficient gas turbines that do a better job at generating energy. Although politicians in the United States have made proclamations about saving the coal industry, all they have done is prolong its decline.
Where are we now?
To put it bluntly, we are facing an unprecedented challenge to create a new energy system compatible with the long-term survival of high-energy civilization. We are not facing an exhaustion of energy resources in the sense that we are in danger of running out, but the ultimate question of whether we meet energy demand in a sustainable way. The Paris Agreement has set lofty goals to get the global economy to net zero emissions and seeks to answer this very question. The European Union is targeting net-carbon neutrality by 2050. China has announced its plan to achieve this target by 2060.
Achieving these targets will require unprecedented sums of money. In the case of the European Green Deal, estimates are in the range of €7 trillion in cumulative investments to 2050. There have been waves of big infrastructure spending programs in the past, and coincidentally they have often been spurred by economic crises that require stimulus to get people back to work. It should draw the attention of political leaders that, by some estimates, global decarbonization efforts could support up to 100 million jobs globally by 2050, potentially more than doubling global GDP. Add in the fact that there has never been a more opportune time to borrow, with interest rates low or negative across the developed world, and you have an extremely accommodative environment for investment.
At the same time, the concerns surrounding sustainability only continue to grow, demonstrated by the visibility and attention paid to ESG principles both by investors and the companies and projects they fund. On the other side of the increasing willingness to finance green energy projects is a loss of appetite for new oil and gas drilling, driving up the cost of doing business in old energy and scaring away new investment in potential stranded assets. Oil companies may very well be profitable for many years to come, but they themselves recognize the need for transformation, and are amongst the largest investors in green energy. These investments are being underpinned by increasingly attractive economics themselves.
In certain regions, renewables can produce electricity at a vast discount versus legacy thermal power plants. As renewable energy technologies continue to develop and economies of scale grow, further improvements are inevitable.
Yes, coal might still be around for a while, and natural gas and oil will be with us for even longer, but the pace of low-carbon renewable energy adoption is only going to accelerate as investors look for attractive future growth and governments deliver policy that incentivizes it. The divergent performance of the stocks of the companies in these sectors show that dynamic is already taking shape.
There are plenty of challenges that will need to be addressed along the way. New solutions for energy grids will be needed to make them more resilient to better manage the variance of intermittent wind and solar power. Battery technology will need to improve to deliver more efficient batteries to store more energy for longer. And then there’s the task of actually building out all the necessary renewable energy capacity to not only de-carbonize current electricity demand (e.g. pushing generation from renewables in Europe from 35% today to 85-90% by 2050) but also address the increased need to produce enough green hydrogen to power industrial processes with heavy emissions that cannot be electrified (by some estimates double today’s total electricity demand). Just to name a few.