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Energy companies are dead already, they just haven’t realised it

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“The stone age came to an end, not for lack of stones, and the oil age will end, but not for lack of oil” (Sheikh Yamani OPEC co-founder and former Saudi Arabian oil minister)

Source: blog.trade.gov

Source: blog.trade.gov

Electricity companies around the world will begin to go bankrupt by 2018, even while they generate profits. It sounds absurd doesn’t it? However, hear me out.

By now everyone has read the headlines. “Tesla Powerwall changes everything, electricity death spiral, energy storage revolution, the Kodak moment for electricity etc.” This was the hype of 2015.

In 2016, reality set in, many households realised a $A17,999 5kW SolarEdge system with a 7kWh Tesla Powerwall would take about 17 years to pay back. These were sobering figures considering most equipment warranties are only 10-12 years. However, in just 2 years this payback equation will be radically different. It will rock the very foundations of modern society, creating and destroying fortunes across the planet.

I contend that it is not widespread adoption of energy storage that will hurt electricity utilities, but instead it is Grid Parity incumbents should be concerned about.

Grid Parity will occur in 2-3 years. Grid Parity is a clear short signal to innovative traders that the 100-year-old electricity delivery model is about to rapidly unravel. Grid Parity will be the stimulus for traders to invest in all manner of short instruments that can capitalise on the convexity that will soon occur in this space.

Algorithmic momentum trading strategies will then cause many listed utilities that are running even conservative debt ratios (30% or less) to rapidly lose market capitalisation value, sending these previously conservative debt ratios to nosebleed levels.

Once a “whale” trader gets a sniff of this once in a lifetime opportunity the herd will all pile in crashing utility valuations around the planet in a matter of hours. The Plunge Protection Team1)Group, and colloquially the Plunge Protection Team) was created by Executive Order 12631, signed on March 18, 1988 by United States President Ronald Reagan. will provide a series of short term relief measures, suspending trading in these entities before valuations continue their inevitable and terminal decline. Make no mistake, this event, which is perfectly foreseeable poses serious global systemic risk. Let’s join some dots and present the grid parity bear case.

In 2015 Bloomberg New Energy Finance released analysis showing long term costs in solar and energy storage had fallen by ~20-25%/annum. Shortly after, in November 2015 Dubai achieved an earth shattering utility scale solar price of less than 3 cents/kWh – cheaper than coal. Even at the residential scale solar is cheaper now than most retail tariffs around the western world. See chart below.

Figure 1 BNEF solar & energy storage experience curves clearly illustrating the 20%/annum falls in price

Figure 1: BNEF solar & energy storage experience curves clearly illustrating the 20%/annum falls in price

So, using the above BNEF example and taking a conservative 20%/annum decrease 2)When the Tesla Powerwall Gen 1 was announced by Tesla in May 2015 costs were ~$350/kWh – just 6 months later Chevy announced its LG Chem powered Bolt had achieved pricing of ~$145/kWh in prices the Tesla Powerwall SolarEdge package with a current price of ~$A17,999 will become ~$A8800 by 2018- 2019.

For many households this represents a payback of 4-6 years.

This is radically different economics resulting in levelised cost of energy (LCOE) below 25.5c/kWh – grid parity or below in many countries and a short signal for innovative investors. Innovative traders and institutions should be purchasing Credit Default Swaps (CDS) 3)Credit Default Swaps were developed by JPMorgan and Blythe McMasters in the late 1980s to insure the Exxon Valdez. Many traders, analysts and regulators contend it was CDS positons that exacerbated and dramatically accelerated the 2008 financial crisis following the collapse of Lehman. A CDS is effectively a bet that a company will default on its debt obligations and likely collapse. on incumbent utilities that look increasingly “subprime”.

The chart below illustrates technology uptake curves over the last 105 years. It is clear as digital technology began to proliferate the uptake trajectories steepened and many items reached saturation levels (>85% penetration) in less than ten years. So regardless of parity and profitability unless incumbent utilities radically transform their businesses in less than ten years they will be relegated to the dustbin of history.

Figure 2Technology uptake S-curves since 1900 (the large shaded area is the Great Depression and World War II.

Figure 2: Technology uptake S-curves since 1900 (the large shaded area is the Great Depression and World War II.

At the industrial and commercial scale where the bulk of Gentailer revenue is derived, the economics of solar and energy storage are already in the 4-6-year payback range. Digital technology including Virtual Power Plants (VPP) as well as the multitude of other services outlined by Rocky Mountain Institute (RMI) in their seminal paper The Economics of Battery Energy Storage can accelerate solar and storage payback periods from the already compelling 4-6 years to as little as 3 years.

This should be truly terrifying to any incumbent Gentailer CEOs and their shareholders. Yet worldwide most of the individuals managing these soon to be stranded assets are either in extreme self-denial, consciously lying to preserve shareholder value until they have developed a new revenue stream, or just oblivious to the disruptive technology on their doorstep. Unfortunately, all of these approaches create systemic risk more serious than what we experienced in 2008.

I contend that listed utilities around the world are what Warren Buffett and Ben Graham have termed “Cigar butt businesses”. Like a cigar butt you find on the ground they have one more puff of “goodness” before they are truly a disgusting investment.

So the question I have is, if a little ole trader from Tasmania has worked this out, what large institutional funds around the world have also worked this out and how are they positioning themselves?

Furthermore, who is going to pay for this rapidly accelerating train wreck that is likely to wipe out pension funds and small and large investors alike? Are energy companies Too Big to Bail (TBTB)? Stay tuned for Part 2 of our analysis—Trading Fossils into Extinction.

  

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References   [ + ]

1. Group, and colloquially the Plunge Protection Team) was created by Executive Order 12631, signed on March 18, 1988 by United States President Ronald Reagan.
2. When the Tesla Powerwall Gen 1 was announced by Tesla in May 2015 costs were ~$350/kWh – just 6 months later Chevy announced its LG Chem powered Bolt had achieved pricing of ~$145/kWh
3. Credit Default Swaps were developed by JPMorgan and Blythe McMasters in the late 1980s to insure the Exxon Valdez. Many traders, analysts and regulators contend it was CDS positons that exacerbated and dramatically accelerated the 2008 financial crisis following the collapse of Lehman. A CDS is effectively a bet that a company will default on its debt obligations and likely collapse.
  • Peter Davies

    Distributed Biomass Power systems of 50-400kWe capacity are already below 15c/kWh cost. Half this if your biomass is part of a waste stream…

  • Malcolm M

    There will still be some value in the grids for cloudy days, for those who don’t have sufficient roof space to power their home, and commercial and industrial users. If we take Royalla solar farm as a solar panel proxy for Canberra (http://energy.anero.id.au/solar-energy/2016/july), there were 3 days in succession in July when the capacity went barely above 20%. It would take a large solar panel and storage system to support household energy use through such an extended period. Southern Victoria and Tasmania receive less sun than Canberra.

    Some houses (such as the family home I grew up in) are largely shaded by trees, and would have insufficient unshaded roof area for solar cells to support normal household use, while others such as townhouses or apartments would be in a similar position. Large commercial users such as cement works and electric train systems are unlikely to have sufficient collection area to support their needs, and would be dependent on some level of grid supply. Nevertheless asset write-downs will need to occur.

    • nakedChimp

      transport companies do (as do other industries, especially high tech) try to source their power from renewables to get their cost down.
      They surely need the grid to get it there, but they don’t need all those “bells and whistles” that come with it currently 😉

  • winfield100

    nice pair of graphs, illustrating drop in cost of PV (~appx $101US in 1975 to ~appx 50 cents of so in 2015) and especially other graph of speed of uptake of technologies. One point you leftout/skimmed is cost of T&D, (~5cents/watt?) (transmission and distribution) and how when you can generate it at that cost on your roof, the utilities would need to pay you to take it. also read Tony Seba’s stuff about “Clean disruption”
    enjoy reading this stuff from Florida, USA

  • solarguy

    This is a likely scenario. Jerremy Leggett has been on to this for some time. As we need the grid to many failures will truly cause disaster.

  • Mark Roest

    Great story! As solar and batteries take over, the aggregators can make them look like power plants & sell into the wholesale markets, like in Germany, and the reason for the central generation and radial distribution model disappears.
    The smart microgrid and network model should take over, and we can use public policy to prepare for a transition in that direction, with understanding that the sudden shock collapse of utility value can indeed happen. Part of the policy can be designed to immediately shift control from the utility to microgrids if they are there, or nationalize if they are not there, so that the cash flow can be used to put the microgrids, and the appropriate control systems, in place. This can be done cost-effectively: a few years ago, Marin and Sonoma Counties in California created non-profit Community Choice Energy (the legal term is Community Choice Aggregation, but it does little for marketing) agencies which buy the electricity with strong preference for renewables, and the result is usually very high renewable percentages, yet prices well below those of the investor owned utility (IOU). This year, San Mateo County, Santa Clara County, and San Francisco County (and all the cities in them, except San Jose, which will do its own CCE) decided to follow their lead. That is an enormous portion of the PG&E rate base!

    The utilities still make a regulated, modest profit on their sunk costs, and on maintaining the distribution system and handling billing for the CCEs. One of them is using the surplus to fund charging stations for EVs, and others will follow that lead.

    Meanwhile somewhere between 25 and 50+ cities across California are moving to follow the lead of the pioneers — doing studies, and starting to take the next steps, based on positive study results. We’re sweeping the state! Given that the IOUs have been monopolies, the CCA law sowed the seeds of a revolution, and they are now bearing fruit!

  • phred01

    Many junk bond Co will be refinancing around 2020 This will be come testing time many of the non performing loans will created a devastating train wreak

  • Neo Lib Yes

    So far as I know they are still using stones, however mankind got a bit smarter and is milling them to extract minerals or manufacturing building materials. If you think the grid or even coal powered power stations will have a Kodak moment and collapse, then I believe you will be disappointed. The grid will just get smarter and I don’t believe consumers will actually depart, they will stay connected and import and export as part of an interconnected demand management system. Much as we would all like to see the end of CO2, the ultra supercritical coal fired power stations are actually better for the environment, if smartly used than gas. The burning of gas might be more efficient and less harmful than coal, however add in the extraction impact and it is worse than coal. What we do need now is for Frydenberg to cobble together a long term plan, however Labor and the greens will hysterically oppose anything that has any degree of common sense. In any event, the states will probably just get on with business and we will muddle our way through.

  • Dan Neumann

    Really good article, keep up the good work Leon!

    I’ve only skimmed some of the comments but someone mentions Jeremy Legget who also does a lot on this type of subject, although usually from a slightly different angle – stranded assets as a result of unburnable carbon limits. Some of the groups he’s involved with (carbon war room I think) have done an analysis in a series of reports to show which of the energy majors, either in coal, oil or gas have the largest future potential financial exposure as well as broken this down by country. Might be of interest to anyone who liked this article.

    I’m also a big fan of the work done by RMI, although I’ve not read the report mentioned in the article, so thanks for giving me something to read.