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The energy disruptions with forever impacts

By now, we’re all well versed on the subject of Amazon disrupting retail, Aldi disrupting supermarkets and fintechs disrupting banking (admittedly to a significantly lesser extent). However, the most significant disruption is occurring right under our noses without us really noticing.

While disruption is just another buzzword for ‘change’, which has always been with us, there is no escaping the profound impact it has on old technology, incumbent businesses and legacy revenue models. It is important to understand the virtuous cycle that accelerates usage and revenue trends in technology.

When a technology advances, bringing down its price, it opens the technology to new markets. Increasing utilisation reduces the price further, opening up still newer markets, increasing demand, reducing the price further and so on … until of course another newer technology replaces it.

Keep that cycle in mind as we examine global developments in energy generation and supply. Energy is a commodity and the winner will be whoever can supply energy most cheaply.

Wind power

Irrespective of your politics, it is vital to understand the trend in prices that wind is delivering. An exponential plunge in wholesale wind power prices was caused by generator rotor surfaces increasing, with their height increasing from 15 meters in 1990 to an estimated 150 meters in 2020. This change has resulted in more than 1000% growth since 2002 in global installed energy capacity from just 31 gigawatts (GW) to 487 GW at the end of 2016. In 2016 alone, a record 55.6 GW of wind power was installed. The average price of wind power contracts signed in the US wholesale electricity grid has fallen more than 95% per unit since 1980.

Solar power

The tipping point for solar energy may now have been reached after which it becomes and remains the cheapest source of energy, without subsidies, in sunny parts of the world.

Improvements in technology and efficiency, and an increase in supply, has seen the average retail price of solar-generated energy plunge from US$77 per KWh in 1977 (according to some analysts such as Ramez Naam) to just US36 cents today. That represents a 200-fold fall in price.

To put the current prices in perspective, a new natural gas plant in the US costs about US5-6cents per kWh to build. A coal plant in India costs US4-5 cents. In China’s Gobi Desert, an unsubsidised solar array has been built for US5 cents per KWh, while last year, First Solar sold contracts to Berkshire Hathaway at US3.9 cents.

India is an enormous market for many manufacturers, and what happens there will have an impact on global manufacturers elsewhere, including Australia. In India in April 2017, the Rewa Ultramega solar power plant was put out to tender and the low bid came in at US4.5 cents per KWh, including labour, frames, modules, and land. The price represents a three-fold decline in just four years. This marks a tipping point according to many observers, making solar power the cheapest unsubsidised source of new energy.

Clean energy is the cheapest

If clean energy is becoming the cheapest source around the world, partly helped by record low interest rates, the utilisation rate of technology that relies on it will also accelerate. As it does so, the prices decline. As prices decline, new markets open up, penetration increases and prices decline again in a virtuous cycle that usurps and ultimately replaces old businesses models entirely.

All-electric vehicle cars will dominate India by 2030. China’s electric vehicle subsidy scheme may see any vehicle sales growth above the 2016 base line entirely filled by electric and hybrid vehicles. Volvo has said it will only make fully electric or hybrid cars by 2019. Car manufacturer announcements reveal that by 2021, there will be at least 143 electric vehicle models on the road compared with just a handful today. Norway has set a target of only allowing sales of 100% electric or plug-in hybrids by 2025. Some states in Germany are considering a 2030 phase-out of fossil fuel vehicles and France’s Macron has announced that France will ban the sale of diesel and petrol cars by 2040. But, if India reaches its target by 2030 and 100% of additional growth is mandated to be electric hybrids, there will be no petrol or diesel cars for France to ban by 2040.

In modeling the take up-rate of electric cars in Australia and what it might mean for Caltex or Santos, keep an eye on what is happening in India and China. It will not be Australians determining which cars are sold here, and trends in Australia will not determine what businesses survive.

A US company owned by Google, Nest, is working with the utility Southern California Edison to convince 50,000 of its customers to agree to install Nest thermostats which automatically reduce the amount of energy used during peak grid times. Nest could make wind and solar work better together, alleviating some of the concerns about base load power for utility companies and other industrial users.

Until recently the problem with energy independence for consumers has been storage. But Tesla recently took US$1 billion of orders for its battery technology in one week. Although Tesla-branded powerwalls are actually Panasonic batteries, it is the three-fold increase since 1990 in battery energy capacity per gram and the ten-fold drop in prices that has made storage viable. Tesla says batteries represent one-third of the cost of manufacturing an electric vehicle and the cost will fall five times in the next five years.

Impact on incumbents

The impact on incumbent energy companies may be a death spiral. If their customers are obtaining even 50% of their power needs independently, prices will rise, accelerating the emigration from their services. A small house with solar cells and a Tesla powerwall unit can have 70% of its power needs met, and that is a house in Germany with a relatively short summer. In Australia and India, much more of a household’s energy needs could be met off grid.

Battery prices are now dropping at a rate faster than wind and solar. Lithium Ion batteries, which deplete after 1,000 charge/discharge cycles, are quickly being followed by new technologies that will not deplete for 10,000 cycles. Demand allows scale, bringing costs down further, opening new markets and accelerating that virtuous cycle. Deployment of the technology will be exponential.

In the US, the four largest coal companies, including Peabody Energy, have fallen into bankruptcy in the last four years. Coal and thermal powerplant utilisation is declining in all major markets including the US, India, China and the EU. If the market for a commodity declines, there’s no escaping the outgoing tide for suppliers who are price takers with high fixed costs. Oil is not running out but is being replaced with better technology.

Watch the virtuous cycle of disruption

The speed at which the virtuous cycle of disruption takes hold is vital for legacy companies, and the impact on energy markets transcends business and economic cycles. For example, Australia’s stock market will not be as heavily-weighted towards fossil fuel energy and resource companies in future as it is today. Your financial security hinges on how quickly you spot and respond to these changes.


Roger Montgomery is Chairman and Chief Investment Officer at Montgomery Investment Management. This article is for general information only and does not consider the circumstances of any individual.

Chris Jankowski
August 04, 2017

I would like to point out to Roger that electricity generation and distribution is not like anything having to do with computers - AI, autonomous vehicles (as in Hamish's article), smart phone and all that stuff.

In digital electronics the physics is with you. The smaller you make a transistor the less energy it uses, the less heat it generates, the more of them you can fit on a chip and the higher processing power you get. The progress in the past 40 years in processing power was astounding - more than a billion times - 1,000,000,000 times.

In power generation and distribution the physics is often against you. Yes, we can make solar panel cheaper with new technologies. But we can make them no more than 3 times as efficient as they already reached about 30% efficiency. So increase in power needs to come with more and more panels. And we cannot abolish the night, rain, clouds and geographic position. The wind turbines also reached maximum sizes due to mechanical constraints. And there is only so much space that they can be built at a reasonable cost. Oh, and the wind may die from time to time over an extended area. This means that you need to have many times more installed power capacity than your maximum consumption if you wish to maintain reasonable security of supply. This of course multiplies the cost by a factor of N. We can live with all of that, but there are other issues never mentioned in the optimistic predictions.

The electric power generated by steam turbines (steam itself generated by coal, oil, gas or nuclear) comes from a rotating generator. These by their very physical nature can stabilise the frequency (50Hz in Australia) and voltage pretty well. The whole network can run reasonably well through major disruptions like a major high voltage line tripping.

The solar power and to great extent the wind power do not bring this physical stability. In principle, you could retrofit it by using very large batteries with very high discharge rates and sophisticated power control systems. The problem is they are so expensive that building a practical system is not economically possible. And the batteries are not going to become much smaller and cheaper. Not by orders of magnitude. Chemistry is against you. They already have reasonable efficiency and they need the right quantity of metals inside.

Roger is right that the business model of a typical power generation/distribution company is going to be disrupted. This is happening already on a large scale in Germany, but not in a good sense.

The old model charged per unit of delivered energy (MWh) more or less regardless of time of the day or year. The energy stability, security of supply, network stability were essentially expected, implied and thrown for free. Then electricity markets were formed with utilities contracting power in 15 minute increments. Then wind and solar came and broke the market. If the wind blows and sun shines their marginal production cost is zero. In fact, in Germany they have been accepting negative prices from time to time to avoid expensive switching and adjustments. This forces the regular utilities into loses and eventually into bankruptcy.

The solution is to adjust the business model and start charging for the always available base power whether it is delivered or not and for security of supply, stability of the network and security of supply that the classical base power can deliver.

There were many other pathologies that occurred in Germany power generation as well - north-south imbalance, increase in use of the dirtiest fuel - brown coal, and a huge overall increase in the price of energy, etc.

Models evolve slowly, but they have to evolve. For example, some organisations, fed up with price increases and instability, built their own generation plants and went off-grid. Now they have to, by law, pay additional fees for being off-grid.

August 03, 2017

Roger has taken on the challenge of trying to justify the future direction of Australia's energy supply - a tall order indeed.

However, I was wondering if he has the type of information i would like to see in an analysis of the energy market.

The type of information I have in mind is:
1] On 2016 [ I think] numbers only 15% of Australia's energy is produced by renewable energy - therefore what is the life of our existing infrastructure and how does it tail off over time?

2] Roger has referred to the costs of developing infrastructure reducing - I would like to know what the cost is of developing black coal power stations; gas power stations, wind generating stations, solar, nuclear, battery, etc.. for equivalent MW production.

3] I would also like to see what the cost per kwh is for generation, transmission, distribution, etc.. for the various generation methods.

4] Also who gains the benefit for the increased price on the market when electricity shortages occur - I assume it will be the generator - which means it will be in the generators interest to limit supply.

And, possibly tongue in cheek:
5] How South Australia intends to charge up a battery as I would think surplus electricity is required to charge a battery - and at the moment electricity is coming from other states to meet their needs - or are we going to be paying for South Australia's battery charging.

Sadly, I think much of the information will be "commercial in confidence". I was hoping Mr Finkel would include this type of information in his report - but no such luck.

Anyway if you can see if Roger could write a report to cover these issues for Cuffelinks benefit it would be appreciated - or alternatively he or his staff can email me directly if he wishes.



August 03, 2017

Roger gathers data points to demonstrate that the RET and state government target renewable energy contributions are achievable without subsidy.
Taxpayers will be pleased to learn of the impending reduction in government expenditure.


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