Is Clean Energy Finally Ready for Prime Time?
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About Jason MatlofCurrent Investments:Current Areas of Interest:Network Security, |
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EmailIntroduction
With growing media attention around rapidly rising energy costs, growing demand for greenhouse gas emissions controls (Kyoto protocol), and growing volumes of capital flowing into clean energy, a key question is being asked in investor corridors: Is it finally time for clean energy(1)? Two extreme thought groups exist in this debate:
- Camp A: Believes that oil, coal and natural gas reserves are still plentiful, that price shocks have historically proven temporary, and that clean energy technologies will not be able to compete without subsidies for decades to come.
- Camp B: Believes that the world oil production will peak this decade, that energy prices will continue to rise for all traditional energy commodities, and that we must pursue sustainable alternatives immediately.
Like most political debates, the answer is likely somewhere in between and requires much research and discussion. This article will explore some of the larger market forces that have the potential to change the overall energy economy. It is worthwhile to begin that process with the crises that spurred the initial wave of clean energy debates nearly three decades ago. (This article will focus largely, but not exclusively, on the global oil market, as it represents the largest primary energy source and nearly 40% of global energy consumption.)
Background: The Energy Crises of the 1970s
The Arab oil embargo of 1973 and the Iranian revolution of 1979 created an urgency to move our energy base away from traditional fossil fuels and toward alternative, more efficient forms of energy. As the nation reeled from the economic shock of oil price surges, then-president Jimmy Carter launched an aggressive campaign of legislative incentives for corporate R&D and subsidies to drive consumer demand for renewable energy technologies.
In his speech to the nation on April 18th, 1977, President Carter threw down the gauntlet(2):
"With the exception of preventing war, this is the greatest challenge our country will face during our lifetimes. The energy crisis has not yet overwhelmed us, but it will if we do not act quickly…"
These are the goals we set for 1985 [partial list included here]:
- Reduce gasoline consumption by ten percent below its current level.
- Cut in half the portion of United States oil which is imported, from a potential level of 16 million barrels to six million barrels a day.
- Use solar energy in more than two and one-half million houses.”
The subsequent energy legislation introduced in the late 1970s drove a variety of industry R&D initiatives around energy efficiency and created subsidies to drive consumer demand. For example, the American Corporate Average Fuel Efficiency (CAFÉ) and the National Petroleum Reserve began in this era. Similarly, the solar and wind energy industries saw a spark in their first mainstream commercial demand.
But the fuel shortage turned out to be short-lived given OPEC’s inability to maintain a unified position and other sources of oil began to gain market share (from Northern Europe, Canada, South America and Africa). As prices began to stabilize, the oil embargo collapsed and the supply-demand relationship equalized again at more reasonable prices. With the return of relatively low cost fuel and the entrance of the Reagan administration, many of the legislatively-driven clean energy initiatives were terminated or allowed to expire. By the mid-1980s, the so-called energy crisis had abruptly ended, Americans quickly cast off the national imperative around fuel efficiency, and we resumed our love affair with fuel-inefficient vehicles (think Suburban and Bronco) and similar energy-demanding luxury technologies. Clearly, we fell far short of realizing the national economic imperative established by President Carter’s call to action.
Can We Compare Our Situation Today with the Past?
Both energy crises of the 1970s were man-made and politically motivated. Said differently, there were no fundamental economic problems driving price increases — purely political. As one considers potential investments in the energy sector today, it is important to consider the lessons from these past events and determine if they are applicable going forward. Are the underlying energy market fundamentals really changing, or are we experiencing some similarly short-term, man-made pricing anomalies? Is the tripling of oil prices in the last five years from $20/bbl to more than $60/bbl sustainable? Is the quadrupling of natural gas prices from $3/MM BTUs to the current $13/MM BTUs sustainable?
There are, however, a number of different factors at play this time around that suggest that the inflated energy prices are not ephemeral and will continue. Instead of largely human intervention driving the market, a number of fundamental energy market dynamics appear to be changing. Are these forces leading indicators or secondary? Will they impact prices immediately or over a multi-decade period? The following data points imply that these fundamental shifts in the market place are significant and likely sustainable, and that the current energy crisis will not be short-lived. This data suggests that the era of “cheap energy” could gradually come to an end.
I) Global Energy Demand Growth
According to the US Energy Information Agency (EIA), the industrialized nations in North America, Western Europe and Japan comprised over one-half of global primary energy demand in 2001(3). This is despite the fact that these countries comprise less than 16 percent of the global population. The good news for global energy markets is the EIA forecasts only 1.2% annual energy growth amongst the industrialized nations in the first quarter of the 21st century. Strong growth in global energy demand during the 20th century was largely driven by the industrialized West, as it went through large industrial growth and modernization of residential and transportation technologies. As we move into the 21st century, the growth rate of industrialization and modernization in the West slows, and new growth is largely counter-balanced by gains in energy efficiency.
A key question is what will the energy forecast look like for the developing world in that same time period? It is possible that events in the developing world in the 21st century could turn the energy market upside down. The rapid industrialization of China and India, in particular, represent significant danger signs for energy demand growth in the coming decades. There are two major trends which present warnings signs to the world energy markets. First, these two nations together comprise more than two billion people and are growing rapidly. China and India are each the size of the entire industrialized West, and together represent one-third of the global population. Second, the economies of these nations are industrializing rapidly, as movement from traditional agrarian to industrial economies drives wage and GDP growth.
The rapid economic growth in China is represented in daily media reports. Recent New York Times articles report that the city of Shanghai has already doubled the number of skyscrapers of New York City and expects another 50% increase by the end of this decade(4). Similarly, the Chinese automobile industry association recently reported a nearly 45% year-over-year increase in sales(5).
The fast-growing economies of the developing world are projected to drive energy demand growth at twice the rate of growth of the industrialized nations over the coming 25 years. (See US EIA graph below).
Source: US EIA, International Energy Outlook 2004
Net Impact: a shift out of the demand curve will likely increase primary energy prices in the absence of an equal shift in the supply curve.
II) Energy Supply & Proved Reserves
A second trend exists with the amount of remaining supply of economically recoverable energy reserves in the earth (“proved reserves”). There is no definitive data on this topic and opinions vary widely. While some pundits suggest that we will reach peak production capacity (“peak oil”) as early as this decade, others suggest that will not occur until the middle or latter half of the 21st century. Without endorsing either perspective, it is evident that we are pumping oil out of the ground at a rate faster than we can discover new proved reserves. The US EIA’s global petroleum production and reserve data shows that during the thirteen year period from 1990 to 2003 we grew total production by 19.8% but global proved reserves increased by only 3.1%(6). The USGS and US EIA have modeled the eventual attainment of “peak oil” with three scenarios — high, low and mean (see below). This exhaustive government study implies that peak oil production will be reached within 30 years.
Source: US EIA, Long-Term World Oil Supply Scenarios, April, 2003
What we do know is that the entities with large profit-oriented or nationalist interests in securing future oil supplies are gobbling up reserves today in anticipation of peak oil. As proved reserve growth declines, large oil corporations and nationalized energy corporations are scrambling to acquire reserve assets. For example, there was the recent failed effort by the national Chinese oil corporation (CNOOC) to acquire Unocal in mid-05, as well as the successful Chinese acquisitions of reserves in Canada and Kazakhstan in prior years. As reserves become even more scarce, and private and national oil companies further compete to acquire these resources, prices will be impacted even further.
Net Impact: a flat or declining proved oil reserve combined with increased demand will likely increase prices.
III) Energy Security
Demand growth trends and increasing supply scarcity have created the threat of an increasingly volatile geopolitical situation. Given that our modern economies are significantly dependent upon energy, alarm bells are sounding about the domestic impact of potentially losing control of a stable, consistently-priced energy supply. Without a domestic source, policy makers are becoming concerned with how we could secure that supply in a time of international crisis.
Compounding the concerns around energy scarcity is the fact that an ever-increasing amount of energy consumed in the industrialized West is imported from politically volatile regions of the world, including the Persian Gulf and the states of the former Soviet Union. The following charts illustrate the US trends in increased import dependency.
Source: US EIA, International Energy Outlook 2004
Even more alarming, the following charts illustrate that the remaining global energy proved reserves are increasingly located in unstable foreign nations. Specifically, more than two-thirds of remaining petroleum and natural gas reserves are located in the Persian Gulf and former states of the Soviet Union.
Source: US EIA, International Energy Outlook 2004
Depending upon the presiding administration’s partisan affiliation and timing of election cycles, national policy reflects either the “wait and see” approach or aggressive activism. If the trends outlined above hold, it is likely that energy security concerns will increasingly drive a more activist national energy policy agenda with incentives to promote cost-effective clean energy technologies and/or domestic sources of energy.
Net Impact: activist energy policies that seek domestic alternatives to more abundant foreign sources could create relative price advantages for clean energy technologies.
IV) Carbon Emission Control
This article is clearly not a forum to debate global warming. There are clearly very bright academics with reams of research to justify both sides of the debate. Increasingly, however, the weight of international diplomacy is moving towards the global warming advocates’ camp. More and more legislation is being passed at the global, regional, national, state and local level to drive compliance with carbon emission reduction standards. The current US federal position is in conflict with the U.N., most of industrialized West, as well as nearly half of our own state-level policies. Presently, the EU has self-imposed their own Emission Trading Scheme with mandatory CO2 emission caps per nation and 19 US states have independently implemented their own emissions limitations programs (or renewable energy portfolio standards).
Many pundits believe that the US will eventually be forced by international and domestic pressures to comply with some form of federal CO2 emissions limitation program, most likely after the current administration leaves the White House. Most challenging will be that coal, our most abundant primary energy reserve, is the greatest CO2 pollutant, adding to our challenge to find domestic energy sources that comply with emissions standards. This will either further inflame the “energy security” issues related to the import of oil and gas discussed above, or will drive the further development of more cost-effective carbon sequestration and coal gasification technologies.
Net Impact: increased emissions controls will likely drive higher energy prices.
Conclusion
The industrialized world has benefited for decades from the cheapest primary energy sources in the history of the world: coal, oil and natural gas. If you consider that a 42 gallon drum of crude oil cost from $10-20/bbl(7) for most of the second half of the 20th century, it is remarkable compared to virtually every other known commodity — even purified water! Based upon the prior market trends discussion, it is reasonable to argue that we will experience consistently upward trends in energy prices and that the days of cheap energy are coming to an end. Even if only two or three of the four major trends discussed above come to fruition, prices will undoubtedly be impacted upwards.
So the remaining question is how can we make energy technology bets in this changing market? Assuming that these pricing trends continue, a number of previously uneconomic energy technologies can become compelling. Said differently, there will be opportunities to create excess returns by investing in technologies that address and exploit these new market dynamics. We believe that at least three different types of technology categories will benefit from relative price competitiveness resulting from these trends. Those technologies are outlined below.
Target Clean Energy Opportunities:
- Higher Efficiency Energy Conversion and Storage Technologies — These devices convert and store energy more efficiently than traditional generation, distribution and storage technologies (e.g., fuel cells, batteries, and related technologies)
- Renewable Energy Technologies — Renewable and/or distributed energy technologies that reduce or eliminate primary fuel sources altogether and that can compete with current and/or projected retail energy prices (e.g., solar, wind, geothermal and ocean renewables, as well as near renewable technologies, like ethanol and biodiesel)
- Emissions Control Technologies — Emissions reduction technologies will be increasingly necessary to exploit cheap fuel sources with lesser emissions (highest on the list would be coal).
Contact me if you would like to discuss this article, or if you have a clean energy business concept and would like to talk about working together.
Footnotes
- The term “Clean Energy” used here refers broadly to “Renewable Energy” technologies that eliminate fossil fuel sources altogether (wind, solar, et al), as well as “Clean Energy Technologies” that burn fuels more efficiently and cleanly (fuel cells, ethanol, biodiesel, et al.)
- President Jimmy Carter, Speech to the Nation on Energy Crisis, 18th April 1977
- US EIA, International Energy Outlook 2004, Appendix A
- NY Times, 10/18/05
- The Auto Channel, 10/7/05
- US Energy Information Agency, International Energy Annual 2003 and International Oil Reserves Data 2005
- In 2004 real dollars
© 2005 Battery Ventures. All rights reserved.