A stable supply of energy generated from clean sources will be worth a premium in the coming years.
As we navigate through these tumultuous times, our collective views on the future would have undoubtedly come away somewhat impacted.
The human race has on a whole has enjoyed a period of sustained peace and progress since the winding down of the 2nd world war. Living through 75 years where life globally only seems to get better influences our perceptions, especially when we extrapolate trends forwards. Human beings have a canny knack for taking the immediate past, and linearly extending it into the infinite future. This works pretty well at most points in time, until a roadblock is reached. With the unfolding of the Covid-19 crisis, we might just be entering into a new paradigm going forward. We shall see.
So what does this have to do with Solar? I have a thesis that a stable supply of energy generated from clean sources will be worth a premium in the coming years. And I am going to try to expound on why, below.
Figure 1: World Consumption of Energy
As you can see from Figure 1, world consumption of energy has been growing at a steady clip. Roughly 40% has been added to demand in two decades. With much of the world still considered to be ‘developing’, we can expect this trend to remain intact for the foreseeable future.
Figure 2: Shares of Global Primary Energy Consumption By Fuel (BP Statistical Review of World Energy 2019)
Of this approximate 14 billion tonnes of oil equivalent energy consumption, breakdown of fuel type can be viewed in Figure 2 above. As of 2018, the non-carbon based fuels (hydro, nuclear & renewables) made up for roughly 15% of the energy mix.
Hydro electric energy has remained relatively flat going back 35 years, as natural sites suited to electricity generation have widely been tapped. Nuclear energy acceptance has also hit a speed bump with costs and safety concerns impeding investment in the space. Politically, communities have started to view nuclear as a non environmentally friendly energy source, further affecting the future of the nuclear energy. This leaves only wind and solar as viable green alternatives in many economies, especially European ones. This is made evident in the graph above, with renewables aggressively growing to now make up 4% of the growing global energy mix (on par with nuclear). This has happened in a relatively short period of time, and is even more impressive if you take into account the growing size of the energy pie on a whole!
Value vs. Price
Currently, the price of solar energy projects can be roughly equated according to the following input costs:
Modules + Balance of System + Engineering + Installation + Land value = approx. Project costs
Something about that pricing model does not sit well with me. Why not? Well, this would be akin to purchasing a home based on the raw price of inputs, such as land, materials and labour. We however do not value homes in such a direct manner. If we did, 30 year old homes would be trading ever closer to underlying land value after taking into account the depreciation of the material. This is definitely a contentious viewpoint, and I would like to caveat it with the fact that most of us probably admit to having no clue as to how properties actually are valued. The best metric we have to value these assets are by comparing and contrasting similar assets in similar locations. In essence, the market (which discounts all factors) determines the price of said assets. Transactions determine price.
Speaking from personal experience, and from discussions with investors in the real estate business, buying decisions (which affects prices) are determined in large part by forward looking considerations (confidence in current societal system) and mortgage repayment costs vs rental costs. Again, transactions determine price, and transactions only occur when individuals believe that taking ownership of an asset is worth their while.
Notice how no one talks about the price of cement or bricks when viewing a home? It is because input costs are irrelevant to buyers of an asset. Only future benefit takes part in the intangible process of valuation.
Phase Shift Ahead?
What happens if we bring the same line of thinking to renewable assets that are currently installed and generating electricity? How do we then price these assets?
Just as we did in principle with real estate, what if we were to price solar assets based on their future value? What is the value of electricity generated in the future, that...
requires no feedstock from fossil fuels – carbon free!
requires only the sun as an energy source, without the geopolitics involved with energy importation
produces no pollution, hence lessens the health and safety impacts of electricity generation
To simplify the argument, let us focus only on the third aspect of clean electricity generation. What is the value of reducing health burdens on society that are related to energy. In other words, how much is clean energy worth?
The paper titled External Costs of Energy: How Much is Clean Energy Worth? published in the Journal of Solar Energy Engineering in 2016 tries to put a currency value on the damage, and comes up with a cost of 40€ per ton of emitted Carbon. Figure 3 below illustrates the methodology in summary.
At 40€ a tonne of carbon, it is 4€ cents per kg, or 1.8€ cents per kWh (conversion: 0.454kg per kWh.)
40€ a tonne multiplied by approx. 35 billion tonnes of global emissions equates to €1.4 trillion a year in emissions related costs. This is approximately 50% of German GDP for the year 2019.
What happens when 86% of carbon laced energy production chases 14% of energy mix that is ‘clean’? €1.4 trillion a year will be chasing roughly 2000 Terawatt Hours of renewable energy (14% of total). Compound the issue with oil and gas being geopolitically sensitive, coupled with ever decreasing reserves and we have a real risk premium associated with the fossil fuel complex.
Figure 4: Global Carbon Dioxide Emissions (2018)
So far in this post, we are taking only a purely commercial perspective. Pricing for in demand energy can behave convexly once behaviors change, since supply is relatively inelastic on short timeframes.
I would ask one to consider what happens when deaths due to pollution become unacceptable? Just refer to the diesel scandal in Germany for reference on what can happen when public sentiments shifts. India and China are becoming richer and will decide to also enjoy clean and safe air.
With these thoughts in mind, what will a 8 year old solar plant sitting on prime electron producing real estate be worth? Only time will tell, but let us watch this space.