The Energy Infrastructure That the U.S. Really Needs

A power grid is what transmits electricity from where it is made to our homes because electricity cannot be stored (efficiently…yet).

There are thousands of power plants that generate electricity using solar, wind, gas or coal. These generating stations produce electricity at a certain electrical voltage. Conventionally, this voltage is then “stepped-up” (increased) to very high voltages, to increase the efficiency of power transmission over long distance and minimize the dispersion of energy. Once this electricity gets near your town, the electrical voltage is “stepped-down” (decreased) in a utility substation to a lower voltage for distribution around town. As this electrical power gets closer to your home, it is stepped-down by another transformer to the voltage you use in your home. This power then enters your home through your electrical meter. All of this is very good, but given the evolution of energy production, it needs to modernize to meet consumer preferences and environmental requirements.

Enter the smart grid.  The core premise of a smart grid is to add monitoring, analysis, control, and communication capabilities to the grid to maximize the throughput (the maximum rate of production) of the system while reducing the energy consumption. A smart grid entails technology applications that will allow an easier integration and higher penetration of renewable energy, facilitating homeowners and businesses that wish to put their privately-produced energy on the grid. It will be essential for accelerating the development and widespread usage of plug-in hybrid electric vehicles (PHEVs) and their potential use as storage for the grid. Smart grids will allow utilities to move electricity around the system as efficiency and economically as possible.

Essential to efficient use smart grids are smart meters:  Smart meters help utilities balance demand, reduce expensive peak power use and provide better prices for consumers by allowing them to see and respond to real-time pricing information through in-home displays and smart thermostats. For example, you may want to run your dryer for 5 cents per kilowatt-hour at 22:00 pm instead of 17 cents per kilowatt-hour at 18:00 pm in the evening, when demand (and price) is highest. Consumers will have the choice and flexibility to manage your electrical use while minimizing costs.

The need for a smart grid is increasingly recognized by US policymakers at all levels of government, as ways to improve the energy efficiency of producing and using electricity in our homes, businesses, and public institutions become an entrenched imperative. Many believe that a smart grid is a critical foundation for reducing greenhouse gas emissions and transitioning to a low-carbon economy. Certainly, PHEVs and renewable energy have been of great interest to Congress.

In light of this brief introduction, I came across Ethan Zindler’s prepared testimony before the senate Committee on Energy and Natural Resources, here is the meat of what he had to say:

Before I get to my main points, a quick note about “infrastructure”. In the current climate, this term has become a Rorschach test of sorts representing different things to different constituent groups. In the case of energy, infrastructure can encompass a broad scope, including, among other things, building power-generating facilities, expanding oil and gas distribution pipelines, or hardening local power grids.

Those topics are worthy of discussion and I know my fellow panelists will shed light on them. However, my testimony today will focus on the next generation of energy technologies and the infrastructure that will be critical to accommodate them.

The U.S. is transforming how it generates, delivers, and consumes energy. These changes are fundamentally empowering business and home owners, presenting them with expanded choices and control. Consumers today can, for instance, analyze and adjust their heating, air-conditioning, and electricity use over their smart phones thanks to smart meters and smart thermostats. And they can make efficiency improvements through advanced heating and cooling systems and innovative building materials and techniques.

Consumers in much of the country can choose their electricity supplier and may opt for “green choice” plans. They can produce power themselves with rooftop solar photovoltaic systems. They can even store it locally with new batteries.

Consumers can choose to drive vehicles propelled by internal combustion engines, electric motors, or some combination of both (hybrids). That car can be powered by gasoline, diesel, electricity, ethanol, or perhaps even methanol, natural gas, or hydrogen. And electric vehicle drivers who own homes can turn their garages into fueling stations simply by using the outlet on the wall.

Now, realistically speaking, few Americans today have the inclination or income to become high-tech energy geeks. But that is changing as prices associated with these technologies plummet. In the case of electric vehicles (EVs), such cars can be appealing simply because they perform better.

We at BNEF believe that further growth and eventual mass adoption of these technologies is not possible, not probable, but inevitable given rapidly declining costs.

For instance, the price of a photovoltaic module has fallen by 90 percent since 2008, to approximately $0.40 per watt today. For millions of U.S. businesses and homeowners, “going solar” is already an economic decision. Last year the U.S. installed far more solar generating capacity than it did any other technology.

By the end of the next decade, cost competitiveness for distributed solar will arrive most places in the US – without the benefit of subsidies. We expect the current installed base of US solar to grow from approximately 3.6 percent capacity to 13 percent by 2030 then to 27 percent by 2040.

Similarly, the value of contracts signed to procure U.S. wind power have dropped by approximately half as the industry has deployed larger, more productive turbines. We expect current wind capacity to at least double by 2030.

Many of these new energy technologies are, of course, variable (no wind, no wind power; no sun, no solar power). Thus the growth in these and other new energy technologies will be accompanied by unprecedented sales of new batteries of various shapes and sizes.

Utilities such as Southern California Edison Co and others have already begun piloting large-scale batteries in certain markets while providers such Stem Inc and Tesla Inc offer “behind-the-meter” storage for businesses and homeowners.

In the past five years, lithium-battery prices have fallen by at least 57 percent and we expect a further 60 percent drop by 2025. That will contribute to 9.5GWh/5.7GW of battery capacity in the U.S. by 2024, up from 1.7GWh/0.9GW today.

Continuing battery price declines will also make electric vehicles (EVs) for the first time a viable option for middle-class US consumers without the benefit of subsidies. Last year, EVs represented 0.8 percent of global vehicle sales. By 2030, we anticipate that growing to one in four vehicles sold.

The most popular place to fuel such cars could be augmented gasoline stations… or the local grocery store, or simply your garage.

The changes we’ve seen to date are giving U.S. energy consumers unprecedented opportunities to manage, store, distribute, and even generate energy. However, the new, empowered consumer poses inherent challenges to the traditional command-and-control / hub-and-spoke models of conventional power generation and power markets. Already, we have seen examples around the globe where incumbent utilities were caught flat-footed by rapid clean energy build-outs.

In some cases, it has been heavy subsidies for renewables that have catalyzed the change. But more recently, simple low costs are allowing wind and solar to elbow their way onto the grid.

So, where does “infrastructure” fit into this changing energy landscape?

First, conceptually, we must accept that the empowered consumer is here to stay. To some degree, this acceptance is already underway in the private sector where companies that once focused mainly on large-scale power generation are merging with consumer-facing utilities, or buying smaller solar installers and battery system providers.

Second, policy-makers should seek to promote infrastructure that accommodates a new, more varied, more distributed world of energy generation and consumption. Most immediately, this can mean supporting greater deployment of so-called smart meters. To date, the U.S. has installed almost 71 million of these devices, which enable better communication between energy consumers and utilities. Compare that to Italy where all consumers have such meters and are now receiving a second generation with more advanced functionality, or China which has installed 447 million units, across almost its entire urban population.

Policy-makers may also seek to facilitate the development of high-voltage transmission across state lines. It has long been an adage that the Great Plains states represent the “Saudi Arabia of wind”, given the exceptional resources there. To some degree, those states might as well be in Saudi Arabia, given the major challenges of building transmission that would move electrons generated there to more densely populated states in the east or west. The US has added approximately 1.5GW of high-voltage direct current transmission since 2010. By comparison, China has added 80GW over that time.

Investment is needed at lower voltages too. Our passive, one-directional, electricity distribution system is under strain as new distributed generation capacity comes online. In addition, policy-makers might also consider ways to expand support for EV charging stations. As sales of such cars grow, consumers are already putting greater pressure on certain distribution nodes around the country. Ensuring that EV “fuel” demand is managed in an orderly manner will be important.

Finally, the changes afoot and to come will require what might best be described as infrastructure “software”. Most importantly and pressingly, this must include the reform of electricity markets to take into account the new realities of 21st Century power supply and demand.

It may also include expanded programs to educate energy professionals on the new realities of modern energy markets. And, yes, it could include more software to improve energy monitoring and optimize system performance.

In closing, I would reiterate that none of this need be done at the exclusion of investing in traditional energy infrastructure where the needs are also pressing. However, any rational discussion about energy infrastructure investment today must do more than take into account the current situation. It must also consider where we will be tomorrow.

Trend #2: Equity Capital for Wind Energy

There are some interesting developments in terms of who’s got skin in the equity game in renewable energy. What’s really interesting to me is that the equity investment landscape has transformed quite a bit in the last few years and in this post we’ll see how and why.

Renewable Energy Asset Financing, 2004-2015

capture
In USD billion, statlink: http://dx.doi.org/10.1787/888933362596

But first, remember that, according to the OECD, there are three (main) ways to finance renewable energy projects:

  1. Project Finance: This involves a mixture of debt (usually from banks) and equity capital (we will go into more detail below). According to Bloomberg, 2015 was the first year in which project finance constitutes more than half of total asset finance in RE electricity. Remember that project finance involves creating a Special Purpose Vehicle (SPV) with its cash flows separated from those of its sponsor companies;
  2. On-the-balance sheet financing: Done by utilities (EDF, ENEL, Suez), independent power producers and other project developers. On the balance sheet financing, makes up over 47% of total asset finance in RE, about 94 billion;
  3. Project Bonds: Project Bonds, these do not include corporate bonds or government bonds. They account for a small fraction of financing.

Nevertheless, there are other emerging financial structures, which I can go into in another post, but venture capital is one of them. Utilities are substantial providers of equity capital in the renewable sector. However, due to the large scale investment and stable income returns, there is greater interest from the financial services industry.

This brings us to wind equity financing

Back in the day, the first offshore wind-power farms were usually financed on the balance sheets of the utilities that planned, built, and operated them. Today, there are many more players involved, such as banks, private equity funds, pension funds, state-backed “green” banks (such as the Green Investment Bank, the Nordic Investment bank and the European Investment Bank) and insurance companies. The graph below shows how the equity mix has morphed in the last couple of years.

Change in Equity Mix for Wind Energy

wind-equity

The share of equity provided by utilities is steadily shrinking as other players get involved, decreasing from 62% in 2010 to 39% in 2015, and that of non-utility corporates from 31% to 15%. In other words, the combined share of the two traditional equity investors in the wind energy sector decreased substantially, from 93% in 2010 to 54% in 2015. Accordingly, other investors have stepped up their game. One of the possible explanations for this decrease may potentially be due to deleveraging as a consequence of the financial crisis.

The Rise of Institutional Investors

For brownfield wind projects, meaning wind projects where there is already existing infrastructure and possibly licenses as well, institutional investors such as pension funds, insurance companies, private equity and infrastructure funds have become major equity investors. According to the OECD, their cut in total equity provisions increased from 6% in 2010 to a staggering 37% in 2015, making them the second most important equity providers in the 2015 sample, just 1% behind utilities. This sharp increase of equity provision by institutional investors can be traced mainly to the acquisition of brownfield assets or portfolios for onshore wind deals. Pension funds and insurers were not involved in any greenfield onshore wind-power transactions included in the OECD 2015 sample.

This trend suggests that institutional investors look to the onshore wind sector mainly for the acquisition of existing projects.Such a strategy presents several advantages:

  • Lower Costs: Existing projects are already (usually) built, and there they do not need to start from scratch;
  • “Up to Code”: Lengthy permits, licensing and commissioning agreements may already be in place and therefore do not need to be requested;
  • Fast Deployment: Ultimately the project can be up and running (and earning) in less time.

Moreover, equity financing in wind energy assets by state agencies and public finance institutions grew from a negligible cut in 2010 to 9% of total equity invested in 2015. This sharp increase can be linked directly to the investments done by the UK Green Investment Bank. The UK’s GIB, an institution created by the UK government in 2012 with the aim of attracting private sector financing for green infrastructure projects. The creation or expansion of similar institutions is a trend observable at the global level and is important for risk sharing with newer technologies. Take offshore wind, for example, as projects scale up and move into deeper water, newer technologies also add to construction risk. This may be a barrier to entry and discourage some investors from participating.

In Europe, commercial banks have started partnering up with government supported banks (United Kingdom’s Green Investment Bank, Germany’s KfW Development Bank), export credit agencies (Denmark’s EKF and Belgium’s Delcredere – Ducroire and Italy’s SACE), and multilateral banks (the European Investment Bank) as a way to provide equity financing to wind projects .

The diversification of participants is good for everyone, because:

  • Risk: The risk that corresponds to the project is diversified across an array of investors, meaning that investors are more likely to invest if they do it along other reputable investors, rather than going in it solo;
  • Mainstreaming: the diversification of participants shows that equity financing for RE is no longer as niche as it was, with pension funds and insurance companies putting skin in the game.

Example: The Galloper Offshore Wind Farm

The largest wind equity deal in Europe in 2015 the the Galloper Offshore Wind Farm. It’s a project that will be completed in 2018, located off the coast if Suffolk, east England.

 The equity investors are:

  • Innogy Renewables UK, a subsidiary of the German utility company RWE
  • The UK’s Green Investment Bank, a public finance institution
  • Macquarie Capital, an institutional investor
  • Siemens Financial Services, a subsidiary of Siemens, a corporation
  • Sumitomo Corporation, a corporation

This array of private and public investors is an example of what the equity landscape is shifting towards.

So why did the equity investing landscape change?

The explosion of new capacity additions fostered equity market growth for wind projects. New projects not only became more frequent but they also grew in average size, requiring more capital. It would only be normal to have several new, independent developers enter the sector under such favorable market conditions. Moreover, many utilities have been financially constrained due to the difficulties in the merchant power sector, further limiting their contribution to the sector.

The take-home message we can draw from this is that as the demand for wind energy increased so did the associated capital requirements. Utilities and developers did not have the necessary capital to cover demand, so third party investors were roped in. Likewise, corporations like Siemens and Sumitomo are using their financial strength to offer financing directly to smaller developers.

 

Trend #1: Investment in Renewable Energy 2015

Old critiques, die hard. For the longest time, renewable energy (RE) has been viewed as too expensive and un-scalable, as a luxury energy source, that will not be deployed in developing countries. As a matter of fact, how many times did you hear the criticism, that by diverting investment away from so-called “cheap” fossil fuel energy, we would be depriving developing countries of their right to develop?

The numbers quantifying investments in RE are in! It should be no surprise that RE investment is increasing significantly and the developing world, especially China, is leading the way.

The findings of the United Nations Environment Programme (UNEP) Global Trends in Renewable Energy Investments 2016 confirmed that RE set new records in 2015 for dollar investments, the amount of new capacity added and the relative importance of developing countries in the context of that growth.

Record-breaking uptrend in Renewable Energy Investments

Global investment in RE rose 5% to $285.9 billion from 2014 to 2015, breaking the previous record of $278.5 billion reached in 2011 (FYI that’s double the dollar allocations to new coal and gas generation, which was an estimated $130 billion in 2015) when the famous ‘green stimulus’ programs in German and Italian were in full throttle. The figure below shows that the 2015 investment increased sixfold since 2004 and that investment in RE has not been below $230b since 2010.

GLOBAL NEW INVESTMENT IN RE BY ASSET CLASS, 2004-2015, $BN

global-investment-in-re-asset-class-2004-2015-b
Source: UNEP, Bloomberg New Energy Finance

*Asset finance volume adjusts for re-invested equity. Total values include estimates for undisclosed deals.

Over the course of the 12 years shown in the chart, the cumulative RE investment has reached $2.3 trillion.

Moreover, in 2015 some 134GW of RE excluding large hydro were commissioned, equivalent to some 53.6% of all power generation capacity completed in that year – and this is worth mentioning because it is the first time it has represented a majority. Of the renewables total, wind accounted for 62GW installed, and solar photovoltaics 56GW, highest ever figure and sharply up from their 2014 additions of 49GW and 45GW respectively.

Developing Countries Leading the Way

The investment which led to record-breaking levels came from China, which lifted its investment by 17% to $102.9 billion, about 36% of the global total. In the Middle East and Africa, investment was up a total of 58% at $12.5 billion, helped by project development in especially in South Africa and Morocco; and in India, up 22% at $10.2 billion.

More significantly, 2015 was the first year in which investment in RE (excluding large hydro) was higher in developing economies than in developed countries. The figure below shows that the developing world invested $156 billion last year, some 19% up on 2014 and a remarkable 17 times the equivalent figure for 2004, of $9 billion.

INVESTMENT IN RE: DEVELOPED/ DEVELOPING COUNTRIES, 2004-2015, $BN

global-new-investment-in-re-developed-vs-developing
source: UNEP, Bloomberg

The key contributors to this shift from developed to developing are the big three: China, India, and Brazil, who saw an investment rise of 16% to $120.2 billion

A large part of the record-breaking investment in developing countries took place in China. Indeed China has been the single biggest reason for the strong increasing trend for the developing world as a whole since 2004. In spite of low market fundamentals and much talk of decreased investment in RE, China has been a key contributor to these figures. China invested $102.9 billion in 2015, up 17%, representing well over a third of the global total.

Likewise, India enjoyed a second successive year of increasing investment, breaching the $10 billion for the first time since 2011.

Other developing countries, excluding the big three, lifted their investment by 30% last year to an all-time high of $36 billion, some 12x their 2004 investment, the biggest players are:

  • South Africa also deserves an honorable mention as it’s RE investment is up 329% at $4.5 billion significantly ramping up their solar PV, in the context of their auction program. In June last year, the government in Pretoria launched a tender for an additional 1.8GW for its renewables program. One of the signal deals later in the year was the financing in September of the 100MW Redstone solar thermal project for an estimated $756m, helped by loans from the World Bank’s International Finance Corporation and Overseas Private Investment Corporation of the US;
  • Mexico saw a 105% increase at $4 billion, aided by investment from the development bank Nafin for 9 wind projects. Moreover, Mexico is emerging as an important location for bond issues to back renewable energy projects. In November last year, National Financiera issued $500 million worth of five-year bonds to contribute towards the development of nine wind farms with a total capacity of 1.6GW;
  • Chile saw an increase of 151% higher at $3.4 billion, thanks to a sizable uptrend in solar project financings;
  • Morocco, Turkey, and Uruguay also saw investment increases in excess of the $1 billion milestone in 2015.

Developed world downward trend (mostly)

In the developed world, however, we are witnessing a downward trend quite consistently, since 2011, when it peaked at $191 billion, some 47% higher than the 2015 outturn. Developed countries invested $130 billion in 2015, down 8% and their lowest figure since 2009. This decline is due to two major factors:

  1. because of the US, where firstly; there was a rush of investment in 2011 as projects and companies tried to catch the Treasury grant and Federal Loan Guarantee programmes before they expired and secondly, the US Supreme Court’s decision in February 2016 to allow all legal objections to the Environmental Protection Agency’s Clean Power Plan to be heard before it can be implemented may be deterring investment in 2016.
  2. but much more to do with Europe, where allocations fell by 60% between 2011 and 2015. That big drop was caused by a mix of factors including retroactive cuts in support for existing projects in Spain, Romania and several other countries, an economic downturn in southern Europe that made electricity bills more of a political hot potato, the cut of government subsidies aimed at incentivizing RE in Germany and Italy, and the big fall in the cost of PV panels over recent years.Italy, in particular, saw renewable energy investment of just under $1 billion, down 21% on 2014 and far below the peak of $31.7 billion seen during the PV boom of 2011.

Retroactive cuts to feed-in tariffs really weaken support for solar energy investments. Spain, scene of particularly painful retroactive revenue cuts imposed by the government during the 2011-14 period, and the end of all support for new projects, saw investments of just $573 million in 2014. This was slightly up on the previous year but miles below the $23.6 billion peak of 2008.

But it’s not all bad in Europe, especially since the UK has not seen a significant slowdown in RE investments in recent years, and is actually pushing in the opposite direction. Moreover, in spite of the fact that offshore wind in the North Sea has seen massive investments amounting to $17b, Europe’s aggregate RE investment is still in decline.