Power struggle

Central to decarbonization plans of both consumers and heavy industry is an increased reliance on access to clean electricity. In today's post, I interview Chris Warnes from Oliver Wyman's Energy practice covering the challenges that lie ahead for the power sector in reducing their reliance on fossil-fuel power sources. We also drill deeply into the various low-carbon alternatives (renewables, nuclear, hydro, etc), the status of carbon capture technology and the potential role of carbon incentives in accelerating the transition towards net-zero emissions.

You can view my interview with Chris here and I would suggest that this one is well worth watching regardless of the sector you operate in:

The electrification of everything

Chris described how pretty much every industrial sector is planning to use access to clean electricity sources to decarbonize their processes and products. Electric vehicles are perhaps the most famous example but there are many other industries where the impact could be even larger. To create green steel, we need access to green hydrogen and we can't create green hydrogen without access to clean electricity sources. Similarly, our homes need to become increasingly electrified if we are to bring down our household emissions replacing gas stoves and boilers with electric cookers and electric heat pumps. Hence, the power sector has the dual challenge of decarbonizing while meeting this great increase in demand.

Balancing supply and demand

You may have noticed some large swings in energy prices recently which have been affecting the economic outlook for energy companies and consumers. As the economy rebounded from the pandemic it exposed a shortage in some vital commodities such as Liquified Natural Gas (LNG). Chris pointed out that there isn't much price elasticity in energy prices since if prices double we still need energy so demand remains fairly constant. This makes power markets very vulnerable to large swings in price. This dynamic is now being exacerbated by the introduction of renewable energy sources such as wind and solar which can flood the market when the wind blows and the sun is shining only to see the supply disappear when these natural sources are not producing. Price swings are not the only problems caused by these fluctuations. The power grid needs to match supply and demand on a second-by-second basis. Finding an outlet for a massive surge in energy output when the wind blows is proving to be a major headache in markets such as California.

Power storage and batteries

The price of renewable energy has fallen dramatically and so has the price of the batteries which are now playing a key role in smoothing supply from these sources. At present, the batteries are large enough to store the power generated during the day (e.g. when the sun is shining) and then release it in the evening (when everyone switches on their lights). However, Chris mentioned that it would be too expensive to store a whole week's worth of energy from, say, a windy week for use a week later when the wind is not blowing. There is therefore little chance in the foreseeable future that we will be able to store the excess solar energy generated in the summer for use in the winter.

Beyond renewables

Chris was positive about solar and wind but pointed out that they still only account for roughly 5% of world energy supply and it will be difficult to get to 100% renewables because of the problems described above with intermittent output and battery limitations. As such, the future of zero-carbon power grids will also depend on the use of other low-carbon sources such as nuclear and hydroelectric . Nuclear is clearly a political hot potato and environmentalists have very mixed views on the topic because nuclear is, on the one hand, a proven and reliable source of low-carbon energy but, on the other hand, a source of potentially devastating environmental disasters (albeit low probability ones). We concluded that countries that don't have access to natural hydro or geothermal resources are going to struggle to get all the way to net-zero and are going to have to rely on a range of technologies. For example, renewables work best in combination with natural gas so to get to net-zero with this combination a country would need to make use of carbon capture technology (see later) or replace natural gas with clean hydrogen.

Carbon Capture Utilization and Storage (CCUS)

Chris reiterated that CCUS is not currently available at a commercial scale for the power sector so isn't yet having any meaningful impact on net emissions. To capture carbon from a large gas or coal-fired plant Chris thinks that the most viable option would be to store it underground but that the risks involved would be significant as massive amounts of pressure would begin to accumulate underground. He also pointed out that the energy required to capture and pump the emissions underground would mean that a material portion of the energy generated by the power station would need to be diverted to power the CCUS processes. In short, we can't rely on CCUS coming to the rescue and need to continue to work on cutting gross emissions which ultimately will require removing our reliance on fossil-fuel sources of power.

Power play

Have a play around with the levers in the model below which includes an extract of our dataset covering the power sector. For each physical power plant in our dataset we know its production amount (GWh), technology type, precise location and the owner of the plant. Crucially, we also know the expected retirement date when the plant will either be decommissioned or renewed. From there it is relatively straight forward to roll up portfolios of assets to the level of individual power companies and also to look at the production and emission dynamics at a national-grid level. Our dataset includes roughly 35,000 power plants, covering the 1000 largest power companies and covering 90%+ of the production capacity across 167 countries.

For each country in the drop-down list you can compare the emissions intensity of their national grid (blue line above) relatively to the net-zero-by-2050 requirements (green line above). If the blue line is above the green line then the country could at some point find itself coming under pressure to pay penalties or use expensive CCUS technology to close the gap. In other words the gap between the blue and green line is going to be a key driver of the hidden carbon liability attached to the national power grid or to companies operating the assets in the grid.

As can be seen from the model, different countries have very different starting points in terms of the current emission levels of their national power grids. Some European countries are already ahead of where they need to be in terms of reducing emissions, whereas many Asian countries are more coal-dependent and in many cases their coal-fired power stations are newly-built meaning the above model is projecting them to stay in operation for many decades to come.

Calibrating Carbon Prices

As public scrutiny relating to GHG emissions continues to rise, each company with net-positive emissions finds itself with an invisible carbon liability attached to it which is likely to crystalize through time as disclosure standards and carbon incentives are implemented. There are two main drivers of a carbon liability: 1) the amount of net emissions a company is expected to produce projected into the future and 2) the price that is levied on those emissions in the forms of taxes or penalties. At the moment, those taxes and penalties are very low in most jurisdictions but there is a general expectation that the carbon price (measured in dollars-per-tonne of CO2-equivalent) is going to rise over time increasing the size of the carbon liability and thereby increasing the incentive to reduce emissions.

Again, you can play around with the model below, this time focusing on the economic impact of carbon prices. I've focused in on the coal and natural gas power plants in each market which account for the vast majority of emissions in the power sector. I've also adjusted for the price of electricity in each market and also the typical cost of producing the electricity for oil versus natural gas. As can be seen, the oil and gas-fired power sector could cope with a carbon price up to $100 per tonne of CO2-equivalent but would see profits move into the red as we move beyond that level. Chris echoed the results of my analysis in the interview when he said "most commentators in the power sector think we need a 100 dollar-per-tonne carbon price to get to net-zero".

Large national power sectors currently produce billions of tonnes of CO2 per annum so at $100 per tonne the carbon taxes are measured in hundreds of billions of dollars. While the actually carbon price is much lower than $100 at present we are recommending to our clients the introduction of "shadow carbon prices" starting around 20-50 dollars and rising to 100 dollars-per-tonne projected into the future. This will ensure that new projects and contracts are pricing in the carbon liability today to prepare for the actual carbon liability potentially materializing later.

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