We are seeing more focus on supply chains as they relate to the energy transition. Some European countries are realizing what we have noted in prior research - EU Energy Policy: Swapping A Bad Supplier For Something Worse? - switching to an aggressive focus on renewable energy may reduce your energy exposure to Russia but it currently doubles down on your exposure to China. It is very easy to look at the scale of the problem – the share that China has in critical metals, as shown below – the share that China has of solar modules – etc., and conclude that it is too hard, especially in Europe where you will find an environmental lobby trying to stop you doing anything industrial. But the net effect is severe reliance on China. One advantage that the UK now has with its exit from the EU is more industrial freedom and the country could benefit from the right industrial policies that would attract broader energy transition investment. In our ESG and Climate report this week we talked about the U.S. desire to “friend-shore” rather than re-shore because of local investment challenges in the U.S. as a consequence of some of the political issues. The UK could benefit from becoming an industrial partner with the U.S. for some critical materials.
We share views from Christopher Sheeron - The first-ever guest author for C-MACC's most recent ESG and Climate report titled "Does DC Understand Economics – Energy Proposals Suggest No".
Main Points from this report include:
Despite all of the rhetoric about the need for green hydrogen, we see most of the large ammonia producers pursuing large blue projects – with Nutrien’s announcement yesterday coming on the heels of a CF new facility announcement and the CO2 capture project announced by LSB a couple of weeks ago. While there are some small (proof of concept) green projects in the works, they are very small, tiny when compared with the ammonia need, whether to replace lost material from Russia and Ukraine or whether to supply what could be substantial needs in Asia to co-fire coal plants, or as a shipping fuel, or as a carrier for hydrogen (see third chart below). The ammonia majors are not waiting around for “green” economics to improve as they see meaningful near-term demand that cannot wait for scale efficiencies of available power on the green side. Large-scale sources of cheap renewable power are hard to find, and where they may exist, there is competition from uses that may be able to pay more.
In the exhibit below, we see another chart that we find unhelpful when looking at the path to net-zero or something close. It is not an either/or game with fossil fuels and renewables. Those promoting this idea are setting impossible goals for the renewable industries, which will keep severe upward pressure on all energy costs. Wood Mackenzie may not mean what is implied in the chart below but taken at face value it suggests that more pressure will be placed on an underfunded materials market to supply an underfunded renewable power market, in which any opportunity to use decarbonized fossil fuels will be frowned upon. It would be good to see an analysis of how much global power could be generated from decarbonized natural gas and how much pressure that would take off the renewable industries.
There is the potential for the ammonia thirst (please don’t drink it) to surpass opportunities to build cost-effective capacity for the medium term. Consequently, the shortages we see today could extend and become more severe. Co-firing coal-based power facilities in Asia is one of the more obvious ways to start decarbonizing a predominantly coal-based power region. The experiments in Japan, if successful, will drive a step-change in demand for blue or green ammonia, and this should drive much more new capacity than we have seen announced to date. The power-based demand comes on top of expected growth in fertilizer-driven demand and a possible rise as a shipping fuel. The issue for investors is that green ammonia at scale is economically challenging, especially with the recent shortfalls in renewable power generating plans and what now looks like rising power costs for a while. Blue ammonia is much easier to think about at scale, but we are still hamstrung by expensive carbon capture costs and a lack of incentives – either in terms of tax breaks or taxes or in terms of a customer willing to pay more, to get most ideas and plans past the “wouldn’t it be nice” phase. In the meantime, as indicated above, installed ammonia capacity is making abnormal returns.
The renewable power space is heading for a very bad year in the US and Europe, as supply chain issues and raw material inflation will impact not only the amount of business that gets completed, but also the margin on that business. The trade issues between the US and China on solar panels have essentially brought the industry to a halt for the moment and suggests that all forecasts of the growth in renewable power contributions in the US in 2022 are too high, and consequently demand estimates for natural gas and coal for power generation are too low – see out comments in the energy section of today's daily report. The EIA forecast below likely fails to take into account the current woes and if governments, at the federal and the state levels act on the information in the chart they may be unprepared for some power shortages later in the year. Overestimation of the rate of renewable power installation as well as its operating rate is responsible for many of the current power shortages that we see in most regions.
The Archaea chart below summarizes one of the strong positives we have discussed for a while: renewable natural gas (RNG) demand is likely to outstrip supply in the long term. Using RNG is a quick fix for many processes, and too many people are likely relying on availability against a challenging supply backdrop. Large landfills and dairy farms are likely to be tapped for RNG, and many of the smaller opportunities will also work if they are logistically well placed. But at the same time, you have investments to lower the amount of waste moving into landfills, and there are also pressures on the dairy and beef farmers to reduce the methane produced. We are very bullish on the RNG producers as we believe that their products will be in short supply, and as long as they are not exposed to input cost inflation, they should see strong margins. In addition to Archaea, Gevo announced earnings yesterday and discussed the successful start-up of its (relatively small) RNG project in Iowa.
Looking at the Bloom results and reflecting on our many recent client discussions, the low-cost providers of fuel cells and electrolyzers are going to win disproportionately in our view, but whether that is Bloom or others remains to be seen. Lower costs will come with scale, and this should allow the leaders to stay ahead, especially if they control their equipment production as Bloom does. The negative for Bloom is that its equipment production is in the US, which may add costs, but the positive is that it is on-shore and this gives the company more control over delivery in the US. Companies that can scale quickly in this space and other renewable sectors, should see the benefit of economies of scale and this should drive more wins and more economies.
We are seeing a flood of CCUS announcements in the US in 2022, but they look like “gathering” exercises at this stage rather than projects that are ready for FID. Companies are chasing potential pore space and, like Talos, leasing onshore and offshore (mainly offshore) acreage, where they believe opportunities exist to sequester CO2. These announcements sometimes include firm commitments from companies that have CO2 surpluses and sometimes are more speculative. At this stage, it seems like a “land grab” and “customer grab”. There is wide agreement that the incentive structure in the US – centered around the 45Q tax credit scheme – is not enough to drive much real investment, unless it can be stacked with other credits like the LCFS structure, which only applies to fuels in California today. We see the land grab as relatively low-cost and low-risk positioning in the hope that incentives or economics change. There are some instances where investments will go ahead, and these will focus on processes that have a reasonably low cost of carbon capture – fermentation, urea, natural gas clean-up for LNG, and a handful of other processes. The LSB Industries announcement for Arkansas, highlighted this week, is likely an example of where the economics work even if LSB cannot get much of a premium for the low-carbon urea.
In the first picture below we see another schematic that shows how different options for polymer recycling could work together. We have suggested a more complex site than the one in the chart as there will be opportunities to recycle some polymers into non-like-for-like applications such as roadbed modification and other durable applications. In addition, there may be a better return in waste to energy versus chemical recycling and that may be an alternative or an add-on. This sort of complex site is what we believe LyondellBasell could be looking at for the Houston refinery site. An integrated waste treatment facility that optimizes that use for each tranche of the waste stream could improve the overall investment returns. In the second picture below we show our version of what a comprehensive waste recycling operation should look like. See more on recycling!