There are several headlines today that speak to one of the most pressing issues that we have with the pace of energy transition – the competition for renewable power and the likely inability of the industry to keep up with the competing needs, let alone do so without significant power cost inflation.
There have been some disappointing headlines out of the UN climate meeting this week, which is intended to pave the way for some of the COP26 discussions and come up with proposals that are likely to be agreed upon at the meeting. Most of the issues are around who is paying for what and whether developed nations are investing enough to help developing nations, using the guidelines put forward when the Paris Agreement was signed. In the US, the climate agenda and the Biden plan are bogged down in Congress and the plan is unlikely to pass in its current form.
The exhibit below summarizes well one of the primary concerns that we have with some of the very ambitious goals for decarbonizing power grids, EV introduction, the further electrification of industry, and hydrogen. While the solar module price increase does not look that significant (yet), to put it in context, solar module prices have collapsed from over $1.80 per watt in 2010 to below $0.20 in 2020, and many of the expectations around cheap hydrogen require the cost to keep falling. The bigger concern is the polysilicon price, which is up 160% this year, good for the polysilicon producers like Wacker (see the headline here), but bad for the solar module producers, who are seeing major margin squeezes, especially given the rise in copper and silver as well this year. The raw material pressure should drive further increases in solar module pricing and while the higher margins for polysilicon will likely drive expansion investment, the metals are harder to call, given the ESG views on mining. We remain firmly of the view that raw material availability and price inflation, as well as module and wind turbine manufacturing capacity, will be the rate-determining constraint in terms of the growth in renewable power and this is why we question all of the near-term cheap power and cheap hydrogen goals that are being suggested by potential producers and government agencies.
In our ESG and Climate report published today we focus on hydrogen and what we believe are some unrealistic cost/timing estimates for green hydrogen. One of our concerns is that the hope of cheap green hydrogen, and absent any other strong incentives, will put the brakes on other carbon abatement initiatives and if the cost of hydrogen does not fall we could reach 2030 having made little progress on any front.
The WSJ article linked talking about rising ESG spending and the risks associated with it is in no way inconsistent with our view that lack of US Government guidelines is constraining ESG spending. The article focuses on the power and auto industries, which, while they face regulatory and incentive uncertainty, have a much clearer path than many others. The power industry is dealing with a customer which is increasingly asking for more renewable power, an investor base that is pushing for less reliance on fossil fuels, and a Government that is pushing for a 50% emissions reduction from the sector. The auto suppliers have clear directives from some US states and some countries about the phasing out of fossil fuel-based vehicle sales, and in some geographies, they have incentive systems that they can tap into. For both industries, there is a significant risk, in that the billions of dollars that they are investing in new plants and new equipment do not come with any guarantees that those investments will pay off well or quickly, but at least the direction of travel is unlikely to change. In other words, there will be demand for their products and investors will likely be happy with the progress – while they might not get the EBITDA they would like, they may get a better multiple of that EBITDA.
We will cover the very comprehensive DoE hydrogen work in more detail in the ESG report next week, but a couple of the charts from that work are worth mentioning today. The first picture below accurately depicts all of the potential uses of hydrogen and shows that over time it could solve a lot of “hard to solve” CO2 emission problems, especially where electricity cannot do the job efficiently. The reason why so many countries and companies are so interested in hydrogen is because of its potential versatility and because of its minimal carbon footprint (there is some carbon leakage in the full lifecycle of the production coming from construction around the plants themselves and infrastructure to use the hydrogen).
We repeat some of the commentaries from yesterday's ESG piece as we do not believe this risk can be highlighted too much.
Whether it is carbon capture, hydrogen investments (blue versus green or just in general), plastics waste, or any other aspect of the drive to greater sustainability and net-zero emissions, everyone is looking for a “playbook”; a set of rules that allow for more effective and less risky decision making. The headline linked that talks about the chemical industry needing governments to take more action is another such example. Companies facing increasing shareholder pressure to make change are not only looking for government guidance and possible incentives but they are also not wanting to second guess what any regulatory move might be. No one wants to make a significant capital decision if there is a risk that a government policy shift will make it the wrong move. The European carbon credit price – shown below is at least a framework that many European companies can use to value possible decisions – even if some European companies and countries are moving at different paces than others in terms of emission and hydrogen mandates. The price is tangible and its mechanism for calculation should also allow companies to forecast how it might change. Europe is also working on a plastic waste tax – this would give a stronger economic framework to push improved recycling.
Source: Bloomberg, C-MACC Analysis, June 2021
The article linked that discusses the “Talent War” for ESG spreads well beyond the investment community. Corporations are having to rethink strategy around new variables, and consequently, the experienced talent pool is limited and in some areas such as carbon abatement, recycling versus renewable polymers, and alternate sources of fuel, there is not much history to have created many “experts”.