Sustainability, Clean Energy, Recycling & ESG

The exhibit below highlights one of the more significant constraints for green hydrogen, which is that the abundant low-cost power opportunities (strong wind and lots of sunshine) are often not where demand for hydrogen exists and the challenge is how to transport it. The problem with reacting it to make something else and then recovering it at the point of use or a distribution hub is that hydrogen is very light and you end up moving a lot of something else to get a little hydrogen. Air Products is looking at making ammonia in Saudi Arabia and shipping the liquid ammonia and the project below is looking at using toluene as a carrier in what appears to be a closed-loop with toluene moving one way and methylcyclohexane moving the other way. The liquid shipping would be cheap, but with the MCH route, only 5% of what you would be moving to Japan would be the green hydrogen. Using ammonia the green hydrogen content is slightly less than 18%, but you have to make the nitrogen on-site. The cost of making the nitrogen would be a function of the local cost of power and these remote locations should have very low-cost renewable power. In the example below, the opportunity is likely unique to the refinery structure and shipping opportunity and we doubt that it is easily replicated in a way that would be more economic than shipping ammonia or shipping compressed hydrogen itself.

Source: H2 Bulletin, August 2021

If we look at the battery storage projects highlighted in today's daily report and in the Exhibit below and then read some of the raw material inflationary concerns around batteries, we conclude that batteries will likely not end up dominating the power storage market. Both hydrogen and hydraulic-based storage are likely to be competitive if the battery costs do not come down. Note that storage batteries can afford to compromise on technology as they do not need leading-edge density – weight is not an issue for something that is not going to move. Even so, with battery demand expected to grow rapidly for EVs, it is not hard to see a scenario where other means of fixed location energy storage are more attractive.

We are back on one of our pet topics today which is the reasonableness around some of the assumptions around the future cost of renewable power. We reference, work done by the US Department of Energy in the Exhibit below, and see two potential pitfalls with the assumptions around continuous improvement in solar, wind, and hydrogen costs, although there is a slight twist for hydrogen. The first is around the dynamics of learning curves. As the exhibit shows, in the early stages of any product development, there are huge leaps in cost improvements, driven by scale, better know-how, more efficient manufacturing, and in the case of solar power, both better processes for installation and some technology improvements. However, as you drive costs lower, the cost of raw materials becomes a much larger component of overall costs, and your ability to lower costs further can be overwhelmed by moves in material costs. Any inability to pass on the costs will result in economics that do not justify additional capital and you find yourselves in a commodity cycle. This is something that we have seen in basic polymers for decades, and no buyer of polyethylene today can claim that they are benefiting from a learning curve improvement. Closer to home for solar, we are seeing the same issue today in semiconductors – not enough margin to invest as everyone has been trying to push costs lower. The expectation in the DOE study and highlighted in the CNBC take on the study below is that annual solar installations in the US need to rise by 3-4X to meet some of the renewable power goals the Biden Administration is looking for by 2030, while similar growth is expected in other markets – the solar panel and other component makers have to be making good money to achieve this.

It is hard to ignore the number of headlines on hydrogen initiatives, today, highlighted in our ESG and climate report, as well as the acceleration in project announcements over the last several months. In the 80s in the UK, it was trendy to drive a VW Golf GTI – everyone had to have one – hydrogen has the same feel today – everyone has to have a project. The projects vary and fall into a handful of categories:

We believe that the plastics industry is right to get as much state backing for chemical recycling as it can – see Louisiana headline and diagram below. While chemical recycling is not as neat as mechanical recycling, it has far more chance of dealing with the core issue, which is the disposal of plastic waste – see report linked here. Our support for chemical recycling stems from the view that it will be very hard to get the behavioral change needed to ramp up mechanical recycling quickly and to a level that will impact waste.

The primary reason for the flurry of carbon capture related headlines in the US over the last few weeks – and our analysis shows a significant step up – is because it looks like this will be the one technology/route to lower carbon emissions that will get a real boost from the infrastructure bill.   There is bipartisan support for CCS because the fossil fuel industry sees it as a way to stay in the game and the unions believe that it will create jobs. This combination should garner enough votes to push it into the bill and get it passed, although the details around how CCS would be supported remain unclear. The infrastructure bill has very few real sources of income in it to offset the very high costs – something we will discuss on Sunday – and consequently giving a bigger tax break, through the 45Q program would create an even larger funding gap than we have today. The value/cost dynamic has to rise to get the activity that everyone is looking for and maybe that could be achieved by overlaying a carbon credit onto the program. Anyone exporting to Europe and concerned about the CBAM extending to natural gas, NGLs, chemicals, and polymers would likely consider CCS if they were eligible for 45Q and could also claim an offset on their exported products to neutralize the CBAM tax/fee.

The decarbonization of the airline industry remains a hot topic. The energy density issue shown in the exhibit below is a correct assessment of why commercial aviation faces a challenge to transition to electric power.  Not only is the energy density too low - which restricts weight/range - but electric power can only turn things, and propellor-based flying has speed limitations relative to jets. The announcements from the airlines to date on electric power have focused on low capacity short-haul opportunities. With this in mind and as noted in the article headlining of the exhibit below, electric power is not the only decarbonizing option for airlines. Hydrogen is the very long-term future - Airbus is saying not before 2050, but in the meantime, the push should be for low carbon or carbon-neutral biofuels. These are essentially plug-in fuels that are identical to current aviation fuel but made either from waste oils or from carbohydrates. Many of the oil majors are working on waste oil or vegetable oil-based processes, especially in California where the LCFS credit helps pay for the conversion, and companies like Gevo and Aemetis are working on carbohydrate-based routes through fermentation. If the carbohydrate, corn in the case of Gevo, is sourced from sustainable agriculture the carbon values of the fuel can be very low and potentially zero or negative through the life cycle. The airlines are going to have to pay up for the low carbon fuel if they want to bid the fuel away from the high credit markets like California diesel and gasoline, but this route could decarbonize the airlines significantly and relatively quickly with the right pricing structure and enough capital. 

While the escalation in solar panel material costs has plateaued over the last couple of months, the increase has been enough already to reverse the decline in solar module pricing as we have noted previously (see charts below). While the increase in module pricing is not that significant there are three points to note:

The MLP headline linked covers a subject that we have addressed in prior work as it looks at the ESG related opportunities for pipelines, not just because pipelines are the lowest cost and lowest carbon footprint means of moving large scale existing gases and liquids around the US, but because of their future potential role moving CO2 and hydrogen. Because the opportunities to grow earnings in the cleaner fuels space will likely be a function of both opportunity (whether you already have some infrastructure that can be repurposed and whether you are in the right locations) and strategy (whether you seize the opportunities as they arise and think a little outside the box), how to play the opportunity from a stock perspective is more challenging as there will be winners and losers. We suggest one of two paths – either buy a basket of the pipeline names or focus on the idea of a positive sector re-rating, in which case you want to own the company with the highest equity leverage to any EV/EBITDA re-rating, which among the large and liquid names would be Energy Transfer – Exhibit below. For more on this see today's ESG report.

One of the themes that we have focused on in our ESG and Climate work is the lack of realism in the Biden climate plan as it relates to power generation and the same with the plan in California. The more limited reliability factor in renewable power (because of its dependence on cooperation from the weather), means that you have to build a lot more new power capacity than you are replacing and you need to build a storage system for the power – batteries, hydrogen or hydraulic. This gets very expensive and will be more so if the push drives inflation in raw materials – which is already a factor YTD in 2021. Natural gas turbines are a cleaner and reliable source of power and cleaner still if combined with CCS. Politicians in the US are taking a considerable risk by promoting plans that could leave the power grid more vulnerable to some of the issues that we have already seen over the last 12 months (California and Texas). Of course, as the plans call for natural gas phase-outs in 10-12 years, none of those making the decisions today will be in the office to face the consequences!