On the economics of energy

I thought this an interesting article by Edward Lucas in the Times today:

Energy revolution brings power to the people

June 16 2017, 12:01am,
Edward Lucas

As consumers are forced to pay more for their gas and electricity, disruptive technologies offer a cheaper alternative

Big decisions made by big companies. That used to be the way the energy industry worked. Extracting oil, gas and coal, and turning it into power, involved costly projects that lasted for decades.

Not any more. The era of energy dinosaurs is over. The mammals are on the march.

The clearest example so far comes from the United States, where technological change and the liberalisation of energy exports have put nimble, innovative shalemen in the driving seat of the global hydrocarbons industry.

Only a decade ago, Saudi Arabia was the “swing producer”, moving the world oil price with a twist of a sheikhly wrist on a stopcock. Now the Saudi-led Opec oil cartel is impotent. Instead of production determining the price, it’s vice versa, just as in most other commodities. Restrictions on output are futile: they simply hand market share to competitors. From a low point in 2008, US crude oil production has already doubled, to a record 10 million barrels a day.

The boom affects the natural gas market too. Last week the first shipment of American liquefied natural gas (LNG) arrived in Poland, a country which used to be in the grip of Russia’s corrupt and exploitative gas-export industry. In neighbouring Lithuania, an LNG import terminal has already paid for itself: before a molecule moved, Russia offered a hefty discount on its pipeline gas.

Abundance and diversity spell freedom. Eastern Europe no longer needs to kowtow to the Kremlin. The West no longer needs to curry favour with Opec.

Utilities dump the cost of big, expensive projects on customers
Much more is to come. Intense competition and human ingenuity are bringing innovations in the fracking and horizontal drilling techniques which have stoked the shale boom. So far it is almost entirely confined to the US, where the financial, geological and legal environment is most favourable. When unconventional oil and gas extraction spreads to other countries, the old energy behemoths’ bets on high-cost projects such as Arctic or deep-water drilling will seem like truly catastrophic mistakes.

For other dinosaurs, even bigger trouble looms. The coal industry is collapsing. One reason is head-on competition from cheap gas (gas-fired power stations are far cheaper to build than coal ones).

But coal is ailing even in countries without abundant natural gas. China and India are turning away from the black stuff, partly to stem public fury at air pollution, but also because of the tumbling price of solar energy, down 40 per cent in the past year in India. A solar electricity provider recently won a supply auction there with a bid of 2.62 rupees (3.2p) per kilowatt-hour (kWh) — undercutting coal-fired power by a fifth.

The economics of renewable energy are devastating for the incumbents. The marginal cost of solar and wind power is zero: once the panels and windmills are installed, they produce electricity willy-nilly. The old producers’ only real advantage is reliability. They can provide power on demand, whereas renewable energy tends to be intermittent: on calm cloudy days, output from both solar and wind drops precipitously. Even that advantage is crumbling. The cost of storage is plummeting as battery technology advances and the economics of mass-production kick in. James Sprinz of Bloomberg New Energy Finance (BNEF), a research company, notes that the cost of capacity in lithium-ion batteries is down by nearly three-quarters since 2010. Cheap storage means that renewable energy can be used whenever it is needed.

Technology also allows us to become a lot more intelligent in the way we consume electricity. One of the most interesting ideas in the electricity market now is “demand response”. Instead of building capacity to provide extra megawatts, we instead use “negawatts”— forgone power consumption. This already works well with cooling, heating and pumping, which are mostly not time-sensitive. If you run greenhouses, or cold-storage equipment, your only priority is keeping the contents within the right temperature range. Whether the machinery comes on at five minutes to the hour, or ten minutes past, does not particularly matter.

To the people running our electricity networks, this flexibility matters a lot. When demand spikes — say on winter mornings — they no longer need to use the dirtiest and most expensive generating capacity, such as banks of diesel generators, to keep the lights on. Instead they pay people to postpone their power consumption to a more convenient time. The result is greater efficiency and lower costs. Increased use of electric vehicles will create even more flexibility: they can charge overnight on cheap wind power, and even send electricity back into the network when needed.

This is not good news for the utility companies. They like big, expensive investments because, in a regulated market, they can dump the cost — plus a profit margin — on the consumer. The question that no country has answered is how to manage the transition between the expensive, old-style power system and the decentralised, flexible, low-cost (and low-carbon) future.

BNEF’s annual energy outlook, published yesterday, forecasts $7.4 trillion (£5.8 trillion) of new investment in renewable energy by 2040. That is an encouraging leap on previous predictions — but still short of the nearly $13 trillion investment in zero-carbon power it reckons is necessary to keep global warming below 2ºC. Getting the economics of power generation right sounds boring. It may be a matter of life and death.

Edward Lucas writes for The Economist