Who are the losers in the energy revolution?

If you own shares in energy companies that are not focusing on solar energy, you should consider selling now, while people are still half asleep, and start buying into energy companies that do focus on solar. There is an energy revolution that is taking place and most of the incumbents in the energy sector wont make it.

The driver for this solar revolution has nothing to do with climate change. As History Future Now has previously stated, arguing over climate change is now a waste of time: everybody who understands the facts can see that we have missed the boat in preventing serious climate change from occurring. We are going to crash through the 550 parts per million barrier of carbon dioxide equivalent and no amount of appealing to peoples’ consciences and national governments will stop that from happening. Those who religiously hold on to the belief that humans could not possibly be causing climate change are so entrenched in their beliefs that no amount of evidence will persuade them otherwise. This makes dinner parties far more agreeable as both climate change deniers and climate change campaigners can agree that nothing material will be done in time.

The driver of this revolution also has nothing to do with national energy security. For a short while environmental campaigners sought to persuade governments to invest in renewables for national security reasons. Relying on Russian or Middle East oil and gas makes it more likely that Europe and America will find itself in perpetual conflict with those parts of the world. The US military is very concerned about the impacts of climate change on global security and has also sought to develop solar, wind, geothermal and wave energy projects as a way of enhancing the self sufficiency of its military bases. It has even gone as far as developing naval vessels that can run on biofuels. But at the end of the day, national security has not been a driver for the adoption of renewables. There are too many incumbents in the national security sector and they have no desire to share a declining amount of tax payer funds with renewable energy projects.

No, the main driver is economics. Solar power is already having a significant impact on electricity generation and supply markets, despite having a relatively low overall market share. The problem for coal, gas and nuclear power is that solar is too cheap and they are increasingly unable to compete.

But how can solar power, which is supposed to be too expensive and needs subsidies be too cheap? For this we need a short and highly simplified explanation about how most electricity markets work.

How electricity markets work

In any electricity market, which can include a collection of countries, as with much of Europe, a country or a region, there is a mix of electricity generation technologies. At the very base of electricity generation are a group of power stations that generate power for most, if not all, of the day, most days of the year. This is the “base load” of power. These power stations generally dont like being switched off, as it can be expensive and time consuming to do so, and are not very flexible. They are also generally the cheapest form of electricity generation and typically comprise of coal power, old nuclear power (which was massively subsidised), large hydro power and some gas fired power stations.

If more electricity is needed, as demand is high, more flexible power stations are switched on and this includes gas power stations, pumped hydro and, at the every end, once everything else has been switched on, back up diesel generators. These more flexible electricity producers typically only operate for a few hours per day due to physical issues (like pumped hydro – once the water reservoir has run out there is nothing more to produce) or because their fuel costs are so high and are expensive to maintain – like diesel. As a result, their cost of electricity is very high. This gradual increase in the cost of electricity is referred to as the “merit order” – which will be referred to in the quote later in this article.

The spot price of electricity at any moment in the day is based on the cost of the most expensive form of electricity being generated at that time of the day. So if you are in the middle of the day and everybody wants to use electricity – demand is high- your most expensive electricity will be switched on – resulting in a high electricity price that will be paid to all of the electricity suppliers – ranging from the very cheap coal plants to the more expensive diesel generator. This means that the bulk of the profits that are made by coal, nuclear and gas power stations comes from the daily peak of demand.

Renewables, such as wind, hydro and solar power, have a key characteristic which is very different from conventional power sources: they have no fuel costs and generally have very low maintenance costs. This means that if there is sun or wind they will always be able to sell their electricity cheaper than all of the conventional power sources, who have to pay for fuel and maintenance costs. This is referred to as the “marginal cost” and renewables have very low marginal costs compared to conventional power.

So you are probably now beginning to see what the problem solar poses for the conventional power sector. The bulk of the conventional power sector’s profits come during the peak daylight hours. Solar power produces its peak output of energy at exactly the same time and can always undercut conventional power as it has a lower marginal cost. As a result, the more solar that is connected to the grid the more it will eat into the profits of conventional power stations and at some point it will no longer be economically viable for conventional power stations to operate.

Industrial consumers are happy, as their peak prices of electricity will drop, thanks to solar, but the main electricity utilities who own conventional power plants are very unhappy. Most solar farms are not owned by electricity utilities, but rather by pension funds and insurance companies, who like the stable revenue streams generated by solar projects and are happy to accept lower rates of return than electricity utilities. As a result, most utilities cannot offset their losses in conventional power generation with gains in solar.

Reneweconomy.com.au had a good article in March 2012 which highlighted this issue very well:

Here is a pair of graphs that demonstrate most vividly the merit order effect and the impact that solar is having on electricity prices in Germany; and why utilities there and elsewhere are desperate to try to reign in the growth of solar PV in Europe. It may also explain why Australian generators are fighting so hard against the extension of feed-in tariffs in this country.

The first graph illustrates what a typical day on the electricity market in Germany looked like in March four years ago; the second illustrates what is happening now, with 25GW of solar PV installed across the country. Essentially, it means that solar PV is not just licking the cream off the profits of the fossil fuel generators – as happens in Australia with a more modest rollout of PV – it is in fact eating their entire cake.

Both graphs were published last week on the website Renewables International, and were sourced from EPEX, the European power price exchange. The first graph, from 2008, shows peaking power prices rising to around €60/MWh and staying there for most of the day, with some visible peaks around noon and the early evening – the size of which would depend on the temperature and the usage.

The second graph shows a brief leap to €65/MWh around 9am, before the impact of solar PV takes hold – erasing the midday peak entirely and leaving only a smaller one in the evening. The huge bite out of day-prices is also a bite out of fossil fuel generators’ earnings and profits. Note that the average peak price in the second graph is barely higher than the baseload price.

Deutsche Bank solar analyst Vishal Shah noted in a report last month that EPEX data was showing solar PV was cutting peak electricity prices by up to 40 per cent, a situation that utilities in Germany and elsewhere in Europe were finding intolerable. “With Germany adopting a drastic cut, we expect major utilities in other European countries to push for similar cuts as well,” Shah noted.

Analysts elsewhere said one quarter of Germany’s gas-fired capacity may be closed, because of the impact of surging solar and wind capacity. Enel, the biggest utility in Italy, which had the most solar PV installed in 2011, highlighted its exposure to reduced peaking prices when it said that a €5/MWh fall in average wholesale prices would translate into a one-third slump in earnings from the generation division.

Wind power also has an impact on wholesale electricity prices but because it is generally windier during the winter months and later on in the day and at night it has not caused as much disruption as solar.

The second problem caused by solar is the difference between retail prices of electricity and wholesale prices of electricity. The retail price of electricity is what normal households and small businesses pay for their electricity. This is typically significantly higher than the wholesale price of electricity, which is the spot market price. Many very large users of electricity can buy electricity at the wholesale price, or slightly higher. It is cheaper for electricity utilities to provide large amounts of electricity to a few big customers than small amounts of electricity to a large number of customers, so it makes sense that there is a price differential. But it is also true that retail customers are more lucrative, as a whole, than big customers who are able to negotiate better rates.

As more and more households put solar PV on their roof they will no longer be paying electricity utilities for their electricity during the day as they will be generating their own electricity for their own consumption. As a result, there will be fewer retail customers which will mean that the cost of providing electricity (costs include building, maintaining and operating the grid and providing balancing services) to retail customers will be borne over a smaller population, which will increase the retail price of electricity for those that have not made the switch to solar. In turn, as the retail price of electricity increases, it will provide a greater incentive for more people to switch to solar. If this continues for a few cycles, you can understand why electricity utilities are in a quandary about domestic PV on roofs: it will start to eat into their higher profit business.

The price of solar PV has dropped remarkably over the past few years and given the fact that the raw material for solar is silicon (basically sand) for both the modules and the glass frames, improved manufacturing techniques should see both decreases in costs and improvements in efficiency – which will make solar even cheaper. At a certain moment in time it will be economically viable in many countries without any form of subsidy, (it is already being built in countries like Spain without any subsidies) but before that even happens the impact that it will have on the conventional electricity market will significant.

So who will be the losers in the solar revolution?

It takes 3-7 years for conventional power stations to get planning permission and then built. Solar projects are much faster from a planning perspective and because of their modular nature can be built faster as well. As a major electricity utility does it make sense to plan for the construction of a new coal, nuclear or gas power station which could very well be more expensive than solar power by the time that it comes on stream? Certainly after 7 years of operation (14 years from now) solar will be cheaper than coal, nuclear and gas. Since solar power will always have a lower marginal cost of power than conventional power even if you could theoretically compete on price you would only be able to generate electricity after the local electricity market has used up all of the available solar power.

As a result, any new conventional power station that is at the beginning of the planning stage today is likely to be economically unviable within a few years of starting operations. While it might take a while for this new reality to sink in, it does mean that companies that produce large electricity generators and all the ancillary equipment to make a nuclear, coal or gas power station have finite life. It also means that companies that own and operate conventional power stations have a finite life.

This is bad news if you are shareholder in a company like GE or in an electricity utility in a country that has reasonable solar irradiation levels. It is also bad news if you are a natural gas company or a coal company, with negative impacts on the tax base of countries that are big gas or coal exporters.

Over the medium term oil companies will be affected as well. Electric vehicles are almost perfect companions to solar power. Cars are mainly used to commute at the beginning and end of the day – rush hour. For the bulk of the day they sit there, doing nothing. But they could recharge their batteries using solar power during the day, resulting in vehicles that are very cheap to run. This is bad news if you are a company that produces and sells oil.

This revolution will take place over a ten year period. More coal and gas power plants will be built in the meantime. The number of conventional cars on the road in developing countries will continue to expand at a rapid pace. Incumbents will continue to innovate and will fight back using their considerable political influence over governments.

But like a game of musical chairs, we all know that the music will stop at some point.

Where do you want to be left standing?



Note: One of the interesting questions with respect to countries like Germany, who have a large installed solar PV base, is whether the drop in daytime electricity prices for the country as a whole has reduced the annual cost of electricity for large industrial consumers of electricity more than the cost of solar feed in tariffs has increased the annual cost of electricity. As a worst case scenario, the day time price drop has at least partially offset the cost of subsidies. As a best case scenario solar feed in tariffs will have resulted in a net decrease in the overall cost of electricity. Perhaps one of the Future History Now readers can provide some insight.

History Future Now, ebook edition, is now available from the Apple iBookstore!  So if you have a iPad or iPhone click on this link to download it.  It is currently on at a special offer of 99c.   The Kindle version has been submitted to Amazon and should be available shortly.

HFN on Twitter