Renewable energy technologies are changing the game, but investment strategies are being misled and missing the signs
How can they get it so wrong?
By they, I’m referring to the International Energy Agency (IEA), the World Bank, Stanford University, the MIT Energy Initiative, the US Energy Information Administration, and other government and internationally recognized consulting agencies.
Allow me to digress. I’m a big fan of RethinkX, an independent think tank focused on analyzing the effects of technology-driven disruption across society. This group goes deep with their research, using a systems approach to studying the complex interactions among individuals, businesses, investors, and policymakers driving disruption and the resultant impacts that wash over society like a rogue wave.
After reading RethinkX’s report entitled “Rethinking Energy – The Great Stranding: How Inaccurate Mainstream LCOE Estimates are Creating a Trillion-Dollar Bubble in Conventional Energy Assets,” I’m at once left appalled and heartened. Appalled because, once again, self-interests appear to trump what’s best for society and the environment at large. Heartened because we have energy-generating tech in place now that offers enormous benefits if implemented at pace, and the transition to carbon neutrality is occurring more rapidly than expected due to the non-linear decline of renewable energy costs and the increasing costs of conventional energy.
Conventional energy generation days are numbered
Let’s recap what’s happening, its implications, and the intelligent choices going forward when understanding the inevitable disruptive transformations in energy production globally.
The levelized cost of Energy (LCOE) is a widely used calculation for comparing the cost of electricity produced by various technologies. LCOE is calculated by dividing all costs incurred in a given time frame across all units of electricity sold during the same time frame. The result is an average (or levelized) cost per unit of energy sold (dollars per kilowatt-hour or megawatt-hour).
Around 2021, solar, wind, and battery (SWB) technologies became the cheapest energy generation sources compared to conventional coal, gas, hydro, and nuclear-generated energy. The cost divergence widens as SWB tech becomes more advanced and less costly. We’re talking multiples less costly.
Forecasting fallacies are misleading investors
Bewilderingly, typical LCOE estimates used by the aforementioned respected government agencies and consultants are based on high and constant utilization rates for conventional power plants despite the competitive onslaught of SWB tech.
For example, in the US, coal-fired power plants find it increasingly difficult to sell their electricity as their costs are non-competitive, first against the abundant fracked natural gas and now with SWB. As a result, the average utilization rates for coal power plants have dropped from 67% in 2010 to 40% in 2020, and the rate of change is accelerating downwards. In the UK, the drop had been even more dramatic – coal power plant utilization dropped from roughly 60% in 2013 to less than 8% in 2019!
In the face of these intense declines, standard LCOE calculations employed by forecasters for coal power plants still assume a constant utilization rate of up to 85% for the plant's entire life expectancy. Similar faulty assumptions apply to gas, hydro, and nuclear power plant utilization forecasting.
Such unrealistic overvaluations of conventional energy assets have encouraged excessive investment in them – to the tune of some $2.2 trillion since 2010. Does it look, smell, and taste like a massive asset valuation bubble, anyone?
Stranded energy assets are an inevitability
What’s one implication of overstating the utilization rates of these power generation assets in the face of overwhelming evidence such assets are increasingly uncompetitive and financially unviable? They will inevitably become stranded assets. And then what? Perhaps you recall the pain created by credit rating agencies mispricing subprime mortgage assets, leading to the housing bubble and the real estate financial crisis of 2007/8. We’re heading in the same direction, where the overvaluation of conventional energy assets could lead to a bubble exceeding $1 trillion by 2030. If the situation heads south, as is most likely… well, pension and retirement funds and other publicly-held investments holding such assets in their portfolios are at risk of being wiped out, affecting millions of average investors and the wealthy alike.
Dealing with the energy financial bubble
My skeptical side figures that governments will cave to conventional energy's strong lobbying influence and try to protect them against the likelihood of massive defaults and bankruptcy. This course of action would be wrong-headed, given that the writing is on the wall for conventional energy's fall from prominence due to competition from SWB.
RethinkX proposes that governments prepare to protect their citizens from the financial risks of such bubbles instead. Pension fund managers, asset managers, and government leaders must choose to divert their support from further financial outlays to overvalued conventional energy projects based on unrealistic utilization rates, diverting it to the transition to SWB and other disruptive technologies. Doing so will benefit investor returns while mitigating environmental degradation caused by outdated modes of energy production.
The bottom line? Let’s adjust LCOE models to reflect realistic and transparent market-based assumptions regarding utilization rates and other variables so that investment risks are assessed appropriately. Distorting the natural transition to renewable energy generation only causes needless hardships.
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