The energy revolution is hitting a tipping point
There is a huge shift going on in the energy markets, with the decline of coal mirrored by the stunning rise of renewable energy. Here's what it means for investors.
Some quite extraordinary things are happening in the energy sector at the moment.
Last year, carbon emissions were flat for the first time in 25 years (apart from a brief period during the financial crisis), according to BP's latest energy sector review.
Last month, Portugal ran solely on renewable power for four days in a row. And across the whole of May, here in Britain, solar power provided 50% more electricity than coal did.
Pretty exciting stuff. Are we near a tipping point?
Well, it's a little more complicated than that
The massive shifts in global energy markets
"Global energy markets are in a state of flux: both energy demand and supplies are changing in profound ways", says economist Spencer Dale in BP's Statistical Review of World Energyreport for 2016.
On the demand side, China's growth has slowed: "the days of double-digit Chinese growth, led by energy-hungry industrial production, are behind us". Meanwhile, countries across the globe are trying to boost energy efficiency.
As a result, global energy demand grew by just 1% last year. That's pretty much half the average rate seen over the past decade.
The fall in China's demand combined with a shift in the energy mix in the US took a particularly big toll on demand for coal. Use of all other forms of energy, from gas to oil to renewables, grew in 2015, but coal usage saw its largest decline on record.
In the US, natural gas was substituted for coal, becoming "the dominant source of energy in the US power sector". In China, slower growth meant less need for coal the country's consumption of the fuel fell for the second year in a row. Coal's share of the energy generation pie is now at its lowest level in ten years, according to BP.
On the supply side, meanwhile, there is of course the effect of the shale revolution, which is partly driving the coal industry's woes. Despite a collapse in the number of US oil rigs in action, total US oil production still grew by a million barrels a day in 2015. That means the US is still the world's largest oil producer (just think how incredible that idea would have sounded ten years ago).
Yet, says Dale, "the technological advances within non-fossil fuels are arguably even more striking". Over the last ten years, solar power production capacity has doubled every 20 months.
So what's coming next?
The share of global energy production accounted for by renewables remains small at just below 3%. However, notes Dale, "its strong growth meant that it accounted for all of the increase in global power generation in 2015 and more than a third (38%) of the entire increase in global energy consumption."
Wind power capacity grew by around 17%, while solar grew by just under 33%. China is now the largest generator of solar power in the world, ahead of Germany and the US.
The rise of renewables and the demise of coal
This is all very exciting. I don't care what your take on the environmental side of all this is. The idea that we could get a significant and increasing proportion of our energy from a source that is relatively clean, and that will never run out, has to be a positive thing.
So how quickly will the change happen? And where are the opportunities?
Well, anything with a price chart that slants downwards from left to right quite as precipitously as coal's has is always going to draw the attention of contrarians. And on coal, as Dale puts it: "The two trillion tonne question is whether we have now seen the peak in Chinese coal consumption?"
Clearly, a move to a more services-orientated economy and an intense political focus on pollution evidenced by the leap in solar capacity suggests that we might have. But at the same time, there's likely to be "a strong cyclical element" to the shift in demand. China's most energy-intensive sectors have been hit by the economic slowdown, but that won't last forever.
So you might be tempted to argue that the market is too downbeat on coal, given that it still has a hugely important role to play in the energy mix. And that's probably a reasonable argument. The pricing picture is likely to change for coal as supply drops off faster than demand, even if it's just a cyclical (short-term) bounce within a secular (long-term) decline.
However, would-be daredevils should also remember that by the time coal looks more appealing, the assets may well be in the hands of different owners from the companies available today.
And what about renewables, the great hope for the future? Dale notes that "the key lesson from history is that it takes considerable time for new types of energy to penetrate the global market."
From accounting for 1% of the primary energy production, oil took more than 40 years to secure a 10% share (it's now above 30%). Natural gas took 50 years to get to 8% (it's now around 25%).
Dale notes that renewables are growing at a pace comparable to nuclear energy, which itself grew far more rapidly than oil or gas. The key difference is that while nuclear plateaued due to a slowing rate of innovation (nuclear plants stopped getting better and cheaper), "we assume that the costs of both wind and solar power will continue to fall".
That means that, under BP's base case, renewables will see "a quicker pace of penetration than any other fuel source in modern history". Yet that still suggests it will take another 20 years for renewables to account for 8% of the energy mix.
What this means for investors
While this might be slightly disappointing for anyone who wants to see the renewable future a lot quicker than that, it's striking that the conversation is changing from "these will always be marginal sources of energy" to "this is something that is very likely to become a significant part of the energy mix".
As Eoin Treacy points out: "The evolution of renewable energy technology represents a major paradigm shift for the energy sector, not least because the cost of production continues to decrease independently of the oil price, and environmental concerns result in a compelling case for adoption."
This is exactly the sort of shift that inspires blue-sky dreaming, speculation, bubble-building, and huge opportunities for profits (and catastrophic losses) along the way. We'll be writing about it a lot more in MoneyWeek magazine, but it's the sort of thing that Eoin writes about in our Frontier Tech Investor newsletter all the time. Find out more about Frontier Tech Investor here.