The renewable energy boom will be great news for consumers, but not investors
More renewable energy capacity will drive down the cost of energy for consumers, as long as we can solve the energy storage issue. However, investors could struggle to see returns in the competitive market argues Max King.
The news that nearly 69% of total electricity had been generated by renewables one day in late March was celebrated as another milestone in the drive to reduce the consumption of hydrocarbons in the UK. Climate-change activists queued up to urge the public, the government and investors to increase investment in renewable energy on the basis that it is the cheapest electricity to generate.
Investors in renewable energy, however, should be worrying about a potential glut of capacity, lowering prices and returns on investment.
Investors may be left out as renewable energy booms
The National Grid website regularly shows that, on a monthly basis, more than half of electricity has come from zero-carbon sources with wind accounting for over 30%. It also shows a peak zero carbon share each month of up to 87%, though not the low point. This demonstrates the intermittency of zero-carbon generation, especially wind and solar.
When the wind isn’t blowing and the sun isn’t shining, the gas turbines have to be switched on, the consequence of which is that gas accounts for more than a third of electricity almost every month. Building more windmills or solar farms won’t make the wind blow or the sun shine more -it will merely increase the competition between suppliers when conditions are favourable.
More competition will likely drive prices lower - good news for customers, though not for generators and their investors.
However, the less that gas turbines are used, the less output there is across which to spread their fixed costs. Generators will need a higher price to switch on the turbines and they will need to be paid merely to keep their plant on standby.
The increased renewables capacity will therefore reduce the income of renewables generators, but not necessarily consumer prices. The alternative is to suffer power shortages that last for days or weeks.
Storage is little help as, until there is a breakthrough in battery technology, batteries can only provide backup for only an hour or two. The UK has few new sites available for hydroelectric plants or for pumped storage, and nuclear plants cannot be readily switched on and off.
In the longer term, battery technology will improve and renewable energy generation will become more efficient but onshore wind is not the answer. Onshore wind has a typical load factor of around 25% while recent offshore wind projects provide about 60% efficiency. The North Sea is a perfect location, offering reliable wind, shallow seas and the potential for vast arrays of turbines. It might be desirable to balance this with locations off the West Coast of Scotland, in the Irish Sea and off Cornwall but geographic conditions don’t allow it.
Increased demand for electricity will provide the basis for new investment but enthusiasm for energy transition has gotten carried away. The infrastructure for recharging electric vehicles outside the South East is poor and the roadside cost of it is high. Heat pumps are expensive, impractical for most properties and troublesome to install. Households will need a level of financial support that the government cannot afford.
Using surplus electricity to generate hydrogen through electrolysis is superficially attractive but the process is likely to be expensive while the storage and transmission of large quantities of hydrogen safely would be a major challenge. Small-scale nuclear plants ought to be easier to turn on and off than large-scale ones but not as easily or quickly as gas turbines.
Net zero stocks are cheap, but do they deserve to be?
The good news for investors in renewable energy in the UK is that the share prices have fallen below asset values, making it impossible for listed funds to raise new capital for investment. Instead, they can concentrate on completing current projects and squeezing out better returns. New supply should therefore tail off.
The bad news is that politicians are keen to invest directly in a desperate drive to achieve carbon reduction targets. The assumption is that such investment will be lucrative but the history of the public sector suggests the opposite. A surge of new capacity will lose money for taxpayers and reduce returns for everyone.
The best solution would be to focus investment overseas in countries that are further away from optimum capacity. After all, the targets for carbon reduction ought to be global, not national. The problem with this is that where investment conditions are most favourable, investment is at least as far advanced as in the UK.
So don’t expect the share prices in the renewables sector to return to large premia over asset value or that they will generate much more of a return than their current attractive yield. The political and activist enthusiasm should be a warning sign.