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Leonard Hyman & William Tilles

Leonard Hyman & William Tilles

Leonard S. Hyman is an economist and financial analyst specializing in the energy sector. He headed utility equity research at a major brokerage house and…

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How Fast Will The Electric Industry Exit Coal?

What do Siemens, General Electric and Toshiba have in common— other than the obvious: they are global manufacturers of electrical equipment? The answer is that this year all three announced they would no longer construct coal-fired electric power generating projects. Regardless of how managements describe this action, we believe their reasoning is simple: they see little future in the coal business. Think of the impact of this decision as akin to what happens when a computer firm no longer wants to support a software program or operating system. Customers can keep using it but who will spend money to develop process improvements? How long with these manufacturers wholeheartedly support their legacy products? No doubt they will assure existing customers of their enduring fealty to old coal but we suspect users familiar with the problems caused by unsupported legacy products might start thinking about accelerating timelines for coal plant shutdowns.

Electric companies around the world have not abandoned coal fired power generation en masse, especially in places such as Poland and Germany, where local economies are heavily dependent on coal mining and industrial production. A similar dynamic exists in mining states in the US. Although it’s a declining industry. coal miners  still earn relatively high wages, especially in rural areas where other opportunities are scarce. US state and local interests also heavily favor retaining these industries and jobs despite knowing that ultimately coal as a boiler fuel for power generation is finished. (Apropos of that point, Peabody Energy, the world’s largest private coal miner, says it may have to file for bankruptcy, for the second time in five years, due to the weak market for coal,)

Electric companies as businesses have a financial incentive to retain aging, polluting coal fired generating assets. because their existing investment in coal assets is not yet fully depreciated. The power companies ask, “Why close down facilities until consumers have fully paid for them?” Doing so entails asset write offs that would result in financial unpleasantness on both income statements and balance sheets at the same time, as a result of which bond rating agencies might increase their scrutiny. Consequently from a business perspective, utilities have an economic incentive to perpetuate the status quo with respect to coal.

This is where we believe there is a useful role for government policy. Regulators, especially at the state public utility commission level, have the means to allow power companies to recover all of their undepreciated legacy coal investments costs from consumers. Regulators can, with relative ease, authorize utilities to amortize these assets over an extended period and at relatively low cost to consumers. But this does require regulatory or administrative action which will likely face some opposition. Related: What Biden’s Victory Means For Middle East Oil

We also suspect that the unions working within the electric industry are less than thrilled about the trend toward renewables. Jobs in the renewables industry may be less unionized and pay lower wages. Close a unionized coal power plant and replace it with renewables and distributed resources and higher paying jobs dwindle. We cannot quarrel with that analysis when taken in isolation, but it may ignore offsetting factors.

We believe that the global electric utility industry faces two main challenges. The first is a typical asset replacement or modernization cycle. The twist here is that the transition that utilities desire, from coal to natural gas, is under fire on environmental grounds. More utility scale wind, solar and storage seems a likelier result. New gas plant construction will carry increased stranded asset risk going forward.

The second challenge for the electric utility industry is part of a newer, broader displacement cycle—or electrification —where electricity produced in an environmentally benign fashion will increasingly be called upon to displace fossil fuel usage. The implications for transportation are clear at least in terms of the potential for battery electric vehicles of all sizes. And natural gas usage is also being gradually displaced in home and commercial uses with heat pumps and induction burners for stoves.

It hardly needs pointing out that this will all occur against a backdrop of climate change. For electric utilities this means increasing difficulties and expense providing an increasingly essential service. The good news is that customers will we believe remain willing to pay for utility services. The bad news is that increased political and regulatory scrutiny may create financial uncertainty. In the extreme version this could result in a review of private utility monopolies and whether publicly owned utilities would be preferable. The lines between public and private economic activity are constantly being redrawn and this may be one of those times where a seemingly archaic structure is ripe for replacement. Related: A Major Oil Rally Could Be On The Horizon

Despite the environmental foot dragging among US electric utilities overall, electric companies elsewhere have not been slow to act. Vattenfall, the Swedish-based European utility not only expects to exit coal fired power generation by 2030 but is also contemplating closure of its newest, most efficient coal station because it is no longer profitable. Similarly Rome-based ENEL, a truly international utility, has been closing coal stations and expects to exit coal on a worldwide basis by 2025. Iberdrola, the Spanish utility with holdings around the word, finished closing its coal stations in 2020. US utilities, however, are taking a more leisurely approach and acting as if the year 2050 is the deadline for some broad environmental compliance.

The Trump administration provided a brief environmental reprieve for US electric utilities. However, with a new Biden administration it is not difficult to believe that the pace of environmental compliance will become more rapid. But there is always something. The new administration was emphatic in denying its opposition to fracked gas. If they’re not opposed to fracking, can they consistently oppose new gas fired power plant construction? While we think the future role of natural gas as a utility boiler fuel is clearly up for debate, we’re not sure what the transition time lines look like.

This leads us back to renewables along with two big “ifs”. If US utilities choose a strategy of intentionally over building renewables like wind and solar AND construct considerable new transmission investment to best utilize this new capacity, then natural gas may play a continuing role as a peaking or cycling asset around periods of unusual demand. But even this implies the increasing relevance of base load gas fired power plants. Ultimately gas as a boiler fuel cannot compete with wind and solar. On a pure economic basis gas is on the way out, too.

It looks more and more as if the question is not whether but how fast the electric industry will exit fossil fuels,

By Leonard Hyman and William Tilles for Oilprice.com

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  • Mamdouh Salameh on November 17 2020 said:
    I have always argued that the notions of an imminent global energy transition from oil and gas to renewables and zero emissions are mere illusions. And while renewables principally solar and wind energy will eventually replace coal in global electricity generation, they wouldn’t satisfy global electricity demand without major contributions from natural gas and nuclear energy.

    Natural gas will be the pivot for a gradual global transition into more renewable energy. However, oil and gas will continue to be the fulcrum of the global economy and the core business of the oil industry well into the future.

    Still, there will be pockets of continued coal consumption around the world for years to come in countries where coal s important for the local economies such as China, Poland and even Germany.

    Dr Mamdouh G Salameh
    International Oil Economist
    Visiting Professor of Energy Economics at ESCP Europe Business School, London
  • Peter Farley on November 17 2020 said:
    I think you have hit the nail on the head, when a company stops making a range of products, eg General Motors abandoning Saturn, people go elsewhere very quickly. That coal plant that needs major maintenance to run an extra 10 years won't get it and then someone might say, why don't we use all the electrical infrastructure to support a battery or cannibalise one unit to support the other units in a multi-unit plant etc, or put in a gas peaker. The plant keeps going but output continues to fall.
    Germany is a good example of this. Most people think it has been slow to phase out coal power. Not many coal plants have closed outright but output has fallen from 245 TWh in 2013 to a projected 105 TWh this year, even while nuclear and gas generation has also fallen.
  • Daniel Williams on November 22 2020 said:
    I know this is oilprice.com; but lets get this correct: Biden has stated emphatically that he plans to decarbonise the US electricity grid by 2035. The EU target is to decarbonise electricity "well before" 2050.

    This is going to happen because wind and solar are simply cheaper than fossil thermal power stations; where in most cases today, it is actually cheaper to power down existing thermal assets and replace them as operating costs are so high in comparison.

    For the final 20% of electricity that needs to ramp up and down to meet daily peak energy use, or to accommodate renewable intermittency, the US already has 4.2GW of hydrogen gas turbines in planning, including electrolysis to convert RES to hydrogen and store it.

    The cost of this is low; so for example say you get 40% of your electricity from wind, 40% from solar PV, and 20% from the detour via hydrogen. That last 20% will cost you 2.5 times more wind and solar electricity, so 50% of electricity demand.

    In total, wind and solar will have to produce 40% + 40% + 50% = 130% of demand. If the levelised cost of electricity from wind and solar is 0.04 €/kWh (pretty reasonable these days), then the electricity production cost per kWh of demand (actually used) is 0.052 €/kWh.

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