The “disruptive” label is overused. However, the unexpected pace of advancement in clean technology over the past decade has taken many established utility companies by surprise. And despite recent, largely reassuring results from the oil sector, Europe’s utilities provide a potentially prophetic glimpse into its future.
In the German city of Hamm, the Westfalen D cooling tower looms like an extinct volcano, a concrete monument to the global energy transition. This coal-fired power plant cost RWE €1.4bn to build in 2008, but less than 10 years later it is being sold for a scrap value of €50m. By 2012, the economics of running the plant had simply become so unfavourable relative to off-shore wind that the asset was abandoned without having produced a single kilowatt of power.
With global energy demand estimated to grow by 48 per cent from 2012 to 2040, large-scale energy investment remains vital. However, this is being matched by increasingly cost-effective renewables which both force down wholesale electricity prices and push more polluting forms of power generation off the grid. The result for companies focused on thermal power generation has been calamitous.
Since 2010, European electricity companies have written-down €104bn, predominantly in coal and gas assets. For bastions of traditional power generation like RWE and E.ON, this has translated into a share price drop from €80 and €35 per share to €12 and €7 per share respectively since 2008. Contrastingly, SSE, EDP and Iberdrola, which all took a proactive stance on renewables, have maintained their market values while sustaining dividend pay-outs.
Like utilities, the energy sector is particularly vulnerable to disruption because of both the sheer scale of its capital expenditure and the timescales over which projects are engineered to operate. The past four years of Opec wranglings are testament to the oil industry’s vulnerability and need for strong demand to sustain prices. However, with BP expecting oil demand to peak in 20 years’ time, the consensus is that decarbonisation does not currently pose a similar threat.
Yet this appears to ignore both the political shifts and technological improvements taking place in the automotive sector.
Around 25 per cent of all oil is consumed in cars and a further 15 per cent in heavy duty transport. Disruption in either of these areas would be devastating for the oil industry. And, as more car companies come under scrutiny for suspect emissions performance, the regulatory and consumer pressure to reduce both local and global pollution is increasing.
From a technological standpoint, electric vehicles (EVs) will be cost competitive with internal combustion engines (ICEs) when battery costs reach $100/kWh. Tesla is aiming for this milestone by 2020 and claims its battery already costs $190/kWh, a drop of 65 per cent since 2010. When EVs as a whole successfully reach this target, the growth in sales is likely to go from linear to exponential.
Demand for EVs will also be bolstered by political ambition. China, currently the world’s largest market for vehicle sales, has recently announced a government target of 12 per cent EV sales by 2020 due to rising concerns about urban pollution. This is a staggering acceleration from just 2 per cent in 2016. Closer to home, Norway has implemented a target of 100 per cent by 2025.
Even heavy transport, widely considered to be the saving grace for oil’s longevity, is under threat from electrification. The chief executive of Proterra, an electric bus company whose sales doubled in 2016, claims its buses have already passed the point of cost parity because of huge fuel savings and halved maintenance costs.
It only took thermal power’s share of electricity supply to drop from 57 per cent in 2010 to 44 per cent in 2015 to wipe billions from utility company balance sheets. Rapid electrification in the auto sector could pose the same threat to Big Oil.
Significantly, this transition is supported by governments but driven by technology. The Paris climate negotiations succeeded where Copenhagen failed because, in the six years in between, wind power costs halved and the average cost of solar came down 90 per cent. Even without pricing in the negative impact of climate change, clean technologies are becoming sufficiently economically viable to enable easy political support.
As an investor, the risk is that despite these clear signals, companies are still making huge investments which are at risk of being stranded. One way to incentivise prudent capital management strategies would be to link executive remuneration to “per share” measures of value creation, rather than absolute metrics which simply encourage growth. This is a direct challenge to the circa $400bn annually invested into oil exploration and production, especially the 20 per cent invested in new projects.
In the past decade, the rapid advancement of clean technology has been a pleasant, if costly, surprise for the energy sector. It would be a great shame if the oil majors, with their established brands and high calibre human capital, were to sleepwalk into the path of their utility counterparts. Westfalen D stands as a reminder for energy companies and capital allocators alike to focus not just on the rise in energy demand but on how that demand will be met.