Opinions expressed whether in general or in both on the performance of individual investments and in a wider economic context represent the views of the contributor at the time of preparation.
Executive summary: Renewables account for ~50% of all new power generation projects today, but this will grow to over 70% by 2040. Before then, renewables will likely have overtaken coal to become the single largest source of power globally. This shift isbeing driven by a combination of factors: economic, technological, political and social. Wind is likely to be the biggest winner. Not only is it free and plentiful, but it produces no carbon dioxide, no greenhouse gases and no hazardous waste. Turbines are becoming easier to construct and are more efficient than in the past. Importantly, wind is now highly cost competitive with other energy sources. Against this background, over $3trillion is forecast to be invested in the wind industry between now and 2040. From an investment perspective, this constitutes a long-term secular shift away from traditional energy sources to renewables. Scale players, particularly in the turbine manufacturing industry, look well-placed to benefit.
The British, it is commonly asserted, love to talk about the weather. Most conversations, however, relate to complaints about how it may be too cold, hot, wet etc. Few probably will be aware though that in the home country of your author, renewable energy was responsible for ~30% electricity generation in 2017 (per the Carbon Brief website). This figure comprises contributions from wind, solar, hydro and biomass, although the former is by far the largest. Indeed, wind alone produced two times as much as electricity in the UK as did coal last year. Furthermore, this is by no means a phenomenon unique to Britain. On average across the EU, wind now accounts for ~10% of the energy mix and as much as 40% in a country such as Denmark. While such a contribution represents a marked change relative even to a decade ago, it is still early days for renewables in general and wind in particular.
At a broad level, electricity demand tends to follow GDP growth. In order to account for future demand, there is a clear need for investment today. Between now and 2040, the International Energy Agency expects $3.1trillion to be invested cumulatively in wind, far more than the $2.1trillion anticipated for fossil fuels, $1.7trillion for solar and $1.5trillion for nuclear. Whereas previous energy revolutions – the transition from biomass (wood and peat) to coal, and then from coal to oil – were driven primarily by economic imperatives, the renewable revolution is a function of multiple factors: economic, technological, political and social. Beyond all this, do not forget that wind is free and plentiful.
Climate change has, arguably, become the defining issue for our generation. Since 1880, the Earth’s average temperature has risen by ~1%, largely driven by an increase in carbon dioxide emissions (per the United Nations). Direct risks include increased frequency of extreme weather events, a greater chance of flooding, higher water stress and altered agricultural production – all of which needs to be thought of in the context of a global population which is not expected to peak until 2050. The landmark Paris Climate Change Conference in 2015 extracted legally-binding emission reduction commitments from 187 countries, starting in 2020. Future investments in energy need to be compatible with a zero-carbon world.
Wind produces no carbon dioxide, no greenhouse gases and no hazardous waste. Unlike coal or nuclear, wind does not consume large amounts of water, which itself is becoming a scarce resource. A standard turbine will generate around 240MW of energy during its 20-year operation, sparing the environment the impact of a net volume of ~230,000 tonnes of carbon dioxide that would be produced were a coal-fired power station to generate an equivalent amount of energy (per Bloomberg New Energy Finance). It is perhaps unsurprising that against this background large numbers of coal, gas and oil plants are being currently decommissioned. Furthermore, within the last two years both China and India announced the cancellation of plans to build new coal plants, preferring other energy sources. Consider also that the construction of new nuclear facilities faces many obstacles globally, while the erection of hydro plants is complicated by planning issues, long lead-times and increasing water stress issues.
Wind turbines are becoming easier to construct and more efficient. Whereas the generating-capacity of turbines in many early wind farms 25 years ago was measured in kilowatts (a thousandth of a megawatt, or MW, the standard unit of energy) and produced only enough power for a handful of households, today they have been supplanted by much more powerful turbines. They have become bigger, with taller hub heights (able to take advantage of stronger wind speeds at higher altitudes) and larger rotor diameters (able to sweep across a wider area). A standard 6MW turbine can provide ~5,500 households with energy in the EU, whereas the largest turbine currently on the market (9.5MW) could power more than 8,000 households. Its blades can sweep an area larger than the London Eye (all data per Vestas). Looking ahead, the Wind Europe trade organisation expects that even larger turbines, with a 15MW capacity, could be available before 2025.
In addition, with advances in remote monitoring and data management, modern turbines can now capture substantial amounts of information of a real-time basis and use this in order to improve the performance of turbines as well as allow for pre-emptive maintenance. Turbines are, therefore, much more reliable than in the past. An average turbine spends just 2% of the year in downtime compared to a figure closer to 5% at the start of this decade. More electricity can be generated from fewer (larger) turbines that cost less to install and maintain than in the past. Vestas estimates that a turbine can be operational in less than a year after planning permission has been granted, with the project generating a positive return on investment within 12 months from launch. At the same time that turbines are becoming more efficient, so too are energy storage facilities. Their size and scalability has improved markedly over the last few years (and certainly since we wrote first on this topic in 2015). This should help drive the renewable revolution.
Beyond these arguments, wind is now cost competitive with other energy sources. The cost to generate a MW of energy from wind has decreased by 80% in the last 20 years and 20% in the last 30 years (per Bloomberg New Energy Finance). Using the preferred industry metric of LCOE (the levelized cost of electricity, or the benchmark to compare the economic costs of different energy sources) onshore wind is now cheaper than any other energy source of a global average basis. Research from the World Economic Forum supports this view and highlights that last year, wind and solar were cheaper than fossil fuels in over 30 countries globally. Wind farms already typically generate 17-39 times as much power as they consume, compared with around 16x for nuclear and 11x for coal plants (per the Global Wind Energy Council). Furthermore, advances in technology mean that the LCOE for wind should fall by at least 25% over the next decade, a view endorsed by both the International Energy Agency and Bloomberg New Energy Finance.
Renewables currently account for around 50% of all new power generation (i.e. incremental project build). Between now and 2040, this share should increase to around 70-80%. On this basis, renewables are forecast to overtake coal by around 2030, to become the largest single source of power globally (all data per the International Energy Agency). Within this, wind is predicted to take the largest share, followed by hydro and then solar. Although the adoption of solar has gained a lot of traction within the last five years (partly owing to the consumer installation of solar panels), wind consistently achieves superior LCOEs, has higher load factors and is more predictable as an energy source. Do not forget that solar reliability increases the closer one gets to the equator, whereas most power demand tends to be located away from the equator – at least for now.
The purpose of this note is less to debate the merits of wind versus solar, however, but more to assert that the renewable revolution is coming. Put simply, within this, wind is likely to be the single most important element. Nonetheless, when thinking about the factors against the case for wind, consider that the market for renewables is becoming increasingly competitive, particularly as many governments have moved away to auctions for new energy capacity as opposed to subsidies to drive demand. At the same time, a number of alternative cleantech solutions such as geothermal and biofuels are emerging, which may provide additional threats over the medium term. Near-term, there are additional considerations such as the increasing complexity of constructing large scale wind projects as well as the aesthetic pushback from some quarters. Some also worry about the safety and security of wind assets in the face of potential terrorist threats. While valid concerns, these are by no means unique to wind and the previously outlined positives would seem clearly to outweigh the potential negatives.
From an investment perspective, there is a long-term secular shift away from traditional energy sources towards renewables. The wind turbine industry is both fragmented and competitive. Nonetheless, the top-ten players typically control 70% of any given market. Globally, Vestas, GE and Siemens Gamesa dominate, although China and several European markets (particularly Germany) have seen the emergence of regional champions. Furthermore, relative to five years ago, the industry has now become markedly more disciplined. Costs have been reduced and pricing has become more rational, helped by a combination of scale, the demand backdrop and industry consolidation. Many industry experts believe that further deals between sub-scale players are likely. Given that turbines typically last for around 20 years, much of the decision about which turbine to purchase centres around aftermarket service, which typically favours larger operators who have greater expertise.
Most listed utilities have publicly committed to growing the share of their energy mix derived from renewables. However, a more direct way of gaining exposure to the renewable theme is via manufacturers. There are fewer quoted solar plays than wind plays and within the wind space, Vestas (listed in Denmark and capitalised at over $15bn) is the market leader, with clear medium-term financial targets and a strong balance sheet. Other pure-play turbine businesses include Siemens Gamesa, Senvion and Nordex. An alternative approach to gain exposure to the renewable (wind) theme could be via a closed-end investment trust such as Greencoat UK Wind, which invests directly in wind farm projects. There are many reasons to be thankful for the weather!
Alexander Gunz, Fund Manager, Heptagon Capital
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Opinions expressed whether in general or in both on the performance of individual investments and in a wider economic context represent the views of the contributor at the time of preparation. Executive Summary: Thematic investing is a core part of our investment process at Heptagon. Since 2011, we have published 50 dedicated pieces of thematic […]
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