Solar: The Third Industrial Revolution

Commodity markets cannot ignore new technologies

Originally published in the September 2014 issue

Today in the age of information overload it is hard to separate the genuine long-term economic developments from the noise. Commodity specialists, like many investors, have been transfixed by oil and gas fracking and so the unblinking eye of the markets has really been focused on the wrong events. The world is undergoing the “Third Industrial Revolution” which will impact every country on the planet both economically and geopolitically. While it has been happening slowly, it is picking up momentum at an exponential rate in time with the speed of its technological development. This feels like the start of the internet: many had heard of it but few understood its impact.
The first industrial revolution was based on coal, the second on oil, and the third is based on solar power. There are three “Big Leaps Forward” for solar energy: technological improvements in the efficiency of solar energy generation; the development of flexible delivery hours by solar energy generators, using utility-scale energy storage; and the development of cheap and efficient batteries for vehicles. The first two have already happened and on their own they are revolutionizing global economies; the third will happen in the next few years and will expand the revolution.
Technological development in solar power has meant it is becoming cheaper to generate solar electricity. In many areas, like Western Europe, solar energy generation is dependent on subsidies. However, in high-irradiance, high-energy-cost areas the cost of solar-generated energy is already well below the cost both of retail electricity prices and other means of producing electricity like oil and coal generation with carbon capture. Solar generation capacity is being installed due to subsidies in low-irradiance areas and simple economics in high-irradiance areas. The ongoing development in solar power technology means we are faced with a supply of clean cheap power with almost unlimited reserves which will reduce the future price of all current types of energy and change the locations where energy is produced.
There are two main types of solar power generation. The first is Concentrated Solar Power (CSP) generation plants which use reflectors to heat a medium, usually molten salt as salt liquidizes in high temperatures. This is then harvested of its heat by steam turbines for power generation. Photovoltaic (PV) generation is where solar radiation is converted directly into electricity by solar panels using photovoltaic material. The important economic difference between PV and CSP solar power generation is that utility-scale CSP produces energy less efficiently than PV and then sells that energy at the low bid price to the distributor for transmission to retail markets. Retail PV generation, having produced energy more efficiently, displaces high-priced retail energy normally bought by the retail customer from the energy distributor. Typically PV panels are not used in utility-scale generation parks but on retail buildings, replacing electricity demand at source as well as feeding power into the grid. The reason for PV being used at the retail end is that it is more economically viable on a small scale, while CSP is used in large utility-size production, as when it is combined with Thermal Energy Storage (TES), CSP is more flexible in delivery. TES flexibility enables the less efficient CSP generation to compete with more efficient PV production by enabling CSP to release more power at peak consumption (high-priced) times of day. Crucially, PV on a utility-scale lacks the ability to store power for peak demand release.

More efficient, lower-cost generation
The first Big Leap Forward for solar power is the fall in costs which has occurred in the last five years and continues to develop. In high-irradiance (sunshine-rich) areas, the ability of solar generation to deliver power to retail users below the cost of many existing forms of utility scale power generation is driving its development. The economic drive from solar comes first from better technology increasing solar panel efficiency, and secondly from cheaper parts, so more power and therefore money from fewer dollars per installation.

The result has been a doubling of global solar power generation capacity every two years since 2006. Since 1972, for every doubling of installed solar capacity, the price of solar panels fell by 22%, although this was accelerated by the collapse in panel prices after 2008. Walmart is currently using 20% renewables today, and this is planned to rise to 100% by 2020 not for reasons of green marketing, but because it is economic to do so. In 10 US states rooftop solar is cheaper than utility power, and this will be true by 2017 in 23 states. In the US, unsubsidized PV-produced energy should be cheaper than unsubsidized retail electricity supply in most US states by 2020 – not just in the high-irradiance states as the situation exists today. So expect high solar generation capacity growth rates. The reason I am sure of this is that while most PV has an efficiency of about 17%, new Concentrated PV (CPV) has been developed with an efficiency of well over 40%, so it is just a matter of waiting for the engineers to build it more cheaply for both CPV and the economically viable solar area to expand.
Simultaneous sunshine no longer needed

The second Big Leap Forward in solar power has been the development of flexible delivery of solar power resulting from the introduction of TES. TES enables CSP generation to deliver power at a different time from when it is produced. The medium which CSP generation uses is molten salt, which stays liquid well over 1,000 degrees, enabling the CSP generation system to be low-pressure and therefore low-cost. The molten salt is then put into a reservoir or ‘heat sink’, enabling power to be generated after the sun has set and during bad weather. Importantly, TES also enables CSP to release more power than is being generated by the sun at any time of day. In effect TES is a utility-scale battery. TES has given CSP the ability to produce power overnight – CSP/TES generation plants have already produced electricity for 24 hours straight. This enables PV generation, when too much power is produced, to use the flexibility of the grid as its battery – to seem to charge into the grid when TES acts as the battery for CSP power displaced by PV generation.
The case for solar power does not need to be made politically as it has already been made economically; huge investments into the area are already ongoing. The US Department of Energy (DOE) has produced a report titled “2014: The Year of Concentrating Solar Power” as 2014 is seeing a fourfold increase in total US-based installed CSP generation capacity, with 1,250 megawatts (MW) of generation capacity being installed during the year, at a cost of $5 billion. Other countries are also advanced, with Australia having so much retail PV generation that the state of Queensland, with 1,100MW of installed PV, has seen peak demand power prices turn negative on days with low power demand. PV rooftop solar is now the fourth-largest generator of electricity in Queensland.

Other countries are also taking solar seriously. One of them is South Africa, which has approved 64 renewable projects since 2011 worth about $10 billion. Another country in Africa which is spending a similar amount to South Africa is Morocco, which is planning to install 2,000MW of solar generation capacity, 18% of its electricity demand, by 2020. Increasingly we will see new solar generation displace fossil fuel demand. For example, Saudi Arabia is currently generating 50% of its electricity by burning oil. In May 2014 Saudi Arabia used 680,000 barrels per day (680kbpd) of oil for power generation versus 547kbpd in May 2013. However, between 2011 and 2032 Saudi Arabia plans to install 41,000MW of solar generation capacity split between PV and CSP. Likewise India is now planning to install 20,000MW (also known as 20 Gigawatts, 20GW) of solar generation capacity.
Solar power generation will continue to expand at exponential rates for a number of reasons. Firstly, economically competitive solar technology already exists and is getting better. Further technological development in the efficiency of solar energy generation, transmission and storage (battery technology) in both the retail and utility areas means future solar power will become cheaper, more flexible, more commoditized and quicker to install. Utility-scale PV is quick to install: one utility-scale PV power plant using well-understood technology was installed in India in a matter of months. It is understandable that the areas with the highest initial solar investment are areas of either high solar irradiance or existing high power generation costs, or both; this means countries like Saudi Arabia, Australia, China, India, Japan, Spain, Italy, Greece, France, Mexico, Morocco and the US, as well large parts of Africa. In addition, countries in sub-Saharan Africa which are importing fossil-based fuels are keen on solar, or should be, as their foreign exchange reserves are negatively impacted by such imports. Countries like China, struggling with high pollution and high import costs, will find solar almost irresistible.

Repercussions for markets
If the first golden rule of commodities is that people do what they are paid to do, the second golden rule is that small changes to tight supply and demand balances in commodities result in much larger price movements, either way. What we know is that solar power is much cheaper than carbon capture coal generation as well as some existing coal generation, so any new coal generation will be vulnerable to being displaced by solar, as are any existing oil-fired power generation plants, no matter how large or small. One has to wonder why anyone would build nuclear plants when solar is cheaper and does not produce unquantifiable costs for waste storage for millions of years. Economically, nuclear power investment by governments is akin to selling inflation-proof bonds with a time settlement date millions of years forward. If solar displaces demand in any or all of these power inputs it will change the supply/demand balance for those inputs, reducing their prices. The greater the switch away from fossil inputs, the bigger the price fall that will occur for those commodities as they compete economically against solar. While at the start solar will compete, rather than dominate, future technological improvements in solar efficiency will continue to lower solar power prices and, with that, fossil energy prices.    

Solar-powered vehicle batteries
The Third Great Leap Forward will be the development of batteries that will enable retail PV solar power to charge up vehicles for their owners. As electric cars are four times as energy efficient as petrol cars today, this will have a huge impact on future oil prices. Further implementation of energy efficiency design in cars, like the use of carbon fibre, will also increase the energy advantage for solar-powered vehicles. Biofuels are a really inefficient way to harvest solar power, utilizing premium-quality land in their production. Declines in biofuel usage mean increasing the available acreage for food production and so food supply, reducing food prices. Many governments’ taxation policies will need to be changed, as any big switch from fossil-based fuels to electricity would reduce the tax take not just from car fuel but also from the energy producers. We are likely to see taxes on transport switch from “Tax on Input” to “Tax on Mileage”.
In the ultimately unsuccessful Scottish independence debate, Alex Salmond liked to say that a “Yes vote” would have put the future of Scotland in the hands of the Scottish people. Actually, it would have put it in the hands of an oil market which is about to experience an unavoidable decline in demand and importance. In this situation, countries like Scotland would be particularly hard hit economically. In essence, the technological development of batteries for powering cars will make high-cost oil extraction from the North Sea less economic. On the other hand, when electric-powered, battery-based cars do become endemic, power prices will initially rise due to increased demand, which in turn will both justify and accelerate solar installations. The technology necessary for the third Great Leap Forward is already well underway and will almost certainly be developed in the next few years.
The implications of the age of solar are almost too many to mention but I will try to touch on a few. Solar generation technology is a “disruptive technology” which has democratized electricity production by removing the decision-making process out of the hands of the few and placing it in the hands of the many. Solar will also disrupt the economic assumptions current industries like power utilities are based on. Already there are large-scale companies installing PV installations and selling the installation for a profit, reducing the energy bought from utilities, and so reducing their profits.

These installers are also installing the PV systems on a lease basis. The leases are provided at a rate cheaper than the utility costs for homeowners, and the homeowners therefore do not have to pay “up-front” installation costs. This enables the installer to install “distributed” generation; in effect, they are building their own distributed power generation utility. Increasing efficiency in solar panels will spread geographically their economic installable footprint. Utilitiesfacing a long-term reduction in demand will have to compete in this market or lose too many customers. The utilities will have the advantage of access to cheaper money, better technological awareness and be without the need to generate installation profit which will make them competitive. This will accelerate the installation of solar as well as changing the economics of existing power generation facilities. Utilities which do not compete will face a contraction of margins, reduction in demand and asset price fall.
Coal, uranium, gas and biofuels
All fuel sources will experience negative price pressure. Uranium prices will not experience the rises expected as installed solar capacity will render many new nuclear plant installations in high-irradiance countries unnecessary and increasingly uncompetitive in a falling energy price market. The price of coal will fall as demand from power generation is met by solar. If coal prices fall, electricity prices will also fall, and then electricity will replace major areas of oil consumption like heating oil and train transport demand. Effectively, countries with expensive-to-develop energy sources – an example is the reported A$60 billion spent in Australia on liquiefied natural gas (LNG) from coal methane gas – will find them less economically attractive to develop, and the money will be spent on solar. Companies or countries with large reserves of expensive-to-extract fossil fuels deep offshore or in Arctic oil fields will probably never develop them, or at least they will not make their anticipated returns.
Solar power is potentially irresistible to a variety of governments like China, which spends so much money importing fossil fuel to convert to energy and pollution. Such a development would free China from the necessity of its currently overly aggressive stance on ownership of the oil-rich South China Sea. It will free both China and India from needing diesel-based generators for water-pumping for agriculture or a predominantly high-pollution, coal-based energy supply. While solar is not efficient enough yet to compete with gas on price, it will still replace gas demand from irradiance-rich countries who then either avoid having to buy gas or who can export for foreign currency what they once consumed. This will in turn reduce gas demand and so prices.

A classic example of such displacement of commodity consumption is the ambition of Morocco and other North African nations to generate solar power to supply to Europe, effectively ending Russia’s energy monopoly together with its monopoly-like pricing and political power. Certainly, it will change the pricing of any gas from Russia consumed under long-term contracts by China, making any large investments in this area subject to a poor return margin. As biofuels will be ended by better battery technology for vehicles, Russia’s grain production will also suffer from lower prices, so China the big commodity importer will be a big winner versus Russia the big exporter who will lose. When food prices fall due to falling biofuel demand expect farmland prices to follow suit. If interest rates were to rise at the same time the fall in farmland values could be acute.
Another effect that will be felt is that countries will lose their feeling of energy insecurity and so geopolitically the world would hopefully be much more stable. There will be other changes: solar power will be the foundation of industrial development in the Middle East, Arabia and parts of Africa, creating energy-rich economies able to thrive long-term due to that critical irradiance advantage. Other winners are high-irradiance African countries with hydropower, one of which will probably be the first 100% renewable power country. The ambition is that Africa will eventually be the first 100% renewable continent with solar, hydro and wind power all adding to the mix.

Future energy prices will become less vulnerable to war or turmoil and future global GDP will be higher due to lower energy prices in much the same way low interest rates accelerate and support global growth today. This strong global GDP growth means that demand for base metals, particularly copper, will be higher, while demand for platinum-group metals (PGMs) longer-term should fall as soon as cars go truly electric – unless new battery technology requires more PGMs. Many companies will see their value fall, while other companies who manage the transition into distributed generation or who own relevant technology patents will see their value soar like the internet companies of recent years, except their prices will reflect real value.
A final idea on the investment front for commodity traders is that technological innovation will in the future, as in the past, repress long-term commodity price inflation. If in general long-term energy prices fall, and with them grain prices, then it is hard to escape the belief that the long-term long-only commodity products will do very badly indeed. Not only will these products not keep up with inflation, but their roll yields will be negative. This will be particularly true when battery-powered cars become endemic, reducing oil demand and increasing oil storage utilization. The roll yield will probably be very negative indeed as oil producers lag consumers, putting stress on inventory storage availability. The long-only commodity products are heavily weighted to the one commodity genuinely capable of a super-contango: oil. Technological innovation means there is essentially no longer an intellectual argument for long-only commodity products based on their ability to counteract long-term inflation. Any investor invested in these products not for the long-term is now a market timer.