Renewables Cannot Replace Fossil Fuels Anytime Soon
Recent optimistic proclamations in regards to the end of the fossil fuel era are running counter to evidence we are seeing emerge from Germany, which is the leader in renewables.
Germany is currently moving towards capping wind and solar installation as it is realizing some of the problems associated with over-dependence on a volatile, undependable energy source.
Stagnating fossil fuel demand from electricity generation at 2014 levels would involve wind and solar providing as much as 40% of total global electricity, which is not practical, or affordable.
Germany is a case study for limitations to wind and solar
Technological change and the market’s quick adoption of it may have indeed put an end to old technologies very fast in many cases. But we have to be careful in trying to apply the same logic to the energy industry as a whole, because it is a much different proposition. As the German government is starting to learn from being one of the leading nations in wind and solar, there are technical difficulties and economic limitations to a wind and solar-powered economy.
Wind and solar make up on average about 19% of all electricity that Germany produces, some days, when the sun shines especially bright and the wind happens to blow harder, there are moments when these sources of energy reach close to 100% of energy generation needs. What this means is that Germany is getting close to reaching its limits in terms of what it can manage in terms of unreliable and unpredictable energy generation sources such as wind and solar. It seems that Germany is nervous about surpassing a certain level of electricity generation from renewables. We already have evidence of limits to renewable energy emerging, which may not be obvious when the technology only starts to penetrate the market, but it becomes more and more obvious once it reaches certain levels of penetration.
What this means for the global electricity production industry
It does not take a global trekker to realize the fact that the world is not Germany. Germany is a particularly special case in large part due to the fact that it has emerged as the main economic winner of the introduction of the Euro currency at the expense of other Eurozone members. Germany is managing to maintain a slight budget surplus despite spending about $26 billion per year on renewable energy subsidies. That is about 0.75% of its GDP, which for the United States, it would be the equivalent of spending about $140 billion on wind and solar subsidies per year. It also committed to spending about $60 billion to re-designing the grid to accommodate the transport of the renewable energy being produced often at some distance from the consumer. By 2015, 150 billion euros were already spent by Germany on supporting the Energiewende plan and it is estimated that if no change in policy will occur, Germans will collectively support a bill of another 400 billion euros by 2025. The whole plan is set to cost each average German family about 25,000 euros.
Needless to say that few countries on the planet can replicate the level of support that Germany has given to its green energy initiatives. Not all countries are able to reap the benefits of being the winner of a common currency meant to suit its needs and ruin many other countries around them, leading to a low rate of unemployment, a balanced budget and an economy growing at a faster rate in the past few years compared with most of its Eurozone peers. Given that even Germany is now looking at abandoning the support it has been lending to the industry, which I think speaks volumes about the viability of massive fossil fuel replacement with wind and solar, it should be a wakeup call for those who envision a world powered by windmills and solar panels.
In my view, Germany has already surpassed the average level of wind and solar power we will ever see worldwide. Aside from the financial aspect, which suggests that most of the rest of the world cannot invest its resources like Germany did, there are also the practical aspects that need to be considered. There is little point, in my view, of encouraging maximum capacity production volumes from these volatile, and very unreliable sources, which will at their peak capacity surpass current demand for electricity, while at low points only provide 5-10% of electricity needs.
Two-thirds of electricity comes from hydrocarbons
As we can see, two-thirds of all electricity generation currently depends on hydrocarbons. I personally do not believe that this ratio will change anytime soon, because most energy demand growth is happening in developing countries where the average GDP/capita is currently below the global average. These countries cannot afford to put too much burden on their populations in the name of the green economy. They need to focus on providing for the basic necessities of enough people within their society in order to have some public support.
There is actually a strong possibility that fossil fuel as a percentage of total electricity generation may increase, because sources such as hydro may be limited in terms of being able to keep up with demand growth, which means that it may start shrinking in importance when it comes to global electricity generation. Nuclear power may also see a shrinking in importance as some developed world countries such as Germany are looking to phase it out, while many smaller developing nations will find the capital investment into such projects to be just too much of a burden. We should keep in mind that we are looking at these proportions within the context of global energy demand increasing. In other words, energy production from all the sources available needs to increase just to maintain the current distribution.
Given the facts hydro and nuclear can fill the need. Assuming a scenario where hydrocarbon use for electricity were to stay flat at 2014 levels by 2040, wind and solar would have to make up about 40% of global electricity generation. I don’t believe that such an increase in renewable energy is possible. At best, we are looking at 20% of total electricity generation coming from these sources, meaning that hydrocarbon use in electricity production is likely to increase by as much as 50% from current levels. The only thing that could, in my view, significantly cut hydrocarbon use in electricity production is a massive increase in nuclear power.
Wind and solar energy are welcome additions to our current mix, because without this new source of energy, we may, in fact, be looking at an energy and arguably an environmental crisis going forward. At the same time, it is unrealistic to say the least to expect these sources of energy to cause hydrocarbon use to stagnate, never mind decline in coming years and decades. The only thing which might make it happen would be a stagnation in energy demand growth, which, at this point, would mean a tragic situation from a global economic point of view. As long as energy demand continues to increase at a relatively robust pace, there is little chance of stopping the continued increase in reliance on hydrocarbon energy. Wind and solar may serve to slow down demand growth, but will not stop it and reverse it as some tech enthusiasts may envision it.
Investment implications
I believe that natural gas demand is set to soar in coming years and decades, which is why I think that global LNG leaders such as Shell are set to perform well in the longer term. Natural gas is going to be the favorite hydrocarbon to use for electricity generation growth because it does provide for a much cleaner alternative compared with coal. For that reason, I like Shell’s acquisition of BG Group, even though the current mainstream consensus seems to lean towards the deal having been too expensive. If most of the 50% or so increase in hydrocarbon demand in electricity generation will be met by natural gas by 2040, it, in effect, puts us on a path for natural gas demand growth to almost double by then, when we also factor in growth in demand from other sectors, such as from the petrochemical industry and perhaps even from transport. It is natural gas-related stocks, which I believe will benefit the most from current global energy trends, not renewable energy companies.
