Click here to see related blog ‘The Energy Transition Part 1: Climate Change and Emissions’
Electricity generation (the Power Sector) is a leading contributor to global CO2 and GHG emissions. While it is part of the global warming problem today, the sector can also be part of the solution tomorrow. Could investors take advantage of this potential growth opportunity?
Power (electricity) generation produces:
- Ca. 13.8 Gt (Gigatons) of CO2 emissions, which is equivalent to 42% of annual global CO2emissions and amounts to 27% of annual global greenhouse gas (GHG) emissions.
The Power sector, as we stand today, is part of the problem, yet has its solutions. Can it be an attractive sector for the future?
According to the International Energy Agency (IEA), the 13.8 Gt of emissions can be split between coal (72%), gas (22%) and oil (6%). To provide some context, 1 GtCO2 is equivalent to 400,000 Olympic-sized pools of CO2. In 2016, ‘power production’ generated the equivalent CO2 weight of water contained in 5.5 million* Olympic-sized pools.
In Part 1, we highlighted the double emission intensity factor of coal power generation versus gas, and that coal is the predominant fuel used by large emitters, primarily China, the US and India.
Before the Industrial Revolution, work was limited to what could be effected by humans and animals. The revolution in harnessing mechanisation, powered by fossil fuels, released this limitation on work and productivity. Conversion of stored energy in raw materials into steam releases huge amounts of energy to power machines – but also heat as a result of chemical reactions.
The combustion of fossil fuels typically results in only 25-50% of primary energy conversion, the rest (heat) is typically not captured and used but, rather, dumped into seas, rivers, lakes or the atmosphere. A thermal power station can hit a best-in-class energy conversion efficiency of ca. 55% when it is a combined heat and power (CHP) plant, providing both electricity generation and heat for use in communal city heating or industrial hubs. Not only do fossil fuels generate huge quantities of CO2 when combusted, they also produce 50% of annual mercury emissions, over 75% of acid gases and 20-60% of toxic metals in the US. Thermal power plants generate the vast majority of particulate matter in our air today.
According to a World Health Organisation (WHO) study, each year up to an estimated 4.2 million people die from ambient (outdoor) air pollution. Another study, published in the Cardiovascular Research journal estimates that air pollution causes up to 8.8 million premature deaths each year, which would put it as the number one cause of death worldwide, ahead of smoking at 7.2 million p.a.
Financial markets typically look to GHG emissions as disclosed by the Carbon Disclosure Project and/or estimates by third party ESG data providers. The primary focus is usually on disclosure of Scope 1 and Scope 2 GHG emissions; deemed more accurate and reliable than Scope 3; where there is significant variability in the quality of reporting, and issues of double counting.
Scope 1 refers to emissions from a company’s own operations, while Scope 2 refers to purchased steam, heat, electricity and cooling (SHEC). Scope 3 wraps in emissions across the supply chain – both upstream and downstream – for example, a car using gasoline which has been produced by an oil company is counted in both the auto maker and the oil company.
Yet, it remains critical that companies with large Scope 3 emissions and supply chains, carry significant influence to bear on reducing emissions – by designing low-carbon products and using their purchasing clout to influence suppliers and improve their industry.
Utilities have high Scope 1 emission intensity, these emissions occur predominantly at the point of production, rather than at the point of use. Utilities rank as the second most intensive emission sector per $1 million of revenue, across MSCI GICS Industry Groups, on widely-used Scope 1 & 2 emissions. Yet, as and when focus turns to Scope 3 emissions, we would expect other sectors to have higher total emission rankings.
Despite power generation accounting for 27% of GHG emissions, utilities companies can largely independently also choose to be part of the solution, by deploying ‘green investments’ whilst setting out clear plans for coal plant closures in the near future. Renewables can tap a limitless supply of clean energy with significantly fewer environmental and health impacts. It is possible to produce (almost entirely) ‘clean’ power, and this capability can also be harnessed by other sectors in a method sometimes referred to as ‘sector coupling’. This is where the energy-consuming sectors such as transport, buildings, and industry interconnect with the power-producing sectors to switch energy sources from fossil fuels to clean renewable power. The result is a harnessing of the environmental system, rather than the polluting of it.
The first blog, The Energy Transition Part 1, illustrated this energy transition over the next three decades – a path towards ‘net zero’ emissions by 2050. Clean power and sector coupling are, in essence, the Energy Transition.
Clean power is the primary enabler in the Energy Transition
Currently 21% of power is generated by renewables (including hydro), and this could grow to be between 70% and 86% of power generation by 2050, depending upon forecasts. However, there is no advantage to coupling other sectors to electricity usage if high amounts of CO2 remain in power generation. The power sector needs to decarbonise ahead of the wider economy. In order to align with a less than +2°C global warming scenario, the power sector needs to lead with a 60% emissions reduction by 2030 to fulfil its role in limiting global warming. This is equivalent to an emissions reduction of 7% p.a. Then, as other sectors switch to clean energy usage, it is expected that power (electricity) will grow to almost 50% of all final energy consumed by 2050, up from 19% today.
Is this growth in renewables enough?
The IEA has analysed the current pace of renewables deployment against their Sustainable Development Scenario (SDS), which is aligned with a +1.8°C global warming scenario (66% probability). However, not everyone would agree this is consistent with the Intergovernmental Panel on Climate Change (IPCC) approach of ‘net zero’ emissions by 2050. Rather, it would be consistent with ‘net zero’ being reached by as late as 2070.
Even using this slower IEA SDS scenario, it is estimated that renewable power investments need to increase to $528 billion p.a. (or 74% higher than in 2018) for every year between 2019 and 2031. This would require coupling sectors to commensurately step up investments to $124 billion p.a., or 396% higher than amounts invested in 2018.
In short, the IEA SDS, would call for a huge acceleration in renewable power investments to meet a sector pathway mitigating climate change to ca. +2°C.There is clear upside to growth estimates according to this scenario, but more so if we were to align with a faster IPCC ‘net zero by 2050’ approach.
We are now witnessing a decisive disruption…
Investors have a key role to play, by investing in these solutions. Scale and advances in technology are providing a tailwind to the relative competitiveness of renewables versus thermal power generation – historically characterised by decades of slow-moving technology and long-life assets (30+ years).
We are now witnessing a decisive disruption. After decades of coal and gas-fired generation offering the cheapest option (and renewables requiring subsidies), all has changed in the space of five years.
In 2014, thermal was the leader, but by 2019 renewables had, and continue to have, the lowest new build cost (levelised cost of production) across the globe, despite subsidies no longer being required.
…and the increasing variability of solutions
Solutions are not limited to mainstream wind and solar technologies. Project drawdown is a fascinating read, collecting climate solutions and estimating the extent to which they can mitigate emissions. For the power sector, there are many solutions – including future technologies such as utility-scale energy storage – which are set to play a large, if currently unquantifiable, role.
The multitude of solutions illustrates the complexity of power systems, and the changing nature of what was a centrally-planned large plant and grid system towards a more disparate arrangement with high complexity. This offers a veritable smorgasbord of options that can be deployed to suit individual project circumstances, impacts and costs.
Project drawdown directly seeks to estimate the potential likely savings from each technology. For every MW (MegaWatt) of renewable energy capacity deployed we can estimate with reasonable accuracy the avoided CO2 emissions for that asset. The chart below highlights some of the posited solutions to help reduce future global CO2 emissions:
How can we effectively measure and monitor progress towards climate-related and societal goals?
Measuring and monitoring progress towards global warming reduction targets is half the battle, not least because of the interconnected nature of many industries, and the great number of variables involved.
For investors, the UN Sustainable Development Goals (SDGs) can offer a starting point from which to measure an investee company’s progress on initiatives developed to meet wider climate-related and societal goals. From a ‘clean energy’ point of view, renewable power generation has key linkages to a number of SDGs including: Health & Wellbeing (SDG 3), Affordable & Clean Energy (SDG 7), and Climate Action (SDG 13). These goals in themselves are not mutually exclusive, but offer a benchmark for action. If we are to collectively meet emission reduction targets by 2030, we will all have to play our roles.
 Source: IEA World Energy Outlook (2016)
 Source: NASA, https://sealevel.nasa.gov/news/114/10-things-all-about-ice *5.5 million Olympic-sized swimming pools is calculated by multiplying annual CO2 emissions (13.8 Gt) by equivalent Olympic-sized pool per 1 Gt of CO2 emissions (400,000).
 Source: US Environmental Protection Agency (EPA) https://www.epa.gov/mats/cleaner-power-plants
 Source: Jos Lelieveld, Andrea Pozzer, Ulrich Pöschl, Mohammed Fnais, Andy Haines and Thomas Münze: ‘Loss of life expectancy from air pollution compared to other risk factors: a worldwide perspective’; Cardiovascular Research, Volume 116, Issue 11, 1 September 2020, Pages 1910–1917 https://academic.oup.com/cardiovascres/article/doi/10.1093/cvr/cvaa025/5770885
 Source: www.climatewatch.org CAIT emissions data (2016). Forecasts: UNEP emissions gap report (2019), IRENA (2019), Bernstein Research (2019)
 IEA Sustainable Development Scenario, https://www.iea.org/weo/weomodel/sds/, https://www.iea.org/reports/world-energy-outlook-2019/renewables#abstract
 Source: Bloomberg New Energy Finance (BNEF), 2019
 Source: https://sdgs.un.org/goals
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