This article is sponsored by Starwood Energy
Where is the US on its energy transition journey?
There has been a seismic shift in the last few years. We are now starting to see large oil companies focusing on decarbonisation, whether through carbon capture projects or investments in renewables.
And the transition is only accelerating, creating a rich variety of investment opportunities – everything from renewables, carbon capture, transmission and battery storage to the gas-fired power plants that are needed to provide grid stability.
Where are the most interesting renewables opportunities?
There is massive demand for both wind and solar from corporate customers and from utilities. Over 25 states have mandates for procuring a certain portion of their energy from renewable sources. Which technology dominates really depends upon location. Texas has more wind than solar at the moment, but that is changing. The Midwest has more wind than solar. California has a great deal of both. It greatly depends upon the shape of the production and demand in every location.
Who is investing in US renewables infrastructure?
There is a lot of capital looking to be invested in the sector, especially since it has become clear that climate change is real. So we see a strong investment appetite, not just from an economic standpoint, but from a social responsibility standpoint as well.
This demand has created a huge compression on the cost of capital, particularly for assets with long-term contracts in place. For example, we have seen the likes of Softbank investing in US renewables. There is US money, Asian money, European money – investors all over the world are looking to deploy capital in US renewables. But in order to generate the returns they are after, some investors are having to take more risk – either development risk or market-pricing risk. That is the only way to justify a cost of capital higher than mid-single digits.
Where other than power generation are you looking to invest?
We continue to look at transmission investment opportunities. Transmission is an enabler. It enables renewable energy to be taken to the load centres. Where the wind blows and the sun shines is not necessarily where people live, so you need transmission solutions to transport electrons. You also need battery storage. Both transmission and storage investments will be necessary to continue upon the decarbonisation path that we are currently on.
We also see interesting midstream opportunities, such as gas pipelines and gathering systems. Gas needs to get to homes for heating, to power plants for producing electricity and to chemical plants to be converted into other products.
And then there are downstream opportunities. For example, we recently invested in an ammonia project in Texas. The plant there turns natural gas into ammonia which is then sold on the global market.
We believe the price of natural gas in the US will remain low for the foreseeable future and so converting it into more valuable products – whether liquefied gas or chemicals – is a very interesting play.
Finally, we are looking at ancillary fields such as carbon capture. The tax credits in place make that a very interesting space, both in terms of installing carbon capture on existing power generating assets or chemicals plants. There are also interesting opportunities for direct air carbon capture.
What lessons can be learnt from California’s experiences?
California has a very aggressive plan for decarbonisation – they are looking for 100 percent clean energy by 2045. As part of that effort, all coal and nuclear plants have been shut down and gas-fired power plants are increasingly out of favour as well. In particular, the gas plants that take water from the ocean for cooling the equipment, before releasing the water back into the ocean, have come under fire from environmental groups. As a result, more than 10,000MW of such gas plants in California have either been retired or are on their way to retirement, while there has been a proliferation of wind and solar. Without sufficient storage, this has resulted in overproduction during the middle of the day and shortages at other times.
The combination of blackouts and wildfires in California have demonstrated that having dispatchable assets, such as gas-supporting intermittent renewable assets, is critical. As a response to the crisis, it was announced in September that a number of plants otherwise scheduled for shutdown will now remain online for a further three years.
There has been a realisation that decarbonisation cannot take place overnight. You need gas-fired power plants to remain online until batteries are ready to solve intermittency issues.
Which opportunities provide the best risk/reward dynamics – renewables or gas?
We believe gas-fired power plants will have an important role to play over the next 25 or 30 years and, with the amount of capital flowing into renewables and the resulting return compression, gas-fired power plants are offering some really attractive investment opportunities now. The level of competition for renewables assets is such that, in some cases, the cost of capital has dipped below an acceptable level for many investors. So, from both a risk and returns perspective, gas may well be the better option.
And what role do batteries have to play in all this?
Storage has been a hot topic for the past few years. Costs are coming down rapidly and we expect prices to fall by as much as a further 30-50 percent over the next five years. As things stand today, however, batteries have to be subsidised before they compete head-to-head with other technologies.
Different markets within the US are coming up with different solutions to this. In New York, there is a programme where grants are made available. In California, utilities are required to secure batteries as part of their mandate. In Texas, meanwhile, people are trying to install batteries on an uncontracted or merchant basis. But although batteries may become competitive in the future, so far it has been difficult to make those numbers work without some form of subsidies.
Is lithium ion the only game in town?
“Both transmission and storage investments will be necessary to continue upon the decarbonisation path”
Over 90 percent of installed storage projects use lithium ion. A supplier ecosystem has developed, with vendors providing long-term warranties. However, certain markets need long-duration batteries. These tend to be more electrolyte based – flow batteries, for example.
It really depends upon the problem you are trying to solve. If you are looking to solve problems with renewable enhancement and peaking capacity, then lithium ion is great. But if you need the battery to store large amounts of electricity or dispatch it on to the grid over long periods, then flow batteries are necessary.
Most of the market is focused on short-duration batteries, but we are starting to see a number of discussions around long-duration flow batteries. It will be important to have a mix of both as we move away from reliance on thermal fuels.
How might the US presidential election impact energy infrastructure opportunities?
There are two possible scenarios. If the current administration remains in place, then we will be left with the status quo. However, if the administration changes there will be a significant acceleration in renewables opportunities. Even the current administration is fast-tracking permitting for some renewables projects sitting on federal land in a bid to boost jobs. Cutting the red tape involved in development would be extremely helpful.
But it isn’t only the presidential election that we need to consider. If the Senate remains controlled by Republicans and the House remains in the Democrats’ hands, again, I think things will carry on pretty much the same as before. But if the Senate becomes Democrat-led and we see a change in the White House as well, there will be a massive increase in renewables procurement and installation in this country. There is a clear mandate for decarbonisation on the left.
What impact has covid-19 had on your activities?
There has been a definite slowdown in development projects because it has been more difficult to get responses from stakeholders, whether it entails permissions from landowners or impact studies on interconnection sites.
The other area where covid-19 has had an impact is tax equity. A number of tax equity investors have paused because of challenges in forecasting their tax appetite. That reduction in the supply of tax equity has been more pronounced for solar than for wind because solar investment tax credits have to be taken all in one year. For projects coming online in 2020 or 2021, that has created difficulties for tax equity investors that are struggling to calculate their tax capacity.
On the other hand, the buying and selling of operating assets has not been affected very much at all. There is still a large amount of capital looking to invest in operational solar and wind projects, and transactions are continuing to get done. People are getting creative with respect to how they conduct due diligence – by using drones, for example, to provide them with visuals instead of site visits.
What does the long-term future hold for US energy infrastructure?
There is massive change ahead for the US power markets and for the type of assets that will serve the needs of the country. It is a trend that started more than 10 years ago – a move away from relying on the old ways of producing electricity, be that coal or nuclear, and a move towards renewable and distributed generation. Despite changes in the political environment, that process has continued, uninterrupted. The decarbonisation of the economy is well underway and nothing, now, is going to stop it.
As a result, the investment landscape is exciting and dynamic. And as corporates increase their participation in the market and oil companies start to play, the space is only going to get more interesting in the years to come.