Have rosy forecasts about the legacy energy industry created a financial bubble?
We’ve been hearing a lot lately about a “bubble” in Tesla and other EV-related stocks. However, a new report from the independent think tank RethinkX argues that a far larger and more dangerous bubble now exists around conventional coal, gas, nuclear and hydroelectric energy assets.
Above: A Tesla parked in front of oil wells (Image: Tesla Owner)
The authors of the report, Adam Dorr and Tony Seba, are prolific writers on clean energy and electrification topics. In 2015, Seba released a book called Clean Disruption, in which he argued that the transition to a clean energy economy would be all over by 2030—many found that date overoptimistic at the time, but in light of various recent news items, it now seems far more feasible.
The basis of the bubble has to do with the way legacy energy assets are priced in the financial markets. What is the value of a nuclear power plant, an oil field, a coal mine? Almost everyone agrees that the impending transition to renewable energy negatively affects the valuation of these assets, but by how much? As regular readers of this blog know, forecasters with ties to the oil and auto industries tend to argue that fossil fuels will maintain their dominance for decades to come, while environmentalists and EV advocates typically predict much shorter timelines. If the latter views turn out to be closer to reality, firms in the fossil fuel, auto and other industries may soon end up with billions of dollars’ worth of stranded assets.
Dorr and Seba point out that the estimates relied on by government policymakers and financial analysts tend to be the conservative ones. “Regulators have outsourced their responsibility for asset pricing to organizations like the International Energy Agency, US Energy Information Administration, a few mainstream consulting firms and Wall Street analysts. These organizations play the role that the credit rating agencies played in mispricing subprime mortgage assets which led to a housing bubble, financial crisis, and ultimately the Great Recession between 2007 and 2009.”
The authors argue that the large and rapidly-expanding global financial bubble “has in part been created by mainstream energy analyses that have, for the last decade, significantly underestimated the levelized cost of electricity (LCOE) from conventional power plants because they assume these plants will be able to successfully sell the same quantity of electricity each year from now through 2040 and beyond. This assumption has been false for at least ten years.”
With renewable energy sources on a steadily declining cost curve, assuming that an existing conventional power plant will continue to produce and sell the same amount of energy at similar prices, decades into the future, would seem to be a rookie mistake—akin to assuming that a Blockbuster store would have continued to generate the same amount of revenue every year during the 2000s ascent of Netflix and other streaming services. However, Dorr and Seba tell us that it’s not only groups aligned with the conventional energy industries that fall into this error.
“The LCOE methodologies used in virtually all mainstream analyses contain the same critical error: they assume a high and constant capacity factor (utilization rate) for the entire lifetime of any individual power plant. In doing so, they assume both existing and newly-built power plants will be able to produce and sell the same number of kilowatt-hours each year throughout their 20+ year operational life. Widely-cited sources that commit this error include the International Energy Agency (IEA), the United States Energy Information Administration (U.S. EIA), the World Bank, the International Renewable Energy Agency (IRENA), the Department for Business, Energy & Industrial Strategy of the UK government, the Australian Energy Regulator, the National Renewable Energy Laboratory (NREL and OpenEI), Lazard, Stanford University, the University of Texas at Austin, the MIT Energy Initiative, and the Natural Resources Defense Council (NRDC).
“Capacity factor of conventional coal, gas, nuclear, and hydro power plants will not remain high or constant, but will instead decline dramatically over the next 10 to 15 years as they are outcompeted and disrupted by the combination of solar photovoltaics, onshore wind, and lithium-ion batteries (SWB). In fact, capacity factor in conventional energy has been dropping since at least 2010. For instance, the average capacity factor of coal in the United States has fallen from 67% in 2010 to just 40% in 2020 – first because of competition with cheap gas from fracking, and now because of SWB. In the United Kingdom, coal capacity factor has collapsed even faster, from 58% in 2013 to just 8% by 2019.
Above: Tony Seba's brief synopsis of his latest report (YouTube: RethinkX)
“Mainstream LCOE analyses thus artificially understate the cost of electricity of prospective coal, gas, nuclear, and hydro power plants based on false assumptions about their potential to continue selling a fixed and high percentage of their electricity output in the decades ahead. Because LCOE figures and asset valuations are very sensitive to the capacity factor parameter, these false assumptions have made conventional energy assets appear to be much more attractive than they actually are.”
The implications reach far beyond the energy and automotive industries. Millions of people around the world have money invested, whether individually or through pension funds, in companies that are thought to be low-risk, but that may be just the opposite.
“If the gap between the mainstream mirage and reality is not corrected quickly, and incumbents continue to assume that coal, gas, nuclear, and hydro power plants will be utilized at 20th century historical rates in perpetuity, then pension/retirement funds and other asset managers may continue to be lured into investing not only in conventional power plants but in their entire value chains—including pipelines, ports, railways, and mines—under the false pretense that these are low-risk investments.”
“Investment in an asset class above and beyond what the fundamental value can return, based on shared and widespread false assumptions, is the very definition of a financial bubble,” the authors conclude.
The issues raised by the new report are complex, and the authors present numerous sources, along with helpful graphs and tables, to support their thesis. I highly recommend downloading the entire report, or at least reading the Executive Summary.
The authors don’t just rail about the current state of affairs—they propose several steps that decision-makers in the energy and finance fields, as well as political leaders and individuals should take (take a close look at your investments, folks).
The good news: “carbon neutrality can be achieved more quickly and cheaply than generally expected.” The bad news: in the tsunami of disruption that’s on the way, a lot of jobs, companies and even whole industries will be wiped out. Governments have an important role to play in mitigating the damage, but policies must be directed at protecting people, not incumbent companies or industries, from the financial pain ahead.