Energy transition has been top of mind for many investors. We have seen evidence of the transition in the US with new, non-fossil fuel assets and we believe the US may possess a pathway to success.
Energy transition has been top of mind for many investors. We have seen evidence of the transition process in the US: hundreds of wind farms dot the landscapes of many states, solar panels shimmer on the roofs of countless homes and electric cars are increasingly appearing in parking lots across the country. To illustrate the potential of new, non-fossil fuel assets, on April 3, 2022, more than 97% of California’s electric power came from just wind and solar generation. That level of sustainable energy usage may fluctuate, but an attractive composition of renewable energy is indeed possible. While this is a great example of observable changes, let’s not forget that the US’s total energy consumption in 2021 was still based 79% on fossil fuels (Figure 1) such as petroleum, natural gas and coal.
To accelerate the global effort to clean up greenhouse gasses (GHG), in 2021 the US rejoined the effort to fulfill the Paris Agreement. On April 22, 2021, the US submitted a plan to cut emissions and adapt to climate changes that is in line with the Nationally Determined Contribution (NDC) of the UN, which is required by the Paris Agreement. The main obligation of the US NDC is an economy-wide target of reducing net GHG by 50% to 52% below 2005 levels by 2030.
By 2019 US nationwide CO2 emissions were already 13% below those of 2005 levels according to the Environmental Protection Agency (EPA) and by 2021 US CO2 emissions from energy consumption were 19% below those of 2005 according to the US Energy Information Administration (EIA).
While CO2 emissions declined 19% since 2005, total energy consumption declined only 3% during that period (2005-2021). As Figure 2 demonstrates, the majority of the declines in emissions since 2005 can be attributed to the lower CO2 emissions from electric generation, which declined around 30% during the 2005-2019 period. (Lower CO2 emissions from electric generation were also responsible for close to 30% of the US CO2 emissions in 2019, according to the EPA.)
Interestingly, the 30% drop in CO2 emissions from electric generation was associated with almost no growth in electric consumption during that period (Figure 3). However, ongoing efficiency improvements comprising the use of electricity in home appliances, as required by the Department of Energy efficiency standards, offset growth in household formation and an increased usage of appliances per capita.
Data from the EIA (Figure 4) permits us a glimpse into the changes in electric generation that drove the decrease in emission rates for electric generation. The dearth of new nuclear power generators (only one new reactor was introduced in the last 25 years) kept nuclear electric power relatively flat, as some reactor retirements offset increased utilization rates. An increase in renewable power was responsible for an 11.6% decrease in emissions between 2005 and 2021, with solar power rising from 0% of US generation to 2.8% and wind power climbing from 0.4% to 9.2%. The remaining 18% decrease in GHG in the US was a direct result of the decline of coal’s role in the total electric mix from 50% in 2005 to 22% in 2021. An increase in natural gas-based generation offset the decrease in the coal generation that was not replaced by wind or solar power.
Availability of natural gas generation in the US has benefited greatly from the introduction of the efficient combined cycle natural gas power plants (they combine gas and steam turbines to generate 50% more electricity from the same fuel source) in the 1990s (Figure 5) and deregulation in the electric industry resulting from the National Energy Policy Act of 1992. This includes 1996 Orders 888 and 889, which provide independent power producers with access to transmission lines, as well as the introduction of Regional Transmission Organizations (RTOs) through Order 2000; RTOs coordinate access to the electric grid and demand loads for all producers – both legacy producers and new independent power producers.
Some of the transition away from coal owes to the introduction of solar and wind power and a retirement of older coal plants, which were too expensive to retrofit to meet the new national standards to reduce mercury and other pollutions from coal-fired plants. There was another factor that accelerated the trend away from coal: lower natural gas prices on a megawatt hour-basis competing head on with coal (Figure 6).
So, what does all of this mean to the US’s goal of a 50% to 52% reduction in CO2 emissions by 2030 as targeted by the US NDC?
The US may handily make its 2030 goals if certain assumptions persist or materialize:
A zero percent growth scenario (Figure 7a) assumes no growth in total electric demand, further declines of coal generation in line with historical retirements of 7% annually, 1% annual growth in natural gas generation, 10% annual growth in solar and 5% annual growth in wind generation.
This scenario provides for a 52% CO2 reduction from 2005 to 2030, assuming lower than historical rates of growth for solar and wind to account for Investment Tax Credit/Production Tax Credit renewal uncertainties; these credits encourage the use of sustainable energy. The zero percent growth scenario also assures relative grid stability with solar and wind-based generation adding up to 21% of total generation. This level of renewable generation from wind and solar could be balanced without natural gas “peaking plants” and limited battery deployments to maintain the integrity of the system.
The alternative 1% annual growth scenario (Figure 7b) assumes 1% annual growth in total electric demand driven by very strong electric vehicle deployment. An average electricity powered vehicle consumes 0.346 kilowatt-hours per mile,1 which combined with 1% of the annual electric demand of 2019 (equal to 41,566G kilowatt-hours), computes to 120,132 million miles driven or around 10 million newly registered plug-in-hybrid-electric vehicles (PHEVs) and battery electric vehicles (BEVs) per year. This compares to the 2019 US light vehicle registration of 16.1 million and 2021 actual electric car registrations of 0.6 million vehicles. This would also result in around 80 million PHEVs and BEVs on the road in 2030, as compared to the current 275 million registered vehicles in the US.
Even here we could see further declines of coal generation, only slightly higher than historical retirements, at 8% annually and 2% annual growth in natural gas generation. This scenario would require a bit faster growth in solar and wind generation at 15% and 7% annual growth rates respectively, leading to a 50% CO2 reduction from 2005 to 2030. Solar and wind generation in this model add up to 25% by 2030. This level of renewable generation from wind and solar could be balanced with an increased deployment of natural gas “peaking plants” and battery storage.
It should be noted that current construction plans of utility companies in the US seem to reflect further buildout of wind, solar and natural gas plants, matched with the retirements of coal plants and some of the older natural gas and nuclear plants (Figures 8a and 8b).
In some states, energy transition is mandated through a legislative process with an introduction of Renewable Portfolio Standards or voluntary targets (Figure 9). States with those standards have decided to promote the development of renewable assets. It should be noted that Nebraska has recently approved a 100% renewable energy goal by 2050 and a few other states have substantially increased their goals with Oregon moving from 50% by 2040 to a new goal of 100% by 2040 and North Carolina moving from a prior goal of 12.5% by 2021 to 100% by 2050.
As the price points for solar and wind energy have fallen, even the southeast region of the US has started replacing older fossil fuel generation assets with renewable assets. A material driver of those decisions is the economics of lower Levelized Cost of Electricity (LCOE) calculations (Figure 10).
Reaching 2030 US NDC goals is achievable at the current transition rate. At the same time, real retail electric rates can remain steady as they have done so far throughout this transition (Figure 11).
Acceleration of the US’s electric transition process and further progress towards its net zero goal by 2050 are possible through electric transmission line developments: connecting new plants and incorporating newer technologies into the grid design. Solutions such as new power lines, battery storage, carbon capture and sequestration and hydrogen are now the most promising tacks, in our view, and are likely to contribute to a successful transition for all stakeholders.
Investment implications of the US energy transition
Incremental capex associated with the energy transition can be a source of increased earnings for utilities and industrial companies as newer assets replace old, depreciated assets. The key is finding companies that embrace the transition and understand the need to convert their portfolios to more sustainable ones. There are also companies participating and enabling the transition through engineering and the construction of new, non-fossil fuel plants, manufacturing required components and maintaining the associated facilities. There are many examples of those companies in the US small cap and mid cap equity space.
The views and opinions contained herein are those of Schroders’ investment teams and/or Economics Group, and do not necessarily represent Schroder Investment Management North America Inc.’s house views. These views are subject to change. This information is intended to be for information purposes only and it is not intended as promotional material in any respect.