Portfolio Adviser • PA April 2019 • Sector Report

The last decade marked the beginning of a paradigm shift in how the world consumes energy. Since 2007, solar power consumption has increased at a compound annual growth rate (CAGR) of 50% and now represents 2% of global capacity, according to the BP Energy Outlook 2018. Wind energy accounts for 5% of the total, after having grown at 21% CAGR in the past decade.

These figures compare with the 1-2% compounded annual growth rate for fossil sources over the same period, implying that clean energy technologies are increasingly challenging the dominance of carbon fuels. We expect this transition to accelerate in the decade ahead.

Policy support has been a key proponent of clean technology investments in the past decade, both in developed markets as well as large emerging economies such as China.

However, we believe regulation will take a backseat to technology as the key driver, thanks to the persistent cost deflation in wind and solar equipment.

Clean energy technologies are cheaper today than they have ever been. The average price of a solar module has fallen by 88% since 2000, while the unit cost of wind turbines has declined by more than 40%, according to the US Energy Information Administration (EIA).

This means the economic viability of renewable power is comparable to – if not better than – conventional sources.

For instance, the EIA estimates for the levelised cost of energy, which includes capital investments, cost of capital and variable/fuel costs, shows that onshore wind and solar power are both rapidly catching up with conventional natural gas and coal plants in the US.

This is true elsewhere in the world. Last year, the first subsidy- free offshore wind farm project was approved in Germany. And in northwest China, which enjoys conducive hot weather and less expensive land, solar farms have begun to operate without state financial support.

This decline in unit costs has been driven by factors including oversupply from the manufacturers, aggressive competition for projects, more efficient solar modules, larger wind turbines and improving load factors.

The relative economics improve in the favour of wind/solar if we account for any new policies that require gas/coal plants to incorporate carbon capture and sequestration facilities.

If we then factor in rising CO2 emission allowance prices, the outlook looks even tougher for legacy power capacity. EU carbon prices averaged €6.30/t from 2015-17, but rose to €25/t towards the end of 2018, according to Bloomberg figures.

Supply-side innovation is not the sole driver of this transition. Changing consumption trends matter, too. We expect the accelerated pace of renewable adoption to be driven primarily by capacity additions in large emerging markets, particularly India and China, with the EIA expecting China alone to be responsible for 30% of solar installations between 2018-30.

First, it’s about demand, not just clean supply. Energy consumption is still growing from very low levels. Per capita electric power consumption in India, for instance, is just 11% of Germany’s. Clean energy will be part of a broader solution as industrialisation and urbanisation boost the need for power in emerging markets.

Second, it’s about pollution, not just climate change. Highgrowth emerging markets face a more immediate need to adopt low-carbon technologies as they seek to manage pollution in dense urban areas. China and India are home to 18 of the 20 most polluted cities in the world, according to the World Health Organisation, 2015.

Finally, it’s about energy independence, not just innovation. Despite having the fifth-largest coal reserves in the world, India is the third-largest importer of the commodity. China’s industrial policies, such as ‘Manufacturing 2025’, are also aimed at achieving self-reliance in a host of industries, such as semiconductors and clean energy.

Given growing populations and continued urbanisation, the demand for power is only likely become greater. But with great power comes great responsibility. Consensus is building around the need to address the global challenge of climate change.

This should translate into continued policy support of clean infrastructure, energy efficiency and renewable sources, both in large emerging markets and advanced economies.

Combine that with continued improvements in technology and declining unit costs and it becomes increasingly clear that we are on the cusp of a global energy transition.

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