Land of the Rising Sun

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A new global economy is emerging, increasingly powered by solar and wind energy. What we are seeing now is an inexorable shift towards renewables all over the world.

Glimpses of this growth can be found nearly everywhere – from Germany and Denmark both sourcing over a quarter of their energy from renewables to China becoming the world’s biggest wind energy producer to Uruguay sourcing nearly 95% of its total electricity from renewables. Such examples continue to make headlines at an increasing rate.

Falling costs

There are several factors driving this structural transition toward renewable energy sources. First, the cost of wind and solar energy are falling fast. In fact, in just the last five years, the price of photovoltaic panels has fallen by over 80%, and by over 99% since the 1980s. Similarly, the cost of wind energy has also fallen by over 90%, down from $0.55 per kilowatt hour (kWh) to $0.05 per kWh. Such remarkable cost reductions represent the main driver behind the energy transition.

Large cost reductions also incentivize the largest emerging markets – from China to India – to make big investments in wind and solar energy. For instance, both China and India are becoming increasingly ambitious with respect to their renewable goals. China recently increased its original commitment of 20,000 megawatts (MW) by 2020 to 70,000 MW by 2017, while India lifted its solar goal from 22,000 MW to 100,000 MW by 2022. Such examples also suggest that some emerging markets – like Uruguay – may take a shortcut to a new energy economy driven by renewable energy, just like many bypassed fixed line phone lines by switching directly to mobile telephony over the last decade.

The pace of this energy evolution is set to accelerate, and in the process, reshape global energy industry. In fact, we are already seeing ambitious renewable energy targets being achieved ahead of schedule. And as more coal-fired power plants are closed and their publicly listed stock loses more and more market value, it seems a tipping point for investors is likely to be closer than many would care to admit

Furthermore, for the 1.5 billion people living without access to electricity today (mainly in Africa and India), the lower costs and new potential of solar energy solutions are exposing a multitude of opportunities to gain access to electricity for the first time. For example, today, it is often cheaper to simply install solar panels on rooftops than to build a central power plant and transmission infrastructure. As such, the significant reduction in solar energy costs offers the developing world – and, in particular, the 1.5 billion people without access to electricity – a big opportunity to gain access to affordable, clean, and efficient electricity.

Growing support

The second important driver of the energy transition is the increasingly strong policy support driving the energy transition forward. For instance, it was early in December that over 1,000 local government leaders from around the globe issued a declaration in Paris offering the clearest commitment to realizing the energy transition to date. This declaration states, “We – the undersigned mayors, governors, premiers, and other local government leaders – commit collectively to support ambitious long-term climate goals such as a transition to 100% renewable energy in our communities.” This sort of policy support only strengthens the structural case for the energy transition.

And although governments around the world still subsidize the fossil fuel industry to the extent of nearly $600 billion per year (five times the subsidies for renewables), the support for renewables is growing steadily. For instance, over the last 18 months, over 70 countries globally have initiated feed-in tariffs to encourage investment in renewables, while 38 countries launched new investment tax credits for renewable energy to support innovation in the sector.

Moreover, over 40 countries have either already implemented or are planning to introduce national carbon pricing mechanisms. And when China launches its planned national cap-and-trade program for carbon dioxide in 2016, over a quarter of global carbon emissions will be included in a new carbon pricing regime, designed to limit the extraction and burning of fossil fuels, and make renewable energy sources economically more attractive on a relative basis.

Shifting focus

The third driver of the energy transition is the increasing momentum of the global fossil fuel divestment campaign. Indeed, leading up to the climate talks in Paris in December, over 500 institutions, representing over $3.4 trillion in assets from around the globe with allocations to fossil fuels, had committed to divesting in some form or another. For example, the world’s biggest insurance company, Allianz, announced that it would divest from companies making more than 30% of their revenue from coal, while at the same time increasing investments in wind energy.

For many investors, the fears that the ‘decarbonization’ movement could leave the biggest companies with vast amounts of stranded assets (e.g. unburnable reserves) has added to the general concern that the best days for investors in oil, gas, and coal may already have passed. Such concerns can have a self-perpetuating effect on the industry, especially as divestment campaigners increase pressure on fiduciaries like pension funds and endowments to cut their losses in a sector that has already lost 30% of its value in the last 22 months.

Moreover, a growing body of research is also adding fuel to the fire. A recent report by the University of Cambridge detailed the material risk of climate change to investment portfolios and found that “short-term shifts in market sentiment induced by awareness of future climate risks could lead to economic shocks and losses of up to 45% in an equity investment portfolio value.” Over the last year, many portfolio managers have already realized the practical impact of these academic insights. For example, the California Pension Fund CALPERS lost more than $5 billion on its fossil fuel holdings this year, which is being criticized by many as an unacceptable opportunity cost of not having divested earlier.

But the role of investors in promoting an energy transition has not only focused on divestment. Warren Buffett has invested $2.5 billion in the Solar Star Project, a 580 MW project, one of the world’s largest photovoltaic systems. Moreover, Bill Gates, the world’s wealthiest man, recently led a group of international philanthropists, The New Energy Coalition, in committing to invest billions of dollars into clean energy via a new fund to be set up in 2016. The international coalition also includes star investor George Soros, Jack Ma of Alibaba, Facebook’s Mark Zuckerberg, Richard Branson of the Virgin Group, Jeff Bezos of Amazon, and Africa’s richest man, Aliko Dangote. These examples show that there is a lot of ‘smart money’ pushing the energy transition forward.

Increasing localization

The fourth driver of the energy transition is the potential to achieve energy independence – or the localization of the energy economy. Indeed, the drive to be less dependent on a few countries producing and controlling most of the world’s energy has also generated a lot of support for renewables, particularly solar energy. So, instead of transporting our energy from halfway around the world, rooftop solar panels enable households to localize their energy, thus allowing households to achieve greater independence from utility companies.

Instead of coming from halfway around the world, our energy will be as close as the rooftops over our heads. Instead of a few countries producing and controlling most of the world’s energy, people everywhere with solar panels on their roofs will be in the energy business, producing and managing their own energy supply. Germany already has more than 1.4 million photovoltaic systems, and the number in the US has reached 675,000, suggesting that the localization of the energy economy is already underway.

For the 1.5 billion people living without access to electricity today (mainly in Africa and India), the lower costs and new potential of solar energy solutions are exposing a multitude of opportunities to gain access to electricity for the first time. For example, today, it is often cheaper to simply install solar panels on rooftops than to build a central power plant and transmission infrastructure

And for emerging markets, where 1.5 billion people do not have access to the grid, distributed energy means that many emerging market consumers will not have to wait until a government decides to build a central-station power plant and expand access to the electricity grid. The people themselves can start building their own micro-grids, which are increasingly more affordable than grid expansion. In fact, last year, developing countries invested more than $13o billion in solar home systems, which is the highest amount ever, signalling a strengthening trend toward localizing solar energy power at the place of consumption.

This rapid spread of solar home systems also has negative effects on the traditionally safe and stable business models of most utility companies. This is because customers who have solar home systems buy less electricity from utility companies, which serves to drive down power prices. Utility companies typically react to this development by raising rates, which in turn incentivizes even more people to shift toward solar energy. This self-perpetuating cycle serves only to accelerate the energy transition.

Opposition to fossil fuels

The final driver of the energy transition is the steadily growing opposition among civil society to the burning of fossil fuels. Many people today find that climate change and the role of carbon emissions in the process are nearly impossible to ignore. In fact, according to NASA data, 2015 will all but certainly be the hottest year since 1880, when NASA began keeping records. It would thus break a record that was previously set in 2014. The consequences of temperature increases include rising sea levels, increased droughts, acute water scarcity, forced relocations, and extinctions – all of which are already costing the world billions of dollars. So, people around the world are beginning to pay attention.

For the world’s biggest emitter of greenhouse gases – China – civil society is also becoming increasingly active in efforts to limit air pollution. The most prescient example is the documentary film Under the Dome, produced by the journalist Chai Jing. The film combines research data with Ms. Jing’s personal story as a mother trying to protect her daughter from Beijing’s toxic air pollution. Within the first week of its release, the film was viewed more than 200 million times, striking a nerve among Chinese civil society, and galvanizing a new collective consciousness
to promote clean economic growth models.

A new energy evolution

So, the tide toward a new energy economy has already turned – and is being accelerated by the five drivers mentioned above. At the same time, the consumption of traditional fossil fuels is falling too. For example, Chinese coal consumption in 2014 fell for the first time in 16 years. In addition, US coal consumption is also down by 21% since 2007, with more than one-third of the nation’s coal-fired power stations set to close. And India has doubled a tax on coal, which is being used to fund ‘ultra-mega’ solar farms that should further boost support for an energy transition.

This new energy evolution is setting the stage for stabilizing the climate disruption caused largely by the burning of fossil fuels in the 20th century. Looking ahead, the pace of this energy evolution is set to accelerate, and in the process, reshape global energy industry. In fact, we are already seeing ambitious renewable energy targets being achieved ahead of schedule. And as more coal-fired power plants are closed and their publicly listed stock loses more and more market value, it seems a tipping point for investors is likely to be closer than many would care to admit.

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