Originally posted on Seeking Alpha http://seekingalpha.com/
By Garvin Jabusch
♦ Solar will become so inexpensive that it will inevitably continue to gain market share from fossil fuels, starting with those used to generate electricity.
♦ Oil Is a Commodity, Solar is Tech. They don’t share fundamental economics and should not trade in tandem.
♦ As demand for a commodity increases, its price goes up. As demand for a tech increases, its price goes down.
Tech Energy and Commodity Energy: Different Worlds
Solar Photovoltaic (PV) as a means of deriving energy is fundamentally different from fossil fuel-based commodities (oil, coal and gas). Consider, a solar PV panel can be thought of as nothing more than a hugely oversized computer chip: a bunch of circuitry embedded in a silicon wafer. Indeed, in most economic sector classification schemes (GICS, etc.), PV manufacturers have often been defined as “semiconductors,” which is basically true (if misleading in other ways). So different are the driving economics behind tech-based and commodities-based means of deriving energy, we at Green Alpha are recommending to Standard & Poor’s and MSCI that they consider formally separating the two into distinct sub-sectors.
Recently, though, the two types of energy – oil and solar – have been trading in tandem, both falling significantly since mid-2014. Traders by and large seem to be thinking “energy is energy.” But this energy-as-monolith view is not appropriate to the reality of the economics, and is not supported by the fundamentals.
To illustrate what I mean, a closer-to-valid comparison is that a solar PV company like First Solar, Inc. (TICKER: FSLR) should trade more like a chip maker such as NVIDIA Corporation (TICKER: NVDA) or Advanced Micro Devices, Inc. (TICKER: AMD) than like West Texas Intermediate oil. If we’re going to treat similar investments as groups, computer processing power makes a better analog for solar modules than oil does.
Exhibit 1: Costs of Computer Processing Power, Electricity from Solar PV, and Oil Price per Barrel, 1976-2014[i]
In my sole exhibit here, it’s difficult not to notice the similar and similarly dramatic price declines in solar PV in cost per Watt (green line) and computing power in cost per GigaFLOP (blue line) over the last 37 years. Solar-PV-derived power has fallen some 170 times over that period. Computer processing power has declined in cost at many times even solar’s rate, owing to huge demand and massive scaling. Meanwhile, Oil (red line) has done what commodities do: fluctuate in price according to demand and supply factors. Oil gets expensive when economies are growing, when there’s geo-political risk, when some nation or supra-national organization decides it wants it to be expensive, and so on.
Technology like computer chips and solar panels, in stark contrast, nearly always go down in price as demand goes up. Think about the price declines in computers and televisions over just the last five years, and the simultaneous improvement in the products. But now, the global economy can apply that same tech cost dynamic beyond goods to the energy we need to power those goods and everything else.
Imagine what that means for world economies. When we grow and use more fossil-commodity based energy, that energy becomes more expensive, and continuing economic growth becomes thwarted. But as we grow with technology-based energies, the increasing power demand decreases the cost of that energy and further stimulates economies! Put another way, consider the simulative effects as we realize the IEA’s estimate of “over USD 115 trillion in fuel savings”[ii] by 2050 as the transition to tech-based renewables, chiefly solar, advances. Solar, although already grid competitive in many areas, is just getting started. The blue line in the exhibit suggests what may yet be possible as solar technology evolves to enjoy the same level of scale and investment as semiconductors. Even with using current solar technology though, $115 trillion is a heck of a liquidity injection.
Solar will become so inexpensive that it will inevitably continue to gain market share from fossil fuels, starting with those used to generate electricity (coal then natural gas), and then, as the global economy adapts to make better use of renewable electricity in more sectors (think electric cars), it will displace oil. The popular current question ‘when will renewables reach grid parity?’ will seem quaint and even funny in less than a decade. As one report has revealed, “a recent sign of the progress that solar is making in taking over the world: In 42 of the 50 biggest U.S. cities, home to about 21 million single-family homeowners, solar power is now cheaper than electricity from the power grid.”[iii] This is happening because, again, as demand increases, so does scale, investment, R&D advances and declines in installation expense, all of which lead to fast-falling overall costs. Solar PV module costs have declined “75 per cent since the end of 2009 and the cost of electricity from utility-scale solar PV falling 50 per cent since 2010.”[iv] Now, reasonable estimates predict that “Solar Costs Will Fall Another 40% In 2 Years.”[v]
Like a pundit in the 1960s or 70s predicting that the computers of 2015 will fill entire rooms and be capable of hundreds of calculations per minute, today’s observers who believe solar is still an expensive niche energy will prove badly mistaken.
Meanwhile, back in fossil fuel land, costs of production aren’t getting any cheaper, even if barrel and pump prices (temporarily) are. Oil costs a lot to find and go get. Production is expensive to the point that oil companies were cutting their exploration budgets long before the beginning of the oil price decline that began in mid-2014. Unfortunately, a decline in oil prices does nothing to cause a decline in exploration and production costs, meaning oil’s margins get squeezed.
No one has written more plainly on this than investor Jeremy Grantham: “As a sign of the immediacy of this problem, we have never spent more money developing new oil supplies than we did last year (nearly $700 billion) nor, despite U.S. fracking, found less – replacing in the last 12 months only 4½ months’ worth of current production! Clearly, the writing is on the wall. It is now up to our leadership and to us as individuals to read it and act accordingly.” In a sidebar, Grantham goes on, “The only longer-term price relief and net benefit to the economy will come when either we reverse recent history and start to find more oil more cheaply, which will be like waiting for pigs to fly, or when cheaper sources of energy displace oil.”[vi] As economist Gregor MacDonald recently tweeted: “Sorry, did everyone forget Majors started cutting capex in Q1 of 2014, because $100 not enough to outrun declining ROI on runaway costs?”[vii]
In the end, no producer can sell oil for less than it costs to recover it. And those costs are high. Too high to compete in the long run. As Stanford lecturer Tony Seba recently said, “Put these numbers together and you find that solar has improved its cost basis by 5,355 times relative to oil since 1970…traditional sources of energy can’t compete with this”[viii] [italics added]. There is a nexus of effects arising from the interplay of tech and commodity energy dynamics, and few if any of them are favorable to fossil fuels.
Solar PV is a technology, and it’s past and future cost dynamics will behave like technology — becoming ever cheaper. Oil is a commodity, finite and expensive to locate, extract, refine and ship, and oil and other fossil fuels have had and will have cost dynamics to match: very volatile, and always subject to what they cost to extract.
Today, solar competes mainly with the other means of making electricity: coal, natural gas and nuclear (more on how those stack up in my next post). In the long run, as our economy and infrastructure make more and better use of renewable electricity, oil and solar will compete directly in a way that they do not now. But by then, renewables, led by solar, will be so inexpensive that cost comparisons with oil will no longer spark argument.[ix] For now, suffice it to say that inexpensive oil can’t and won’t prevent the solar boom from continuing, because solar and oil, economically, scarcely share the same world.
Disclosure: At the time this article was published, Green Alpha Advisors was long FSLR, and had no positions in NVDA, AMD or Oil.
Other important disclosures http://greenalphaadvisors.com/legal-disclaimers/
[i] Exhibit by Jake Raden, Green Alpha Advisors, LLC
3. Bloomberg Historical Oil Prices; 1976-2014
4. Crude Oil Prices from 1861 https://www.quandl.com/data/BP/CRUDE_OIL_PRICES-Crude-Oil-Prices-from-1861
Solar PV Data:
5. Bloomberg New Energy Finance http://www.economist.com/news/21566414-alternative-energy-will-no-longer-be-alternative-sunny-uplands