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Renewables – The Next Major Disruptor
Disruptions and S Curves - An Investing Framework with Renewables as a Case Study
Disclaimer: No part of this article is an investment advice, please consult a financial advisor before investing
In one of my previous articles, I have explored Renewables Sector in India and its general outlook. If you’re a new subscriber, you can read it here.
In this article, I will be exploring renewables as a general theme and how it may very well be the next major disruption in our lifetime.
Before we start discussing renewables, I would like to point out an investing framework I follow – disruptions and S Curves.
Disruption - is anything that can substantially change the paradigm in an industry or advent even new ones.
All disruptions follow a S curve in adoption. They are typically slow at the start as the technology is in research and development mode. Costs of research are high, failures are frequent and tech is limited to lab or niche government areas where investors cannot participate. Once the technology is ready for commercial application though, there is an incredibly fast adoption at a pace which astounds most analysts.
The last major disruption was the internet.
It started as a niche military experiment and then later got adopted at a very small scale at CERN before breaking out of the lab and getting commercial adoption.
In case of Internet, it took about 30 years before it went from a military research paper to small scale adoption at CERN and then took less than 3 years from CERN to commercial scale.
To give a perspective, for the internet disruption, here is the below timeline
Early 1960s - First papers envisioning modern day internet are published
1969 - First contracts for Internet Research (ARPANET) awarded by US Department of Defense
1990 - Tim Berners Lee creates the first World Wide Web network at CERN
1993 - 1% of all two-way telecommunication flows through WorldWideWeb
2000 - 51% of all two-way telecommunication flows through WorldWideWeb
2007 - 97% of all two-way telecommunication flows through WorldWideWeb
2020 - I don't need to state the importance of Internet and Web during the pandemic and how an integral part of our lives it has become
All of this happened in less than two decades. Amazing, isn’t it!
Even the most bullish projections couldn’t capture the growth of internet in early 1990s.
This is what disruption do, and all of them follow a S curve.
Below is an example of a S curve, that can be applied to any disruption (old or new).
As the graphic explains, the reasons why disruptions work is because
a. The new technology is far superior and more economically efficient than the current one
b. As new technology gets adopted and scaled, its costs reduce dramatically
c. This cost reduction, incentivizes other producers to shift from old to new technology
d. This shift further reduces the costs of new technology while also increasing the costs of the old one
e. This cycle continues until the new technology has captured the entire market from the old tech
Something similar is playing out today in the most lucrative industry – the energy sector.
Let’s try to understand briefly, what are renewables and how does this disruption thesis apply to the energy sector.
Renewable – A Renewable is any naturally occurring source that will replenish itself automatically by the portion depleted by usage or consumption of that source.
In short, using the source doesn’t cause it to reduce as in the long run the resource replenishes itself and is thus by definition – infinite.
Sources like wind, solar, biogas, geothermal, nuclear all fall under the definition of renewables. For this article, I will be focusing majorly on solar and wind as those are two areas where most developments are happening.
With this let’s try to apply the disruption framework and S curve thesis to renewables.
Let’s first try to understand the current energy industry structure.
There are various moving parts to the current energy infra.
First is the raw material – this is usually coal in most cases. This raw material is used by a power plant to burn the coal and produce enough heat that is then used to create electricity.
A typical drawback here is, a coal plant once started cannot be shut down. Shutting down and restarting the coal plant will take more resources and is not economically feasible.
Once electricity is generated, its sent to the grid which then ultimately reaches the end consumer – residential, commercial and industrial users.
As you can imagine, you need endless source of coal to keep burning and setting up more and more thermal power plants to produce electricity. Further, as the electricity consumption in the economy increases, the need to set up even more power plants.
I do not need to point out that burning all this coal is causing a lot of harm to the environment and further contributes to climate change.
Throughout this article, I will analyze renewables with an economic point of view rather than through the lens of climate change – the main reason being, disruptions work when they are economically feasible as the economics itself acts as an incentive to switch.
Now let’s examine what the energy grid will look like once we switch our dependence on coal.
As highlighted earlier, disruption works when the new technology becomes economically viable and is superior than the old technology.
I think we can all agree that renewables are more superior than fossil fuels for many obvious reasons (infinite and clean) we do not need to list here.
So, we just need to explore the second part of the equation – does it make economic sense to install a renewable plant over a fossil fuel plant for our energy needs?
Solar – Fuel for Limitless Energy
Before I deep dive into solar, let me just get a very frequently asked question about this sector out of the way.
Question: Solar has been around for more than a decade, wind even more, so what has changed now that will cause them to disrupt the energy sector?
A very good question indeed and the answer is simple – costs and convergence of technologies.
Let me explain.
Solar and Wind, while still green and clean a decade ago, weren’t as economically viable as they are today. Over the last 10 years, there has been a significant drop in prices of solar and wind along with developments in another very important technology – batteries.
Pre-2011, batteries weren’t that important in our daily lives. Remember Nokia phones that had batteries that used to last weeks? The advent of smart phones meant we could no longer rely on our existing battery technology and had to work on improving Lithium Ion batteries. As improvements were made in Lithium Ion battery and more phones, laptops, smart watches etc. started to sell in the world, the cost to produce these batteries started reducing at a dramatic rate.
Post 2015, the rise of Tesla and other electric car companies meant Lithium Ion battery market increased multi-fold and new players started emerging with new advances in both cost reduction and capacity increase of batteries.
The below chart shows how serious this reduction in Lithium Ion battery prices is.
(Note: The x-axis is logarithmic)
Remember from earlier in the S curve, how adoption of new technology is slow at first. Solar and Wind went through the same from 2000 to 2010. Barely any new capacity was added, most capacity added was mainly to either prove that the technology works or to make a point against climate change and fossil fuel. Nobody set up a solar or wind plant in 2000s because it made economic sense to do so.
Thus, the prices remained high and whatever capacity was added couldn’t be stored cheaply as the cost to set up required batteries remained very high.
However, in 2011 as smartphones took off and Lithium Ion battery prices started coming down, a nation saw an opportunity to embrace renewables – China.
Now, China didn’t embrace renewables because it cares about the environment. It did it for economic reasons. Remember S curve again – how disruptions accelerate dramatically when it makes economic sense to do so.
By 2011, China had become the factory to the world and amassed enough wealth for it to be called a super power. The rise of China through the 2000s is just extraordinary and I am sure something that will be studied as a case study in colleges for decades to come.
China though a super power, was still reliant on a lot of oil import as the nation barely has enough oil reserves of its own. This over reliance on oil meant that Chinese growth was dependent on how much oil can it import for itself and oil in 2000s and 2011 wasn’t cheap – it costed well over a $100 per barrel. Every year China was spending billions of dollars in oil imports to keep the economic growth engine running.
With renewables, it saw an opportunity and made an early move to incentivize its citizens and industries to embrace renewables. This early move paid off and China today controls well over 65% of all solar power value chain. This early move combined with Chinese enormous scale meant giant factories that can manufacture parts of solar value chain were set up, which ultimately pushed the prices of solar PV modules down (as shown below).
Let me give you a quick walkthrough of the solar power value chain.
Solar panels are made from silicon which comes from heating sand at abnormally high temperatures of >2000 degree Celsius to refine the sand and convert it into silicon with 99.9999% purity.
This silicon is then compressed into ingots which are then sliced into wafers and then converted into solar cells. A combination of solar cells is called a solar module.
The whole process is very industrial and hence works well when factories with large capacities are set up and economies of scale of those capacities drive the costs down. That’s why the price of solar cell decreased so dramatically as China started scaling up solar manufacturing.
Meanwhile in the last decade, some improvements in solar cells have also led to increase efficiency of about 18 to 21%.
All the above led to a drastic decline in electricity generated via solar, and I do mean drastic. Look at the chart below.
Costs to generate electricity from solar went from $359 per MWh in 2000 to $40 per MWh. That’s a decline of almost 90% in costs. I expect them to reduce well below $10 per MWh in the coming decade.
With this decline – it now makes economic sense to generate electricity via solar than any other resource, and this is exactly what the governments around the world are up to.
Solar Wind Battery Systems
Earlier in this article, I spoke about batteries and how they play a key role in adoption of solar. Over the next decade, it’s the battery tech and advances in that industry that will really drive the growth in renewables adoption.
100% solar, wind and battery farms will be common across the world. These hybrid farms will be capable of supporting all electricity needs of the communities and we will move from a central power structure to a distributed one with micro grids made up of various community solar, wind and battery farms.
These grids are already a reality in remote corners of the world with Tesla setting up large scale solar wind and battery farms in Hawaii and Australia.
As battery costs reduce and further advancements are made, the adoption will dramatically increase further (S-curves).
How to Invest?
By now you must be wondering – this is all great, but how do I as an investor invest in this disruption and benefit from it financially.
My advice – don’t invest. Stay away from it for now and continue to read about the disruptions and all developments taking place.
Here is the reason why.
As disruption takes place and new players enter the market, costs reduce dramatically with competition increasing and businesses find hard to survive and keep up with the change. The same playbook has played out multiple times in the past.
In 1900s during automobile boom, 1000s of companies went bust.
In 1940s during the airline boom, 100s of airlines went bust.
In 1990s during the internet boom, 1000s of internet companies went bust.
Like before, even in renewables boom, many companies will go bust.
But, if you study the sector, keep up with it, there will certainly be a time when the industry will mature and stabilize enough for you to identify the winners from the losers and at that point in time, you can use all the knowledge you gained by studying the sector today, to your advantage.
In the coming two decades, there will be a lot many disruptions than the century went before. Science and technology is advancing at a rapid pace and some of these advancements will trickle down to industry.
Study them but be vigilant.
See you in the next one.