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It is known as the Gusher Age. On 10 January 1901, a well at Spindletop, Texas, hit oil, sending an oil gusher 150 feet in the air and spilling 100,000 barrels of oil in a day. It took more than a week to get the gusher under control.

The discovery changed the course of human history. Suddenly, using oil for fuel was feasible and the global economy was rebuilt around access to cheap petroleum.

Today, America is on the brink of another historic change. This time, the word is moving away from fossil fuels in a great transition to clean, renewable energy sources like wind, solar and hydrogen.

Known as the energy transition, this change will once again alter the fundamentals of the energy industry – and the global economy itself. From an investment perspective, the energy transition offers an evolving and significant opportunity.

Infrastructure – as the fundamental base of our economy and society – faces an increasing challenge to adapt to changes that will be wrought by the transition, whether new government policies and regulations, changes to supply and evolving preferences and demands from consumers.

The energy transition

The term ‘energy transition’ is used to refer to the many changes required to move the global energy system from fossil fuel to zero-carbon energy sources.

The entire industry – supply, demand, and regulation – faces transformation if the world is to realise the goal of a zero-carbon future. It is a big ship to turn.

Fossil fuels dominate energy because they are cheap and plentiful. In the history of the US, the fossil fuel industry has only been impacted twice – by the emergence of hydro-power in the early 1900s and the development of nuclear in the 1960s.

Recently, US government policies, like federal tax credits and state government renewable energy targets, have given renewables a foothold. And as technologies mature, renewables are becoming increasingly competitive with traditionally cheaper fossil fuels.

Already, wind and solar are cost-competitive with conventional generation technologies even without subsidies. Coupled with the need for fiscal stimulus to revive the US economy, policymakers are also turning to green investments as a way to drive economic growth.

Consequently, countries around the world – or in the case of the US, certain states – have started setting zero-carbon emission targets.

The energy transition is underway.

 

Energy demand

Key to the speed of the transition will be the evolution and nature of energy demand.

Efficient use of energy has been a feature of the market for decades and will only increase as the benefits of efficient energy use – both lower costs and better environmental outcomes – become greater.

And as the market becomes more flexible, energy users can more easily switch to cleaner or cheaper sources of electricity – or even produce their own.

Different trends are affecting the different types of consumers.

Transport is the largest energy consumer in the US – and the most reliant on fossil fuels.

Just two million of the 360 million vehicles in North America are electric but numbers are growing rapidly1.

The key to widespread adoption of electric vehicles will be price parity with petrol and diesel cars, which is a few years away yet. This means government policies will be the important driver of demand.

One intractable issue is road funding: petrol taxes fund roads. The rollout of the charging network is also a critical consideration.

Buildings are another key energy consumer. The building sector is a diverse set of relatively small power users with differing local regulations across cities that are trending towards more environmentally friendly consumption.

Heating and cooling comprise two-thirds of building energy demand in North America, which goes a long way to driving supply preferences2. Gas is more effective for heating than electricity, particularly in cooler climates.

Smart technologies like internet-connected meters and thermostats are also impacting demand by making customers more aware of pricing and consumption.

These new technologies are allowing demand-side management, where consumers are rewarded for managing their power use, which can help moderate demand in peak hours.

In contrast to the building sector, power usage in the industry segment is characterised by a smaller number of large energy customers, each with quite different needs and often with direct, unique relationships with energy suppliers.

The industry sector is increasingly seeking green energy and is increasingly using Power Purchase Agreements – longer-term contracts to buy energy – to source renewable supply.

Countries around the world – and even some states – have started setting zero-carbon emission targets. The energy transition is underway.”

Energy supply

From a supply point of view, continued technological advancement supported by government policy means renewables will continue to grow strongly as fossil fuels play a declining role.

Oil will stay a significant part of the energy mix for decades as it is embedded in the economy as an input to goods and services – and the US still has significant oil resources available.

Similarly, gas will play a role – especially as a flexible resource supporting renewables – because it is cheap and plentiful in the US. It will also continue to play an important role as a heating source, for reasons already mentioned.

But coal-fired generators will continue to be retired as they face increasingly unfavourable economics versus renewables. And the eventual deployment of so-called renewable diesel and renewable natural gas – essentially manufactured versions of the fuels that are more environmentally friendly – will require ongoing subsidies as these are not economic in their own right.

Meanwhile, renewable, zero-carbon energy technologies will continue their growing momentum. Technology advances are driving wind and solar’s inroads into the energy mix, despite concerns about variability.

Rooftop solar continues to grow, comprising a third of total solar capacity. And while more than half of the 2.7 million solar installations in the US are in the southwest, penetration is pushing north and across the continent3. Technology advances in panels and battery storage will put a tailwind behind the sector.

Despite some mixed success, utility-scale batteries are continuing to see a build in momentum, particularly for short durations. The focus going forward will increasingly be on long-duration technologies, where today only pumped-hydro energy storage has been effective.

Carbon capture and storage has significant potential but is not yet economic at scale. A technological breakthrough would be a meaningful catalyst for the transition, and continues to be a focus of R&D and pilot projects.

And in the background is hydrogen, considered the holy grail of the energy transition.

Hydrogen can be made with renewable energy. It is easy to store and transport.

And when used to make electricity, its only emission is water.

Hydrogen is already used in industrial processes in the US and Canada and pilot projects have been established for energy storage and generation. A commercialised hydrogen industry would create significant demand.

Nuclear remains a fundamental and well-supported zero-carbon energy resource and reliable provider of baseload electricity.

Nuclear will play an important role during the transition, but it is unlikely to see growth due to the prohibitive cost of new nuclear power plants and instead will likely slowly decline as a source of supply.

 

The US in focus

US President Joe Biden has proposed many ambitious climate change policies. Details are limited and the proposals need to be passed into legislation, but some of the most significant include:

  • Re-enter the Paris Climate Agreement
  • 100% clean energy economy and net-zero emissions by 2050
  • $1.7 trillion (over 10 years) federal investment in climate and environmental proposals (total of $5 trillion with state and local governments, and private sector)
  • $400 billion investment (over 10 years) in clean energy innovation
  • 100% of new sales of light and medium vehicles are zero emissions, improvements for heavy vehicles
  • 500,000 new EV charging outlets by 2030
  • Reducing carbon footprint of buildings by 50% by 2035
  • Aggressive methane reduction targets
  • First economy to achieve net-zero emmissions from the agriculture sector
  • Creation of 10 million new jobs

 

 

The impact on infrastructure

So, what does this all mean for infrastructure investors?

The energy transition would not be possible without the infrastructure connecting supply and demand.

Energy infrastructure has seen considerable change over the past 100 years but arguably no change has been as significant as the change the industry is facing today.

Change is driven by new technology and rapidly evolving customer preferences. But regulators are often reminded of the dangers of moving too fast. Blackouts in California last year highlight the need for reliability, as does the Texas power crisis which unfolded earlier this year4.

Regulators need to strike a balance between making sure capital is available for new investments and ensuring existing assets do not become stranded.

AMP Capital’s global listed infrastructure team sees five main opportunities for the infrastructure sector from the energy transition in North America:

1. Oil and gas pipelines becoming increasingly strategic

Fossil fuels will be a meaningful source of supply for many decades to come, which means the pipelines connecting supply with demand will continue to play a key role.

Different markets will have different values, but given the difficulty in getting new pipeline infrastructure approved, certain assets already in the ground will be that much more valuable.

2. Repurposing existing infrastructure

Some infrastructure assets could be repurposed for technologies like hydrogen and carbon transport, and storage development. Pipelines and storage assets could be adapted for use by another commodity, although conversion costs could be a barrier.

Canada is using depleted oilfields and saline aquifers to store carbon emitted from refineries, industrial processes and power plants. The related transportation infrastructure has also proven to be a growth area.

3. Electricity transmission for renewables

Transmission for renewable electricity is a large growth driver partly because these types of assets – offshore and onshore wind and solar – are often located well away from demand centres.

This result is the need for a meaningful extension of transmission networks to connect them to the grid.

These opportunities will likely continue for many years.

Similarly, the changing generation mix and the different locations of supply means investment is also needed to adapt networks to cope with the different flows.

4. Electric vehicle (EV) charging and electricity distribution networks

The growth of EVs is requiring an entirely new infrastructure of charging points.

Policymakers recognise the environmental and economic potential from EVs, but range anxiety – the fear of running out of charge and being stranded – is real. It’s also a serious headwind to increased EV market share.

There is no consensus on who should pay for charging stations – there are arguments for and against governments, energy utilities and private enterprise footing the bill.

There’s also no sight of standards across chargers, meaning EV drivers will need to find a charging station compatible with their vehicle.

Estimates in the US suggest only 4 per cent of the chargers needed to support growth to 2040 are operational today, so the opportunity is considerable5.

5. The future of gas distribution networks

Gas remains the cheapest source of supply for heating in the US – and much cleaner than some of the existing alternatives like oil.

However, some cities have banned gas in new buildings putting a question mark over the growth of the industry.

Despite this, the economics of electric heating remain unfavourable and – in the medium term – is unlikely to change.

Gas networks have considerable investment programs available to repair aged and leaking pipes, improve safety and reduce methane emissions.

Ultimately, renewable natural gas – gas manufactured from renewable sources – or hydrogen may take their place in the gas infrastructure.

This article was drawn from Joseph Titmus’s whitepaper, The Energy Transition in North America6.

Important Notes

While every care has been taken in the preparation of these articles, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) makes no representation or warranty as to the accuracy or completeness of any statement in them including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. Performance goals are merely goals. There is no guarantee that the strategy will achieve that level of performance. The information in this document contains statements that are the author’s beliefs and/or opinions. Any beliefs and/or opinions shared are as at the date shown and are subject to change without notice. These articles have been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. They should not be construed as investment advice or investment recommendations. An investor should, before making any investment decisions, consider the appropriateness of the information in this document, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This document is solely for the use of the party to whom it is provided and must not be provided to any other person or entity without the express written consent of AMP Capital.

Edition 11 - Real Estate

Preparing for the post COVID recovery in Real Estate

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