Will Surging Smart Grid Investment Result in Surging Electric Prices?

| About: First Trust (GRID)

The electric power system in the U.S. is dirty, antiquated, stupid, unstable, and a security nightmare. After years of discussion and debate, consensus now holds that the generation, transmission and distribution infrastructure will need hundreds of billions in new investment to reduce emissions, improve reliability, minimize waste and inefficiency, improve security, and facilitate the integration of wind, solar and other emerging alternative energy technologies.

Commonly cited capital spending estimates range from $200 billion globally by 2015 to $2 trillion overall. In his November 2008 report, "The Sixth Industrial Revolution: The Coming of Cleantech," Merrill Lynch strategist Steven Millunovich observed that cleantech markets will dwarf IT to the tune of two orders of magnitude. While there's plenty of room to debate how the future will unfold, there's little question that we're watching the emergence of an investment mega-trend that will endure for decades.

The elephant in the living room is that while some smart grid spending will be recovered through increased efficiency, consumers will ultimately pay for any excess costs in the form of higher electric bills.

In the early release overview for its 2010 Annual Energy Outlook, the Energy Information Administration forecast that over the next 25 years, the constant dollar costs price per million BTUs of energy would change as follows:

2009 2035 Price Percent
Price Price Change Change
Crude Oil $10.24 $23.04 $12.80 125.0%
Natural Gas $3.24 $7.84 $4.60 142.0%
Coal $1.56 $1.44 -$0.12 -7.7%
Electricity $28.07 $29.87 $1.80 6.4%

To put these seemingly benign price forecasts into historical context, I prepared the following graph to show what happened to constant dollar energy costs over the last 17 years, expressed as a percentage of their April 1993 values.

Click to enlarge
Energy Cost History.png

When I look at the historical trend-lines and factor in what I know about the energy industry and global economics, my sense is that:

  • The estimate for crude oil prices is too low given likely economic development in Asia and elsewhere;
  • The estimate for natural gas prices is too high given the recent emergence of shale gas as a resource; and
  • The estimates for coal and electricity prices must assume continuation of the status quo into the indefinite future.

When I consider the costs of alternative energy from wind and solar, the storage required to make these inherently variable alternative resources stable, the carbon mitigation requirements that will almost certainly be imposed on the coal mining and electric power industries, initiatives to move transportation from fossil fuels to electricity, and the huge amounts of capital spending required for the transition to a smart grid, the only conclusion I can reach is that electricity prices will have to climb. The increase is likely to be dramatic, particularly in the early years of a smart-grid build out. I don't have the skills required to forecast the probable magnitude of the coming price escalations, but I don't believe for a second that a flat line on the price graph is either a possible long-term outcome or a rational expectation. In short, there is no free lunch.

Every industrial revolution in history has been driven by new technologies that proved their ability to do more beneficial work with fewer economic inputs. The fundamental dynamic will be no different in cleantech, however the need will be even more pressing as global demand for energy, along with water, food and every commodity you can imagine, continues to skyrocket.

My friend and colleague Jack Lifton is fond of reminding readers that the "Green Road to a sustainable energy future begins in the black earth." We truly can't have a secure energy future without a security in raw materials supplies, which is why I'm an unrelenting critic of ideologically appealing, but resource foolish notions like plug-in vehicles, that promise to do less beneficial work while requiring far greater economic inputs. It's all about getting the energy we need at the lowest possible price. But discussing energy options without carefully considering the natural resource constraints for proposed solutions is a non-starter.

Many of the adjustments we'll be forced to make in coming decades will be quite painful, but the world has already moved on while we were paying attention to other things. I'm a firm believer that energy storage is a critical enabling technology for our energy future, but unless and until storage is cheaper than waste, the potential benefits of storage will remain unrealized. This truly is a sector where price is the only thing that matters and the technology that does the required work for the cheapest price will win the lion's share of the potential market.

Disclosure: No companies mentioned.