2016 has been an incredibly frustrating general election cycle for U.S. energy investors, especially those in the fossil fuel markets. Last week the Republicans officially nominated reality TV star and real estate magnate Donald Trump as their presidential candidate. While Mr. Trump nominally supports domestic energy production, he is also proposing to implement a raft of protectionist and anti-trade measures, up to and including a withdrawal from the World Trade Organization, at a time when U.S. exports of both petroleum and natural gas have surged to multi-decade highs (see figure). Mr. Trump's pledge to build a wall along the border with Mexico that he would force that country to pay for is especially alarming given that fully 59% of U.S. natural gas exports went there in 2015. Likewise, his promise to renegotiate or end NAFTA must be considered against the fact that 92% of U.S. petroleum exports last year were destined for Canada.
US Natural Gas Exports data by YCharts
U.S. energy investors have been able to take solace in the fact that Mr. Trump continues to face an incredibly steep climb to the White House in the electoral college, notwithstanding a recent post-convention surge in the polls. Last night the Democrats officially nominated former New York senator and U.S. Secretary of State Hillary Clinton to be their presidential candidate. Mrs. Clinton has been widely perceived to represent a continuation of the Obama Administration that has trumpeted an "all-of-the-above" approach to energy production that combines domestic production of fossil fuels (excluding coal) with renewables.
The Democrats have recently taken steps to change that perception and, in the process of doing so, have raised the prospect that the most likely victor in November's election will not support domestic natural gas to the same extent as her predecessor. The 2016 Democratic Party Platform, which was published last week in advance of the party's national convention, explicitly calls for construction of new renewable electricity capacity to take priority over even that of new natural gas-fired facilities:
"[Democrats] will streamline federal permitting to accelerate the construction of new transmission lines to get low-cost renewable energy to market, and incentivize wind, solar, and other renewable energy over the development of new natural gas power plants." (emphasis added)
The Platform goes on to take a strong stance against shale gas production, even if it falls short of the national ban on hydraulic fracturing that was almost included as a goal. It pledges to leave decisions regarding where the process can occur to state and even local governments. Such a move would grant NIMBYist opponents of shale gas with an unprecedented level of control in major gas plays in states such as Colorado and even Texas.
Going a step further, the Platform even calls for the precedent set by the Obama Administration's anti-Keystone XL pipeline decision to be carried forward to all federal government energy permitting decisions. Specifically,
"[Democrats] must ensure federal actions do not 'significantly exacerbate' global warming. [Democrats] support a comprehensive approach that ensures all federal decisions going forward contribute to solving, not significantly exacerbating, climate change."
Notably, this new stance would be implemented at a time when the fossil fuel industry is waiting on a number of important federal permits and regulatory decisions related to extraction, transportation, and exports. While past Democratic opposition at the federal level has been mostly restricted to coal, the Platform's proposed standard could feasibly be applied to petroleum and natural gas as well despite the latter's low carbon intensity relative to coal. This is especially true when taken within the context of the Platform's other pledges to limit natural gas production and combustion. Noted environmentalist and DNC Platform Committee member Bill McKibben hailed the new platform by contrasting it with previous platforms in a tweet:
No more all of the above. No more bridge to the future. Sun and wind are now above natural gas- Bill McKibben (@billmckibben) July 10, 2016
Political fantasies and economic realities
Unlike Mr. Trump, I do not believe that climate change is a hoax that has been perpetrated by China to improve that country's trade position. However, I find a number of serious flaws with the Democratic Platform's energy pledges. First, renewable electricity continues to only be feasible on a widespread level if combined with natural gas due to its intermittency. Access to non-intermittent sources such as hydroelectric and geothermal is limited to only certain regions of the country; despite having been around for more than a century, hydropower contributed only 6% of America's electricity last year. The Platform recognizes this fact by calling for the installation of 500 million solar panels over the next four years (i.e., what would be Mrs. Clinton's first term in the White House).
The challenge with solar PV and, to a lesser extent, wind is that non-hydro renewables only generate electricity for a limited time each day. This results in capacity factors (the percentage of time spent generating electricity out of the year) for the two pathways of 29-33% compared to 92% for nuclear power and 55% for coal and natural gas. Other things being equal, intermittent renewables require 2-4x as much capacity to be installed to generate the same output as non-renewable pathways.
Renewables, of course, have zero fuel costs, which is a significant advantage compared to non-renewable pathways. This valuable trait allows for the levelized cost of electricity (i.e., accounting for differences in intermittency and capital costs) of wind to be competitive on an unsubsidized basis with new natural gas facilities and solar PV to be competitive in especially sunny regions on a subsidized basis. Both renewable pathways are attractive as marginal, or peak, sources of electricity as a result. They work especially well when natural gas serves as a back-up in the form of either baseload or peaker capacity.
The attractiveness of wind and solar PV diminishes when it comes to utilizing them as baseload sources of power, which is a necessity if they are to become major contributors to the U.S. grid on par with coal or natural gas (wind and solar PV met only 4.7% and 0.6%, respectively, of U.S. electricity needs last year). Even the building of excess capacity cannot overcome the intermittency problem since no electricity can be generated from solar PV at night no matter how many panels are installed in a region. (Solar thermal represents a possible exception to this rule, but it is too expensive to be competitive on an unsubsidized basis even in the sunny Southwest.) Without natural gas, intermittent and non-dispatchable electricity pathways can only meet a substantial fraction, let alone a majority, of electricity demand when combined with energy storage.
Energy storage has been around for decades (if not longer) in the form of pumped hydropower. This resource is greatly limited by terrain constraints, however, that prevent it from being used in most of the U.S. Batteries, such as those that Tesla (NASDAQ:TSLA) is on the verge of building at scale in its Gigafactory, are often presented as the solution to the quandary faced by wind and solar PV. The challenge with batteries, unfortunately, is that they are an extremely expensive means of storing electricity.
Just how expensive was quantified last November in a report by Lazard on the levelized costs of energy storage. The report compared several methods of energy storage, both upstream (i.e., at the site of generation) and downstream (i.e., at the site of end-use) compared to conventional means of quickly providing dispatchable electricity. Very few compared favorably. A new natural gas peaker facility averages $192/megawatt-hour, which is a high cost compared to baseload power due to its infrequent use (as the name suggests, peakers lie dormant most of the day, only coming online during periods of peak demand). Not a single upstream storage source averaged less than $200/megawatt-hour, however. Only pumped hydro came close, while the various battery and other unconventional configurations such as flywheels averaged from $600 to $1,000/megawatt-hour. That is up to 8x higher than the retail rate even in expensive electricity markets such as New York State.
Downstream storage systems, such as the configuration that Tesla is proposing to market via a tie-up with residential solar PV firm SolarCity (NASDAQ:SCTY), fares still worse due to a lack of economies of scale. While small diesel generators are quite expensive (not to mention polluting) at $247/megawatt-hour, levelized costs for residential battery configurations ranged from $1,200 to $1,600/megawatt-hour. Larger, multi-building systems such as microgrid storage configurations were more competitive but still outpaced the costs of diesel generators by 50% and natural gas peakers by 100% on average.
It should be noted that the analysis does not account for subsidies. Furthermore, while I report average values above, all of the storage configuration costs were lower under optimistic assumptions (although, the vast majority still weren't competitive with peakers and diesel generators even then). Storage costs could continue to fall in the coming decades as new battery types are commercialized, whereas natural gas and diesel prices are unlikely to fall below the levels witnessed earlier this year. That said, it will be at least a decade, and probably longer, before storage costs fall to the level necessary to make natural gas peakers obsolete.
Politicians are notoriously apt to ignore economic realities, unfortunately, and this is especially true in the aftermath of contentious primaries that have pushed the winning candidates toward the political fringes (just look how the label "centrist" has been used as an insult at both parties' national conventions). While a President Hillary Clinton would be under no obligation to follow her party's platform, the need to prevent Senator Bernie Sanders's supporters from switching to the Green Party candidate or not voting at all makes it likely that Mrs. Clinton will push the energy planks during her campaign. This alone could create turmoil in the energy markets.
LNG firms are most at risk from the current campaign cycle. LNG continues to make up only a tiny fraction of U.S. natural gas exports, let alone production (see figure). This could change following proposals to build 17 new LNG export sites in the U.S., mostly in the Gulf of Mexico and Alaska. One of the largest of these is an Alaska project supported by Exxon Mobil (NYSE:XOM), ConocoPhillips (NYSE:COP), BP (NYSE:BP), and TransCanada (NYSE:TRP). Other major firms involved with large proposed export projects are the appropriately-tickered Cheniere Energy (NYSEMKT:LNG) and Chevron (NYSE:CVX).
US Natural Gas Marketed Production data by YCharts
My concern is that the permitting process for these sites could become a political football regardless of who wins in November. Members of the Democratic Party have adopted an unfavorable view toward fossil fuel exports in the past on the grounds that the carbon is better left underground; after all, the argument runs, since greenhouse gas emissions are global in nature, the environmental damage is done regardless of where the fuel is actually combusted (unlike emissions of, say, particulate matter). This is now the Democratic Party's official position going into the presidential election. Likewise, Mr. Trump's "America First" platform has led to statements by the candidate that America's domestic fuels should be used at home so as to keep energy prices affordable.
Looking beyond LNG exporters, however, the Democratic Party Platform represents a potential headwind for electric utilities, as represented by the Utilities Select Sector SPDR ETF (NYSEARCA:XLU), many of which are already grappling with the consequences of the Obama Administration's Clean Power Plan. Truly favoring the construction of new renewables capacity over that of natural gas would likely cause electricity rates to rise. My concern under such a scenario is that this rise would cause utility customers to decrease their consumption and/or switch to distributed electricity generation such as solar PV. While such a shift is a goal of the Democratic Party's environmentalist wing (higher rates push more consumers toward distributed generation, which forces utilities to increase rates still more, thereby moving the cycle forward), it could reduce the capex increases that many utilities have come to expect under the Clean Power Plan.
Somewhat counterintuitively, even renewables could be placed at risk if the Democratic Party's energy planks are pursued after the election. Voters have a tendency to quickly turn against environmental and energy policies when they perceive those policies to be an additional cost; the U.S. quickly dumped the corn ethanol blending credit a few years back after its costs ballooned, while Australian voters ditched the country's cap-and-trade program only a few years after it was implemented. Voters favor gradual transitions, especially when it comes to essential goods such as electricity, and a powerful backlash could arise if the transition does not proceed smoothly (again, see Australia's experience).
Party planks are more wishlist than rulebook, and next year's White House occupant while shape his or her energy policies more according to the political realities at that time than this month's backroom votes. Whereas most political candidates move toward the center following the end of the primaries in a bid to take the independent vote, however, this year's nominees are not: the GOP nominee is a radical by any definition of the word and the Democratic nominee is focused on keeping her party's radical wing in line through November. I find it telling that, only four years after adopting an "everything but coal" platform, the Democratic Party only narrowly defeated a proposal to adopt a national hydraulic fracturing ban plank as part of its 2016 platform. No matter who wins in November, I expect headline volatility in the energy markets to increase as the presidential election draws to a bitter and contentious close.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.