Pass The Candle, Please

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Includes: ABB, AMSC, FLR, GE, HASI, MTZ, OERLY, SIEGY, WDGJF
by: James Hanshaw

Summary

The western world is facing a dark future due to decaying electrical power supply systems.

New demand sources are adding to the stress of existing demand growth.

There are only two alternatives for investments; candle or power generator system makers.

I find it difficult to find sufficient information on plans for future electrical power supplies in major western countries to come to any conclusion other than we are sleepwalking back to living in candle lit caves. Political leaders have their heads in the sand over the investment required and are introducing environmentally useful issues that themselves add to increased power demand.

Trying to join dots on this matter to build a complete and clear picture is like punching holes in thick fog, and I would appreciate it if readers with additional - and possibly better - knowledge could help shine more light on this matter and preferably not candle light.

To simplify things for myself, I will focus on the largest western countries. The other two most important countries, China and India, have their own growth problems but appear to be addressing those with large investments in new supply capacity and that is especially so in China, the world's second largest economy.

Supply

Taking the world's largest economy first:

America: Electricity delivery in the US depends on an ageing and complex patchwork of power generation facilities, transmission and distribution (T&D) grids, local distribution lines and substations. These are owned by an array of investor and publicly-owned utilities, independent power producers and government agencies. Some parts of the grid predate the turn of the 20th century! Most T&D lines were installed in the 1950s and 1960s with a 50-year life expectancy and were not originally engineered to meet today's demands or severe weather conditions. With more than 640,000 miles of high-voltage lines across three interconnected transmission grids - the Eastern, Western and Texas Interconnections - the lower 48 states' power grid is at full capacity with many lines operating well beyond their design criteria. The consequent congestion raises constant problems with distribution and reliability plus adding constraints on delivering power from remote, mostly renewable, energy generators to customers. Often a single line cannot be taken out of service for maintenance because that would overload other interconnected lines in the system. Virtually the whole system is vulnerable to outages caused by bad weather, vandalism and cyber attacks.

It takes many years for new projects to get started due to regulatory hurdles, even longer to get anything finished and that which is in the pipeline is insufficient to replace the existing system with apparently no account being taken of the massive additional amounts needed to supply new sources of demand.

Germany is the world's fourth largest economy (China second and Japan third). It is also one of the world's largest manufacturing countries. It has a policy - made during political electioneering in 2012 - to phase out nuclear power by 2022, but no corresponding policy was made on replacements. Germany also remains largely dependent on coal-burning, power-generating plants, many old. Little has been done to build replacements for either as partly evidenced by the fact it will miss on four of its fifteen Energiewende 2020 - change to renewables - targets, and one of that four includes security of electricity supply simply for existing needs! Since it takes decades to get anything new built in Germany due to stifling politics and bureaucracy, it is a safe bet that more political promises will be broken. As elsewhere, new sources of demand are coming on-stream rapidly, but like a Porsche in the fast lane on a similarly overcrowded and neglected German autobahn, they are going to come to a dead stop - or at best a crawl - slowing the economy down with it.

Britain is the fifth largest economy and has long neglected replacing old nuclear and coal-fired power stations that can barely cope with today's demands. Those facilities are approaching the end of their lives - some have already had life extensions - and planned new facilities, such as the long delayed and horrendously expensive (the most expensive ever built in the world if and when it gets completed) Hinkley Point C nuclear plant, are insufficient to replace those old facilities. Billions of pounds have been spent on wind power generation as the political answer to pollution, but those politicians have no answer that makes those turbines work on the coldest days when they are most needed but there is no wind!

France is the fifth largest economy and its nuclear industry is facing an existential crisis. Many of its 58 nuclear reactors were built in the 1970s and are reaching the end of their life span simultaneously with almost no new ones being built at present. Since nuclear energy provides about 75% of France's electricity, the potential for a disastrous energy shortfall grows daily. The French president recently announced a target to reduce nuclear dependence to 50% by 2025, replacing it with renewables. That target is a mere seven years away, and even if the near impossible is achieved, it takes no account of new demand that, as in other countries, is hitting the system almost daily now.

Much could be done in all these countries to insulate new homes and offices to stop massive energy wastage, but the need to keep short-term upfront costs low overrides more important environmental and operating costs over the long term. Some locations are installing batteries to store power off-peak, but that does not address the crucial issue of replacing ageing and decaying existing facilities nor of new demand requirements.

Demand

I will not dwell on existing demand types that will grow anyway with population growth. Some of the new demand sources are already here adding enormous burdens on supply systems and more are coming:

Electric Vehicles (EVs): EVs are a classical example of political blindness to reality. Headlines to prove these "leaders" are leading the herd on cleaning up the environment ignore the demand they will put on already stressed supply systems. Both Britain and France have boldly declared that all cars on their roads will be EVs by 2040. The US, or parts of it like California, will do likewise. Bloomberg Energy forecasts that one third of the world's cars will be EVs by 2040. Car makers are pouring billions into developing EVs to meet these targets, yet before then their factories might not have sufficient electricity to produce them with! The production of EV batteries is energy intensive too.

Data Centres: The digital world is growing fast, and so is its accompanying need for enormous amounts of energy for cooling data centres that are being built or expanded. IBM (NYSE:IBM) estimates that data produced and stored in 2014 and 2015 surpassed all data that had come into existence in the entire history of man prior to then. My favourite, Equinix (NASDAQ:EQIX), recently announced expansions in Australia and London. This localised demand growth is happening in the US too as the needs are met of big financial firms moving some operations away from New York. AllianceBernstein is going to Nashville, Charles Schwab and Fidelity to Denver, Goldman Sachs to Salt Lake City and Pimco to Austin. Data centres already used about 7% of the world's electricity supply in 2017.

Air Conditioning: This has been around for so long that many of us take it for granted, but the International Energy Agency, IEA, recently warned that this is one of the "biggest blind spots in international energy policy". A fascinating report from the agency on the future of cooling suggests that the increase in electricity generation needed to power all the new systems installed by 2050 could equal the entire consumption of the US, EU and Japan today. While much of this will be in countries like China and India, which I am not covering here, it will produce opportunities in these countries for the companies I mention later.

Blockchain: Crypto currencies are enormous users of electricity. Bitcoin alone requires as much as all the EVs currently on the road around the world require for recharging. I have seen estimates showing that a single Bitcoin transaction requires 215 kilowatt hours, which is the same as the average US house uses in a week. Trading of commodities using blockchain has just begun. It is early days for this, but I suspect virtually all such trades will eventually be done this way, putting enormous new demand on the power supply system. And - if I were younger and unmarried - I would do a lot of high speed dating at Luna and would light romantic candles when meeting my dates...purely to reduce the burden on the power supply system, I hasten to add!

Quantum Computing: Some data centres will be built in colder climates closer to the Arctic Circle to take advantage of natural cooling, but this will not work with quantum computing. This will make quantum leaps forward in the speed of data processing, but it requires temperatures of minus 243°C. It uses liquid helium to get to that and achieve the superconductivity required from known, existing materials. There is no place on earth that cold. Normal use of this form of computing may be several years away, but banks will be among the many big users when it comes.

In sum - something must be done to fix the power supply system soon, and this will provide investment opportunities.

Opportunities

Biomass: At first, I thought using wood waste for power generation to be an excellent and clean way of adding some new capacity, but then I learned of the giant Drax power station in Britain that has been converted to use it and that political "leaders" there laud as proof of their green credentials. They do not tell us that wood waste is insufficient and the vast amount of wood needed to feed Drax means complete deforestation in parts of the US - those trees are one of nature's carbon absorbers! - and a conveyor belt of ships burning filthy fuel is needed to transport that wood to Britain. Very Green!! Few opportunities there for responsible investors.

Nuclear: Despite new technology that makes nuclear power very safe, it has become a political football in many western countries, and even though there are new plants planned, they take decades to complete, and I suspect some of those planned in the west will not get started. There is comprehensive information here on this that shows how few are planned in the west, and even if they all got built, they are insufficient to replace existing power stations. In the US the main policy seems to be like that in Europe - extend and pretend.

NatGas: Natural gas is my favourite. Renewables such as wind and solar will continue to grow in importance but will not be the main suppliers for the foreseeable future. I show their estimated contribution in my recent article "Gas Is The New Oil."

That brings me to companies I least like - because they are conglomerates - but might prove to be good investment opportunities due to their gas turbine and other power generator and transmission parts, all of which have suffered for a long time with insufficient orders.

General Electric (NYSE:GE) has some world-leading technology and looks as though it intends to stay that way as it reimagines the future of electricity. GE is not for me until it reimagines its future under an entirely new management that breaks it into entirely separate niche companies. Some of those parts are worth a lot of money if separated, but the sum of those parts as presently structured is woeful.

Siemens (OTCPK:SIEGY) is a giant German company, and I have no idea why it does not have a main board US listing. It too is well placed with excellent technology, but it too is a disjointed conglomerate, and I will stay away, but others might like it.

ABB (NYSE:ABB): Of these three conglomerates, I prefer Swiss giant ABB because it is only involved with electrical products and is well placed to win contracts in both power generation and transmission, plus connected parts including EV charging stations in the US that it is now building.

MasTec (NYSE:MTZ) is a long held favourite of mine that should do well building new power generation and transmission networks. I wrote more about it in MasTec In The Connected Age.

American Superconductor (NASDAQ:AMSC) is a leader in producing superconducting transmission cables and other essential grid components. It nearly got destroyed when its Chinese partner stole its wind turbine technology and did not pay a mountain of debt, but it survived. Its cables carry up to ten times as much power as traditional cables and are ideal for being laid in trenches, thus putting it out of the way of severe weather and vandalism - thus drastically reducing servicing costs over the long term - but short-termism in the sector means that few have been prepared to pay the higher upfront costs, so far.

Oerlikon (OTCPK:OERLY) - or better OERL on the Zürich exchange - is another favourite of mine. This Swiss company is a world leader in new materials and is already well established in the energy generation sector. If it develops new materials for quantum computing, it will be a leader in that too.

Hannon Armstrong (NYSE:HASI) is different from all the others. While others make things, HASI only invests. It is a REIT that invests in renewable energy infrastructure. Its stock price has not done well but HASI pays a safe 7% dividend, and I especially like the fact that most of that is paid as a return of capital, and I pay no tax on that.

There are many others, too numerous, to list here including Fluor (NYSE:FLR) and John Wood (OTCPK:WDGJF), and perhaps readers will share names of their favourites in the comments section.

Pass the candle, please

Yankee Candle is an American success story, but it is not a listed company, and I hope the US and the rest of the west get started on rebuilding our electrical power infrastructure before too many romantic, candle lit dinners lead to a population explosion!

I have two suggestions. The first is to get appropriate teams together to design the new integrated power generation and distribution systems needed for the remainder of the 21st century and give big tax incentives to encourage the private sector to finance the building. This is especially important since the US, Britain and France are already mired in government debt and political dogma in Germany - all debt is bad debt - means little will get financed by public means in those countries.

Second and more difficult. Since you can't beat the oppressive government agencies that prevent anything happening, join them and get them to add their own ideas to the mix. There is a process called bootstrapping development - that came out of ideas of Charles Sabel of Columbia University - intended to bring imperfect institutions into the development process from the beginning in emerging countries. It contradicts the ideas the west has conceptualised for itself, but those ideas are no longer working and something new is needed. Those western government agencies know how they work (and don't work), and if they are partnered on the purpose and objectives during the design stages - and can input their own ideas on how to get things done - better outcomes will be achieved rather than no or long delayed outcomes. This also entails linking in agencies that prefer engaging in turf wars. This sounds idealistic and may not be perfect but... when someone shares in the ownership of anything, they have a vested interest in a successful outcome, and in this case, we and those agencies will be talking about preserving the world we all want to live in. And that requires electricity!

Since we have hydro power in our home with its source being the Swiss alpine snow and glaciers, our lights are not likely to go out anytime soon. But I like to make money too - candle lit dinners with my wife in Zürich are expensive - and I am optimistic that the political policies of extend and pretend will soon come to an end.

Disclosure: I am/we are long HASI, MTZ, OERLY, EQIX.

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.

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