Decarbonising energy is leading to a raft of infrastructure challenges for the electric grid. So, what will this mean for investors?
Read this article to understand:
- How meeting net zero will scale up electricity demand
- Why a smarter grid is needed to match supply and demand
- Investment opportunities associated with grid hardening
Keeping the lights on when more than one million kettles are switched on simultaneously is an issue today. During closely fought elections or major sporting events, the call for tea brings big surges in electricity demand. It makes grid balancing – matching supply and demand, minute by minute in real-time – a delicate art. The system operator might need thousands of megawatts of extra capacity at its fingertips to satisfy the surge.
But the demand in today’s TV ‘pick-up effects’ could pale into insignificance compared with a net-zero future. As consumers abandon fossil fuels, switching from petrol engines to electric vehicles (EVs) and gas boilers to heat pumps, the demands on the electricity grid will grow, just as those managing the power mix are pressing on with efforts to decarbonise.
Research from the Goldman School of Public Policy at the University of California, Berkeley, suggests this could mean mega-scale change. “By 2050, the US will demand nearly 90 per cent more power than it did in 2018,” it suggests in its high-electrification scenario,1 while its more conservative scenario suggests a 35 per cent uplift.
Without a smarter grid and more mindful consumers, how will network operators and utilities cope?
Improving resilience to face more extreme weather
Climate change is causing stresses too. Think of the heatwave in the Pacific North West in the summer of 2021.2 Power cables melted, and water levels dropped so low that some hydro plants were forced to close.3 (More here from Rick Stathers on adapting to climate extremes).4 Elsewhere, high temperatures and water shortages have been impacting nuclear facilities, limiting cooling;5 while in other zones, extreme flooding has triggered blackouts.
“Regulators are pressing for ‘harder’ utility networks,” says Max Burns, global equities portfolio manager at Aviva Investors. “In the US, events like Hurricane Sandy in 2012 and the ‘Great Flood’ in the Midwest in 2019 resulted in power outages, which drew the ire of regulators. The large number of people affected underscored the vulnerability of energy transmission and distribution infrastructure. Many networks have underinvested for decades – they are under stress.”
Modernising the grid to bring greater flexibility and resilience has become an urgent priority, not just in the US. These vast, interconnected pieces of engineering are already carrying out roles that were not imagined when first designed. Significant investment is needed to meet relevant carbon budgets, scale up and connect renewables, handle the intermittent energy generated by them, and cope with demand surges from EVs and the digitalising economy.
Our energy networks of tomorrow must be different. Although the changes are critical from an environmental perspective, adding renewables into the power mix has made outputs from centralised systems more volatile and complex. But decentralisation has also made power faster and cheaper to deliver, bringing opportunities to communities that have never been on the grid.
Figure 1: All change for the grid - balancing complex demands
Source: McKinsey & Company, November 20207
The grid needs to be managed better and more efficiently so it can respond to 21st century demands and threats
With complex, multiway flows, the grid needs to be managed better and more efficiently, so it can respond to 21st century demands and hold up against threats, from extreme weather to cyberattacks (see Figure 1). Energy consumers need to become active prosumers, mindful about how and when they are using and generating power. This gives them the chance to manage their own energy destiny, as they can generate revenue by feeding any excess power back into the network. The environment is also proving a dynamic ecosystem for entrepreneurs developing smart grid solutions, including storage and demand response.
All this needs investment, but there will be no net zero without appropriate infrastructure, as Dieter Helm, professor of energy policy at the University of Oxford, points out.6
Scaling up for an electrified future
The change needed to power up and deliver an electrified future is hard to imagine. Take road transport, for example, a major source of carbon emissions worldwide. Even EV converts like Lex Hartman, CEO of ubitricity, a European provider of on-street EV charging recently acquired by Shell, accept current targets might have been described as “lunatic” just a few years ago.8
In the US, President Biden is boldly aiming to take electrification of autos from two per cent to 50 per cent in just nine years9 (see Figure 2 for international comparisons). Clearly targets like this only make sense if progress has been made decarbonising the power network – a first step on the path to net zero – and the electricity to power the vehicles is generated from renewable sources.
Figure 2: Penetration of electric cars is small but growing fast (percentage of market share 2010-2020)
Source: Pew Research Center, June 202110
The UK also faces an enormous challenge. Out of more than 38 million vehicles licensed to drive on the roads, only around 330,000 are wholly battery driven, existing alongside around one million hybrids.11 Not everyone with a car now will convert to an EV, but for those that do, millions of charging stations are needed in short order: on motorways, in car parks, around lamp posts and on drives. These additions are not there yet, but it will be testing if demand increases as swiftly as the government hopes. For instance, 25 per cent EV penetration could push peak loads up by one third if everyone plugs in overnight12 (see Figure 3).
There will likely be increased demand from heat pumps and air conditioning units
This is just the start. There will also likely be increased demand from heat pumps, where annual installations could reach into the millions, and air-conditioning units.
“As we electrify transport, and then heat too, we're looking at an order of magnitude more power demand,” says Beverley Gower-Jones, managing partner of the impact-oriented Clean Growth Fund. “There are transmission and distribution challenges arising for the people responsible for managing those networks. They are actively seeking the innovations that are going to enable the smart grid of the future.” She flags a new platform seeking to match system operators with flexible energy providers, trading flexibility, to fill the gaps.
Figure 3: Plugging in will boost circuit loads – 25 per cent EV penetration could boost peak loads by 30 per cent (kilowatts)
Source: McKinsey & Company, 201813
The renewable balancing act
On the supply side, one obstacle in the transition away from fossil fuels is the intermittency of renewables. While renewable capacity has ramped up rapidly in the last decade (up ten per cent worldwide in 2020 alone),14 without capacity to store excess energy, the variability introduces both uncertainties and opportunities.
Although we have been adding capacity, we do not have a consistent flow into the grid
“Power plants driven by coal and natural gas produce a continuous stream of power,” explains Burns. “Recently, we have been adding renewables driven by wind and solar, but their output is variable. So, although we have been adding capacity, we do not have a consistent flow into the grid. That creates stability problems because the grid was designed for a steadier baseload environment. The issues only grow as you increase renewables in the mix.”
For the grid to work, supply must match demand – all the time. “There are already times when we produce so much green electricity, we don’t know what to do with it,” says Hartman. “That can be in the middle of the day when the sun is shining, or in the middle of the night when we are not using so much electricity, but we are producing a lot from wind turbines.” At certain times, energy goes to waste; producers are paid to take capacity offline.
On the other hand, the vagaries of the weather mean generation can fall short of expectations as well. For instance, on rare occasions both Germany and the UK have experienced ‘not much sun’ and ‘not much wind’, so respective energy outputs slumped at the same time. Hence the hive of research activity around energy storage. Behind it is a key idea: if storage can be made cheap enough, dense enough and extensive enough, it becomes viable to operate an energy mix with a much higher percentage of renewables.
Figure 4: Building out battery capacity - battery megafactories worldwide
Source: Aviva Investors, 2022. Data from Benchmark Mineral Intelligence, 202116
This is driving deployment of grid-scale storage; something companies like Tesla, LG Chem and Samsung are anticipating as they construct battery megafactories around the world15 (see Figure 4). Combining renewables with large, preassembled battery units to store excess power, with energy fed back into the grid when demand requires it, has taken off.
The relative attractiveness of this has shifted “seismically” recently, according to energy consultancy Wood MacKenzie.17 Producing energy using solar and wind power already undercuts natural gas on a levelised cost basis (see Figure 5) and recent discoveries suggest further efficiency gains are possible.
Henry Snaith, professor of physics at the University of Oxford, describes solar “being in 1965 in silicon technology terms,” for example, with “lots of room to improve”. (In Search of Wild Solutions has more details.) Now battery costs have fallen rapidly as well, so ‘solar PV + large-scale battery storage’ are cheaper than ‘solar PV + natural gas’ as back-up to meet peak demand.18
Figure 5: Solar and wind are cheap…and there’s further to go
Source: Lazard, October 202119
What about hydrogen as an energy store? In theory, using surplus energy to produce green hydrogen from excess wind or solar power could also increase grid resilience, with the energy being fed into electrolysers and used to split water. At present, the economics to make this happen are challenging (read more on hydrogen here).20
If peak loads could become a limiting factor, another option for system operators and utilities to consider is how to manage demand better. That needs a good understanding of who is using what and when: a target that might be delivered through intelligent connectivity.
The software and systems attached to manage power loads is critical
“We are placing so many more demands on the grid,” Burns says. “The only way we will be able to manage capacity to deliver all those wants at the same time is through adopting smarter systems for load management. These will allow utilities to manage their operations better and should help to maintain a more stable network. Access to real-time data at the consumer level is essential for creating more efficient power grids. It requires investment, but the software and systems attached to manage power loads is critical. It's a necessity as demands on the grid change.”
One option utilities will likely use more is flexible tariffs. Many major power users optimise profit margins by shifting consumption to avoid peak costs,21 but this behaviour is not so common in the consumer market because flexible tariffs have not been available. As a result, consumers are not so aware of the cost of using all their electric appliances and white goods at the same time.
Mindful consumers will be able to benefit from using off-peak power and may choose to load activities into lower-cost periods or accept less flexibility for cheaper tariffs. “You could say ‘charge my car when the least amount of carbon is on the grid’,” says Gower-Jones. “That could be 3am. The idea would be that the consumer says: “Make sure my car is ready by seven o'clock in the morning, with a range of x miles,” then the system must figure out when it is lowest cost to do that.”
Customers could use a dedicated EV battery to feed back into the grid or power their own home
Conversely, with an energy squeeze or extreme weather event, customers could use a dedicated EV battery to feed back into the grid or power their own home. This is something the designers of the F-150 Lightening, a new Ford pick-up, have enabled already.22
“In the new world, consumers will be generating and storing their own electricity,” Gower-Jones adds. “With an electric vehicle on your driveway and solar panels on your roof, you can power your home, have energy for cooking and lighting and sell any excess back to the grid or peer-to-peer with your neighbours.”
Investing in the secular shift to renewables
The spectacular changes in the way energy is being managed and distributed could present significant investment opportunities. “In the near to medium term, we believe demand for cables – which are essential for a connected grid – is likely to accelerate meaningfully,” Burns says. “Windfarms are being built further away from the coast and in deeper waters, and they will need high-voltage cabling to connect to the grid on shore.
Medium term, demand for interconnectors should grow and longer term, demand for cables looks robust
“In the medium term, demand for interconnectors (cables used to connect countries and/or regions) should grow as well, as renewable-rich countries and regions export power. Longer term, demand for cables still looks robust too, as disparate sources of renewable power (wind, solar, and even green hydrogen) will require interconnection.”
Another stand-out potential growth area is data management, as companies develop essential tools for utilities to manage variable loads. “There is a real need for more sophisticated ways for power generators and consumers to communicate,” Burns says. “There are companies working to link usage data back to the utilities, to help them understand where demand is coming from and control allocations more effectively.”
Innovative battery storage is also getting attention, making it possible to smooth the intermittency of renewables, regulate frequency and power smaller microgrids that can be either connected or disconnected from centralised infrastructure. Growth expectations here are also overwhelmingly positive; Wood MacKenzie suggests compound annual growth of over 30 per cent over the next decade.23
Access to another potential storage option – hydrogen – is currently limited via liquid large-cap stocks, according to Rick Stathers, senior ESG analyst and climate specialist at Aviva Investors. “Some are beginning to develop pilot projects now but it is early days. There are few where the impact on revenues is material yet from where we are now, but you can gain exposure through pure-play fuel cell and electrolyser producers.”
The importance of grid hardening
What is striking about all these changes are the unknowns, particularly how swift and extensive the energy transition will be. It is clear, though, that unless the grid evolves to handle more complex demands, it will not be possible to achieve rapid progress towards climate targets. Why? Because achieving net zero will require cleaner electricity, and electricity to be used more widely.
Achieving net zero will require cleaner electricity and electricity to be used more widely
Evolving the power grid to be more flexible and more robust is what will underpin advances in payments, communications, transport, heating and cooling. Grid hardening is essential: an enormous amount is at stake.
Aviva Ventures is invested in the Clean Growth Fund as at January 26, 2022.