Authors include: Graham Copley and C-MACC associates.
- Renewable power is likely to be supply constrained for the next decade at least, with the desire for it eclipsing availability, potentially driving costs higher.
- The largest challenge, as a consequence, is likely to be hydrogen, as the lure of cheap power is driving investment ideas that are uneconomic without it.
- The pressure on wind and solar is driving a much greater focus on alternatives, especially nuclear, but also further use of natural gas and more hydropower.
2023 Will Be All About Power
The geopolitical events of 2022 have focused the world on renewable power much more quickly than the sustainability (and especially the clean energy) lobby could have hoped. Renewable power is now not just about reducing emissions, it is front and center in many countries’ energy security plans. For energy importers, especially in Europe, 2022 has provided a lesson in how vulnerable economies are to any political shock that disrupts the global flows of trade that have evolved over the last few decades. The abundant availability of reasonably priced natural gas imports allowed Europe to move away from fossil fuels quickly on the path to a longer-term green goal but consequently left the region very dependent on Russia. As we enter 2023 the Russia problems are unchanged, but we are looking to accelerate renewable power initiatives as part of the cure, exposing manufacturing limitations throughout the supply chain and raw material shortages that are driving inflation in the sector, lowering profits at many of the stages in the chain, while raising others.
Exhibit 1: A distinct difference between the winners and losers
Source: Capital IQ and C-MACC Analysis January 2023
In the chart above, we have excluded several smaller companies that were already expected to lose money in 2022 and where estimates have got worse. It is perhaps a little unfair to include Bloom in the chart above as when you are dealing with early-stage companies the numbers are small and percentage changes can be very high. Bloom’s revenue estimate is also down, which explains the earnings revision. Vestas’ revenues have fallen enough to explain most of the earnings revision, but this is not the case for First Solar where cost increases have squeezed margins in 2022. The larger problem for Vestas has been delays. Both cost increases and delays are likely to challenge the renewable power industry in 2023, with governments likely more focused on delays, while companies like Covestro and other German companies very levered to energy prices will be equally focused on costs. For the industrial base in Europe, it is not only about getting adequate power, but also about how that power cost will impact costs versus the competition. Future offshore wind to hydrogen projects in Europe may get delayed or canceled if the ones that are already on the books see construction delays and cost inflation.
The cost inflation shown in the chart below was the core of our themed piece for ESG and Climate change investments for 2023 this week – A Spending Spree in ‘23 – But Profitable? Selectively Maybe. The inflation in 2022 has been particularly damaging to the wind and solar industry as companies have been working off fixed-price contracts and cannot pass on costs. Further problems have come from supply chain-related delays, which have resulted in penalties on some projects, The inflationary impact will drive higher pricing in 2023 as the industries push to recover from losses in 2023, with Vestas, for example, predicted to move from an EBIT loss in 2022 to a profit in 2023, and First Solar expected to do the same. As we noted in our report last week, the wind and solar sector outperformed in 2022, but only from the middle of the year. Some of this is perhaps support from the IRA and an expected pick up in investing in renewables, but we suspect that most of it is comfort in the idea that prices and margins will rise in 2023. What is good for the stocks is not necessarily good for the ambitions of the sector – companies growing earnings through growth, while driving costs lower are good for shareholders and the industries they serve. Companies growing earnings by raising prices, because they have little option to remain viable, are not necessarily good for the industry they serve.
The negative of this is that the lower pricing momentum for renewable power, batteries, etc., is at an end for now. This may impact some plans for downstream investment, but it may also favor some sectors/processes over others. We think it could change the focus on hydrogen technology from low capital cost to low operating costs – if power is not very cheap, this matters – this could be good for Bloom Energy and others in the solid oxide camp. Also, we think it could help initiatives for alternative renewable power – nuclear, geothermal, and hydro. The news flow and discussions around nuclear are increasing weekly right now and it is not just about cost and availability, it is also about the capacity factor. The same opportunity exists for hydropower if the construction costs can be brought down.
- US nuclear enjoys revival as public and private funding pours in
- NuScale Power and RoPower Announce Signing of the Contract for Phase 1 of Front-End Engineering and Design Work for First SMR Power Plant in Romania
But is not as simple as the cost inflation that we have seen in 2022. There is also a supply security issue with many of the materials that are in the critical paths outlined in the chart. In every sector, except some parts of CCUS and Green Hydrogen, there is an over-dependence on one country, China (mostly), for either the entire product or when it has been produced elsewhere, for components critical to the product – the major exception to China would the dependence on the DRC for cobalt. As the events in Europe have shown us, losing a key supplier can turbocharge inflation and create real shortages. All the promises of renewable energy, batteries, and EVs will take a step back if costs move so high that they cause more economic and political damage than countries are willing to bear.
Exhibit 2: Significant inflation seen in low-carbon energy sources relative to traditional oil and gas
Source: Rystad Energy, January 2023
One of the headlines below talks about Chinese wafer prices coming down, which would be a good thing for the solar industry in 2023. We are concerned that China tries to address its slow economic growth in 2023 by boosting domestic spending on renewable power. This would create jobs, pour money into the economy, and help to accelerate energy independence in China. The net effect would be that fewer PV components would be available for the rest of the world and that this would bid up prices. China may benefit from the lower wafer pricing, but others may not. The second headline discusses the need to make miners of critical minerals more ESG-friendly in the eyes of investors. This happens already with lithium, despite its high environmental footprint, and as the rest of the critical mineral mining space, including nickel and copper needs capital – some of the concerns with these companies need to be accommodated.
The third headline is a prediction of EV sales growing because of incentives. This may well be the case and we expect the EV sector of the auto industry to have a much better year than the auto industry in aggregate. The risk is a collapse in demand for autos because of affordability. Interest rates are likely more negative for EV demand in 2023 than incentives are positive – sales may not skyrocket if the marginal buyer is financing the purchase. The other issue is price increases for EVs, note the BYD headline below. Tesla, Ford, and others are raising vehicle prices in 2023 because of higher costs, mostly batteries, but also labor, and these increases are in most cases higher than any increased EV incentive.
- Chinese PV Industry Brief: Longi, TCL cut wafer prices by more than 20%
- Financiers, end-users press for ESG mine ratings as critical minerals demand grows
- EV sales set to skyrocket with tax credit changes
- BYD Hikes Pricing for Dolphin Model Despite Slowing Car Demand
- Chinese battery makers strengthen grip on global supply
The polysilicon price drop shown in the chart below contrasts with the inflationary environment that we expect for renewable power in 2023 and as discussed above. While China has been adding substantial capacity for polysilicon, it is possible that we have seen the product caught up in the same inventory build and collapse that has been witnessed in other commodities over 2022. We note that some PV makers have reduced prices in China, and this will help ease some of the inflationary fears, but we would not be surprised to see the price trend in the chart below reverse as demand picks up this year, especially if China tries to kick start the economy with a boost to renewable power spending. When we look at charts like the one on India below, we struggle with the idea that raw materials and components will be in surplus at any point over the next 10-15 years, except for very brief periods.
Exhibit 3: We highlight the sharp decline in polysilicon prices in late 2022.
Source: Bloomberg, C-MACC Analysis, January 2023
Exhibit 4: India Plans to Triple Clean Power Generation as High Prices Put Natural Gas Out of Reach
Source: EIA, NGI, January 2023
Authors: C-MACC, Graham Copley