The Rise of Renewables

There is major disruption underway in how electricity is generated in the United States. Historically, coal-burning power plants provided more than half of the nation’s electricity. Recently, however, coal has been losing share to natural gas and renewable energy sources.

Solar photovoltaic and onshore wind energy are two of the most viable renewable sources available yet they currently account for only a small portion of the U.S. electricity generation mix. As of March 2020, wind energy accounted for 9% of electricity generation with solar at a much smaller 2%. The largest conventional methods of generation include natural gas, accounting for 40% of total electricity produced, and coal at a much smaller 18%.

Coal has experienced a consistent decline in its share of total electricity generation over the last decade. At the same time, natural gas, wind, and solar have all gained share. While natural gas now dominates electricity generation, renewable energy sources appear poised to compete with natural gas as the largest provider of U.S. electricity generation in the not-so-distant future.

The Rise of Solar Photovoltaic and Onshore Wind

Over the past two decades, the use of wind and solar energy has exploded within the U.S. Wind energy electricity generation has increased at an annualized growth rate of 26% and solar energy at an even more impressive rate of 32%. When shortening this time frame to just the past decade, wind energy’s annualized growth rate slows to 18% but solar energy’s growth rate increases to 54%. Natural gas electricity generation has increased at a constant annualized rate of 6% over the past 20 years. Meanwhile, coal electricity generation has decreased at a constant annualized rate of 6% over the same period.

Indexing the number of kilowatt hours produced by each electricity source clearly illustrates the trajectory of wind and solar energy compared with that of coal and natural gas. From 2000 to 2019, the amount of electricity generated in the U.S. by solar energy has increased by 14,641% and wind energy by 5,365%. Over the same period, the amount of electricity generated from natural gas has increased at a much smaller 263% while electricity generated from coal has decreased by 51%. It’s easy to register such dramatic growth rates when starting from a small base, but the trend is telling.

The rapid decline of renewable energy prices has been the single greatest contributor to the growth of solar and wind energy. As of 2020, both solar and wind electricity generation costs have fallen below that of coal and even natural gas. Solar costs have decreased 87% over the last 10 years from an average of $370 per megawatt hour (MWH) in 2010 to $48 per MWH in 2020. Wind costs have followed a similar trajectory, decreasing 46% from an average of $84 per MWH in 2010 to $45 per MWH in 2020.

Conventional electricity generation methods have not experienced nearly the same cost declines as renewables. The cost of coal has stayed relatively stable, decreasing just 14% from $111 per MWH in 2010 to $95 per MWH in 2020. Natural gas has decreased by 40% from $83 per MWH in 2010 to $50 per MWH in 2020. This translates to a 5% annual decrease in the cost of natural gas compared with annual decreases of 18% for solar and 6% for wind.

It’s not surprising to see the dramatic declines in electricity generation costs of renewables. Both wind and solar technologies are relatively young compared to conventional methods and as a result, have just begun to see massive public and private investment. The production of solar panels has now reached economies of scale and the cost of panels will continue to decrease. According to Swanson’s Law, the price of solar modules drops 20% for every doubling of cumulative volume shipped. The average diameter of wind turbine rotors has increased by 67% since 2010 from 240 feet to 360 feet according to the U.S. Energy Information Administration (EIA). Every time a rotor doubles in size, the amount of electricity generated quadruples, meaning every increase in rotor diameter decreases the costs of generation.

Additionally, renewable technologies only require the fixed costs associated with the construction of an acquisition plant; after that, the fuel is free to obtain. Coal and natural gas require the fixed costs of building power plants as well as the variable costs associated with acquiring the fuels. These factors will continue drawing investment away from conventional methods and into renewable technologies.

The Death of Coal

The diminishing portion of U.S. electricity generated from coal over the last two decades is a direct result of increased competition from lower-cost renewables and natural gas. As costs continue to decline for competitor fuels, it is unlikely that the generation of electricity from coal will be sustainable.

My colleague Sara B. Potter, CFA, explored the decline of coal in a 2019 Insight article, The Economics of Coal. Due to declining demand, coal mining industrial production decreased by 47% between April 2006 and April 2020. As a result, the number of workers employed by the coal mining industry has fallen 62% from a high of 89,300 in February 2012 to 41,600 in April 2020. The difference in domestic production could certainly be subsidized by imports, but those have fallen as well from a high of 0.48 quadrillion BTUs in 2010 to .01 quadrillion BTUs in February of 2020 according to the U.S. Department of Energy.

Over the past decade, revenues for the U.S. coal production industry have increased just 3.5% annually on average, while EBIT has declined 2% annually on average. The decrease in industry EBIT is significant because it shows that while revenues are increasing slightly, expenses have increased at a greater rate. The only tailwind the coal industry has experienced in the past decade has been the 2016 election of President Donald Trump. His promise to revamp the American coal industry and the resulting policies implemented by his administration encouraged investment in the industry, boosting production and employment slightly in 2017 and 2018. The increase in production is attributable to a 237% increase in exports from a 2016 pre-election low of 0.08 quadrillion BTUs to a 2018 high of 0.27 quadrillion BTUs. The boost in production led to growth in sales and profits; however, this trend was short lived. Exports have now fallen to 0.17 quadrillion BTUs and as a result, production, employment, sales, and profits are back on the decline.

Has Natural Gas Reached an Inflection Point?

While natural gas is the largest source of electricity generation in the U.S. and boasts consistent year-over-year growth, there are signs that this trend will come to an end. Contrary to renewables, the falling price of natural gas may be the single greatest contributor to its decline as a generator of U.S. electricity.

The price of natural gas has declined 62% from a high of $4.94 in January 2014 to its lowest level in a decade, averaging $1.86 per 1 million BTUs (MMBtu) year to date. The dramatic price decline has occurred as natural gas production has surged; between 2010 and 2020, we saw a 72% increase in natural gas production.

As the supply of natural gas continues to increase, downward pressure on the price of natural gas will continue. Analysts surveyed by FactSet expect natural gas prices to rise and stabilize at an average of $2.66 per MMBtu over the next five years. However, with production slated to increase and continued pressure from lower-cost renewables, it is unlikely that this price level will be sustainable. The acquisition of natural gas is a time consuming and costly process that involves continuous exploration to find new gas wells to frack, pipelines to be laid for transport, and the costs of selling the commodity to the end user for electricity production. There are significant variable costs and due to the commodity-based pricing structure, these costs are not always integrated into what the market deems a fair price.

The low price of natural gas combined with the high costs of obtaining it has caused the profitability of the industry to collapse. The aggregate earnings per share of the industry have been extremely volatile over the past decade, diving in 2015 and remaining negative in 2016 and 2017. This forced firms to shutter rigs that were not performing at peak efficiency. From 2010 to 2016, the number of natural gas rigs in the U.S. fell 92% from a high of 992 to a low of 82 according to Baker Hughes. As we saw with coal, after the 2016 election, President Trump’s policies toward conventional fuels and the resulting investment boosted earnings of the oil and natural gas industry close to 2014 levels. However, as of 2020 the industry has experienced weakening earnings to the point of unprofitability and the number of rigs in operation has dropped from a post-election high of 198 to a current low of 76.

COVID-19 and the Future

The COVID-19 environment has only accelerated the growth of renewables in the electricity generation market. For the first time in U.S. history, the amount of electricity generated from all renewable energy technologies has surpassed that of coal. In the first quarter of 2020, renewable energy accounted for 19% of U.S. electricity needs compared with 18% for coal. This is the highest percentage of electricity generated from renewable energy sources ever in the first quarter of a year. Wind energy also overtook hydroelectric as the dominant source of renewable generation, providing 9% of U.S. electricity needs compared with hydro’s 7%.

As a result of lockdown measures put in place by state and municipal governments, transportation in the U.S. ground to a halt, causing the price of WTI crude oil to trade in negative territory at -$36.98 for the first time in history on April 20, 2020. The price of natural gas, which has a strong correlation with the price of oil, experienced a decline of 30% from its pre-COVID-19 high to a decade low of $1.50 per MMBtu. The price decline is a direct result of demand for oil and natural gas crumbling in the first quarter of 2020, which led to a 4% contraction in sales and a 51% decline in net income for the industry. An industry net income being halved is alarming and helps explain why many firms couldn’t turn a profit. Considering that aggregate earnings dropped to -$1.98 per share, firms have been forced to shutter rigs, dropping the count from 123 at the start of 2020 to an historic low of 75 in mid-June.

Conclusion

Coal’s days as a generator of electricity are numbered. It simply cannot compete against low-cost natural gas, wind, and solar energy. Renewables will continue to fall in cost at annualized rates that exceed those of natural gas and as they do domestic demand for the fuel will continue to decrease. If demand falls and production continues to increase, the price of natural gas will no doubt continue to decline if not collapse entirely as we saw with oil. This will leave corresponding power plants with fewer suppliers as the unprofitable natural gas production industry contracts. Investors will then be hesitant to finance any new natural gas projects for fear of stranding their assets in plants that can’t effectively obtain fuel nor produce electricity at a rate that can compete against wind and solar energy.

As conventional energy sources are battered by external factors, renewable energy’s growth will continue until the sector rises to a dominant source of electricity generation in the U.S. In the 2020 Annual Energy Outlook, the EIA projects that by 2050 renewables will account for 38% of U.S. electricity generation, followed by natural gas (36%), coal (13%), and nuclear (12%).