INVESTMENT MANAGEMENT

Transformation of the
energysector
Have we reached an inflection point?

OCTOBER 2015
A

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Contents
Introduction 2
Executive summary

Global energy consumption

1. Technology

2. Government policy

13

3. Economics

14

Conclusions 17

About the author

ANTHONY FELTON PORTFOLIO MANAGER, LISTED INFRASTRUCTURE
Portfolio manager for a number of global infrastructure portfolios and member of the portfolio
management team.
Transferred within Macquarie in Sydney to join the Infrastructure Securities team in 2004 with responsibility
for the analysis of European infrastructure stocks.
Has significant experience in the analysis of both regulated infrastructure companies, such as
water and electricity/gas transmission/distribution and utilities as well as user demand infrastructure
companies such as airports, toll roads and seaports.
1

Introduction
The consumption of energy is critical to our everyday lives, as well as our
economic development. While aggregate demand for energy remains
relatively static ona global basis, the sources of our energy supply are
constantlychanging.
The drivers of change include technological developments, government
policy, and the relative economics of differing sources of energy. In this paper
we explore the likely future shifts in the sourcing of energy, as well as some
implications for investment in the infrastructuresector.

Executive summary
Changes in the composition of our energy mix have occurred over
many years, as a result of technological change, government policy
and changing economics.
Against a backdrop of ever present energy demand,
the way energy is supplied has changed in recent
years as emerging technologies such as wind and
solar have created inroads into the traditional electricity
generationmix.

Battery technology is rapidly emerging as a solution to

the problem of solars intermittency subject to ongoing
cost reductions it may be possible for batteries to work
symbiotically with solar photo voltaic (PV) to increase the
level of self-consumption of electricity production.

Solar generation is increasingly competitive without

subsidies but suffers from some drawbacks as electricity
is not necessarily generated when demanded. Negative
impacts on the wider electricity system can result from
solars intermittent output, where significant output during
daylight hours can rapidly give way in the evening period to
an ongoing reliance on traditional sources of generation.

Future investment in electricity generation will reflect

government policies and relative lifelong costs. In the
current environment these factors favour both renewables
and gas-fired generation. Coal-fired generation and nuclear
power both face regulatory and economic headwinds
across many countries.

The electricity industry is concerned about the potential for

a shift away from traditional sources of generation, such as
coal and gas, reducing returns for utilities and potentially
leading to higher prices, thus driving away further customers.
This potential death spiral scenario will, we believe spur
regulators and governments to develop new tariff frameworks
to protect the future serviceability of the electricity network.
2

Infrastructure investors stand to benefit from increased

investment in assets supporting the shift in the generation
mix such as electricity transmissionand distribution
assets that generate predictable cashflows from either
long term contracts orregulation.

Global energy consumption

In assessing the future composition of the energy mix we
first examine the playing field on which these changes
are being made namely a consumer base that directly
consumes energy through residential use of electricity, gas
and petroleum, as well as indirectly through services that are
consumed and capital goods that are manufactured.

superior energy content per unit of weight. Subsequent

technological innovations allowed for petroleum and natural
gas to contribute significantly to the energy mix. It is clear that
technological advances have been important in shaping the
energy landscape.
Government policy is also a significant driver of the energy
mix. Ensuring security of supply is a key government objective.
The chart below shows that during the oil embargo in the
1970s an uncertain supply of oil spurred government policies
designed to broaden the energy mix, as evidenced by the
emergence of nuclear generation. Outside of the United
States, other countries such as France adopted significantly
more aggressive policies to diversify away from fossil fuels into
nuclear energy.

In terms of raw energy consumption, the worlds population

consumes 1.9 tons of oil equivalent per annum for every man,
woman and child1. In simple terms, each person consumes
enough energy to keep 25 x 100W light bulbs running all
day, every day. Of course energy consumption is vastly tilted
toward developed nations with Australians, for example,
consuming around three times as much per capita.
Energy is currently derived primarily from thermal sources such
as natural gas and petroleum but this hasnt always been the
case. Through history we can see periods of inflection points
in energy generation, as evidenced in the United States. The
use of wood reach an inflection point in 1880, the result of a
new fuel appearing on the scene coal. It was technological
innovation that allowed for the emergence of coal due to
innovative mining techniques. The energy intensity of coal
allowed for significant economic progress, a function of coals

Economics is the third driver of the energy mix. Capital has

been, and will continue to be attracted to higher risk-adjusted
returns. The significant reduction in capital costs for alternative
sources of energy such as wind and solar places them at an
increasing advantage relative to traditional energy sources.
We explore the relative attractiveness of differing generation
sources in the third section of this paper.

Figure 1: US primary energy consumption by source 1775 to 2011

Wood Coal Petroleum Natural gas
Nucleur electric power Other renewable energy1
45

QUADRILLION BTU

40
35
30
25
20
15
10

2011

2008

2005

2002

1999

1996

1993

1990

1987

1984

1981

1978

1975

1972

1969

1966

1963

1960

1957

1954

1951

1945

1930

1915

1900

1885

1870

1855

1835

1805

1775

Source: U.S. Energy Information Administration Annual Energy Review, Tables 1.3, 10.1, and E1. 1Geothermal, solar/PV, wind, waste, and biofuels

World Bank Energy Use (kg of oil equivalent per capita)

Global energy consumption

Energy demand

Energy supply

Global demand for energy has proven to be relatively stable

over time. To the extent that energy is required for essential
activities such as heating, cooking, transportation and
industrial and commercial applications, we would expect that
demand is on a gradual upward trend over time, reflecting
economic and population growth. Indeed, industry specialists
forecast very moderate growth of 1.4 per cent per annum
in energy consumption through to 2035. In the US, energy
consumption per capita has been on a very shallow declining
trend since the early 1970s, notwithstanding a change in the
composition over time. This stable level of demand needs to
be contrasted with some significant changes as to how energy
is supplied from the perspective of the customer. The gentle
decline in the US, driven largely by increasing energy efficiency,
has been more than offset by increasing consumption,
particularly in developing countries such as India and China.

Energy consumers have faced some significant changes

over the last decade. Higher peak demand recorded in
the summer season, driven by air conditioning, has driven
up costs as network assets have required reinforcing and
replacement. Average demand however has declined as
energy efficiency has started to make inroads into energy
consumption from such technologies as LED light globes and
more energy efficient appliances. Commodity price volatility
has directly impacted the cost of energy consumption, and the
environmental policies adopted by governments have spread
the cost of emissions abatement across all energy consumers.
Technological innovation has allowed consumers to take an
increased level of ownership of their energy consumption,
and rapidly evolving technological advances have provided
alternative sources of generation.
It seems logical that rapid changes in the way energy is supplied
to meet relatively stable and ever present demand will result in
some changes in the energy mix. In the remainder of this paper
we explore the extent to which technology, government policy
and economics will combine to drive change.

Figure 2: US primary energy consumption per capita, 1949 to 2011

400
350

MILLION BTU

300
250
200
150
100

Source: U.S. Energy Information Administration Annual Energy Review, Table 1.5

2009

2006

2003

2000

1997

1994

1991

1988

1985

1982

1979

1976

1973

1970

1967

1964

1961

1958

1955

1952

1949

50

Technology

Solar has emerged over the last five years as one of the fastest growing
forms of electricity generation driven by increased competitiveness relative
to traditional sources of generation.
In order to establish whether such improved competitiveness
is sufficient to alter the growth trajectory of traditional forms
of energy generation as the worlds population grows, further
analysis is required. We focus on the improving economics as
a driver of solars growth.
The competitiveness of solar PV is a function of multiple
inputs, the most obvious of which is the price of the solar
panel itself, but also factors in the solar PVs system efficiency,
the funding cost and the level of solar radiation received by the
panel. In simple terms, the lower the panel cost, the higher its
efficiency and the more sun received, the lower the cost per
kilowatt-hour (kWh) of energy produced.

How does solar PV benefit

thehousehold?
Owners of solar PV systems benefit in two ways:
1. avoided grid consumption every kWh generated and
consumed avoids consumption of a kWh from the
electricity grid
2. excess energy production sold to the grid can either be
netted against grid consumption, or sold at a specified rate,
currently around 6c inAustralia.

What is solar-powered generation? Inwhat

forms does it come?
A 4kWh solar panel installation can produce on
average in Sydney around 16kWh of electricity
per day, enough for a mid-size family, at a cost of
around 10c/kWh relative to a domestic electricity
price of 25c-30c/kWh.

Solar-powered generation of electricity comes from two

main technologies Solar Photovoltaic (Solar PV) and Solar
Thermal. Solar PV is available on a residential, commercial
or utility scale, and converts solar energy to electricity via a
photovoltaic material such as polycrystalline silicon.
Solar Thermal uses solar radiation to generate heat or
electricity via reflectors that concentrate sunlight onto a
receiver. Utility scale solar thermal generators heat molten salt
that boils water to drive steam generators. The heat retention
in the molten salt allows for generation during the night. The
most successful solar thermal generator currently operating
is the Gemsolar plant in Spain that set a 36 day record for
24/7 output.

Technology

Drivers of solars relative attractiveness

Figure 3: Direct Normal Irradiation averaged annual sum

The key variables

Solar radiation
System efficiency
Funding cost of equipment
Panel cost
Tariff for excess production
Cost of grid-sourced energy

Key inputs into solar PVs cost of production per kWh

Panel efficiency

Solar radiation

Panel efficiency is measured in terms of the conversion rate of

solar radiation to electricity and is independent of the area of
the panel. A lower cost of electricity production will come
from higher panel efficiency.

The potential level of output from a solar installation is clearly

contingent on the level of solar radiation available. Equatorial
regions are favourably located given the more direct angle of
solar radiation, however weather patterns also figure in the
analysis. As Figure 3 above shows Australia, northern Africa
and the South West of the United States all feature as regions
with above average solar resources. On an average day a
square metre of ground in Sydney receives 4.5kWh of energy.
Sydney rates around middle of the pack in terms of solar
resources. A lower cost of electricity production will come
from a higher irradiance level. This factor is a constant
over time but varies by geography.

System efficiency
Once produced by the panel electricity is routed to the socket via
various components that leak energy in the form of inverter losses,
thermal and conduction losses. A lower cost of electricity
production will come from higher systemefficiency.

Funding costs
Solar PV in the residential context has historically been funded
by each household. The cost of capital could reasonably
be considered to be the mortgage rate. A lower cost of
electricity production will come from lower funding costs.

Technology

Panel cost
Falling panel costs have been driven by R&D and economies of scale. Capital costs have dramatically declined over the last
twenty years as the chart below shows. The current price of around $0.70 per watt is expected to decline further. A lower cost of
electricity production will come from lower panel costs which look highly probable.
Figure 4: Panel cost
80

PRICE, $ PER WATT

70
60
50
40

$0.74 per watt

and expected to get lower

30
20

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

1992

1991

1990

1989

1988

1987

1986

1985

1984

1983

1982

1981

1980

1979

1978

1977

10

Source: Bloomberg New Energy Finance and The Economist

Tariff for excess production

The typical generation profile of solar in the domestic context
sees a large percentage of power being fed back into the
grid. The price at which this power is remunerated by the
network varies across the world, using typically a feed-in
tariff structure to pay the solar PV owner a price per kWh.
The level of the feed-in tariff is set by regulation, and is on a
declining trend. Initially set at a high level in order to encourage
investment in solar generation, solar PVs improved economics
are now seeing feed-in tariffs decline to very modest levels,
well below the retail cost of electricity for example. Currently,
feed-in tariffs are in the order of 6c-8c per kWh around
Australia compared to historical levels of 40c to 60c.
A secondary mechanism seen around the world is becoming
increasingly uncommon. It is called net metering and
allows households to net off power generated against power
consumed, which implicitly pays the household the grid
tariff. This can be considered quite generous considering the
grid tariff is set at a level to compensate for investments in
generation, as well as transmission and distribution assets.

Cost of grid-sourced electricity

The alternative cost of electricity has emerged as one of the
most significant variables in a households decision regarding
investment in solar PV. Given a reduction in feed-in tariffs,
it is now increasingly apparent that the extent to which
generation from solar PV can displace traditional grid-sourced
energy will drive marginal take-up of new investors. That is,
the investment case for households is no longer predicated
on earning income from high feed-in tariffs, but rather is a
function of the households ability to displace grid-sourced
electricity with solar power. For example, in the United States,
notwithstanding significantly more abundant solar radiation in
the south west of the country, it is actually in the north east

where power bills are higher, and where there is an increasingly

frequent equivalence between the cost of power generated
from solar PV sources and traditional grid-sourced energy.
As the cost of traditional grid-sourced energy increases, this
makes solar PV increasingly more attractive.

Mismatch between supply and demand

Solar PV generates electricity not necessarily when it is
needed. While a typical household consumes electricity in the
morning and evening peaks (see Figure 5), solar PV generates
electricity during the day with peak output in the middle of the
day. As we have seen above, households generate maximum
utility when consumption of energy from the network is
avoided. For the typical household, the all-in cost of power
generated is around 10c/kWh in the current market relative
to grid-sourced energy in Australia in the range of 25c-30c.
To avoid usage from the grid therefore saves the household
around 15c-20c per kWh. Offsetting this benefit is the loss
incurred on each kWh not consumed, sold into the network
at a feed-in tariff of around 6c. It is clear from these figures
that the typical household will benefit from consuming more
of its own self-generation. The benefit to the household can
be maximised by using appliances more intensively during the
day. Similarly, industrial and commercial users may also benefit
as their typical usage profile would be a closer fit to the output
from the solar PV ie economic activity would peak during
daylight hours.
It is clear from the above that the typical household will benefit
by using less grid-sourced energy. The implications for the overall
energy system are negative. The potential for lower consumption
by households on average has the potential to place financial
stress on utilities that earn less revenue than previously see
death spiral commentary below. The second potential impact
is that of network-wide supply and demand imbalances as
foreshadowed in the duck curve analysis below.
7

Technology

The death spiral?

Residential solar PV has the potential to generate benefits for consumers namely a significantly lower cost of electricity for those
hours when the sun shines. From a flow of funds perspective it can be easily seen that more money invested in solar PV capital
to avoid grid usage will, prima facie reduce the aggregate revenue for the electric utilities sector.
The so-called death spiral could result from customers reducing the volume of electricity sourced from the grid.

Figure 5: The supply/demand balance in a typicalhousehold

Energy consumption

Solar generation

Solar export Grid consumption

POWER FLOWS (KW)

1.5

11pm

10pm

9pm

8pm

7pm

6pm

5pm

4pm

3pm

2pm

1pm

12pm

11am

10am

9am

8am

7am

6am

5am

4am

3am

2am

1am

12am

0.5

Source: Macquarie

This would result in the same fixed cost of the grid network
being spread across a smaller number of remaining customers,
who in turn then see solar PV become increasingly attractive
on a relative basis leading to further defections from the grid,
and so on.
The problem stems from an electricity network that comprises
long life, high capital value fixed assets that are remunerated
by customers paying a bill that is calculated primarily using
volume of electricity consumed. The calculation of bills which
assume a certain volume of energy consumption per customer
is spelled out in further detail below:
electricity tariffs at the retail level are comprised of four
main costs: generation, transmission, distribution, retail margin
generation: cost of electricity production from primary
energy sources coal, gas, nuclear, hydro, wind,
solar,biomass
transmission: high voltage transport of electricity from
generation source through to the city gate
distribution: low voltage transport network from city gate
to individual houses, businesses, factories
retail margin: covers account administration and
profitmargin.

Generation typically comprises around 50 per cent of the

total retail bill. The other half is split between distribution,
transmission and retail margin, in decreasing level of
significance. The majority of costs incurred by utilities are fixed
irrespective of volumes sold the most obvious example is
investments made in transmission networks that have virtually
zero marginal costs, but significant funding costs.
The flaw in the current billing methodology is that consumers
are billed on a per unit basis, the calculation of which
assumes a certain volume of electricity being consumed. If a
household chooses to consume less, it still enjoys the benefit
of grid connection, but pays a lot less than the cost to provide
that service. In summary, the death spiral could eventuate as
a large fixed cost base is funded by customers consuming a
smaller quantity of energy.

Technology

System wide impacts

the rapid ramp-up in generation required from 1pm through

6pm in the 2020 scenario gives rise to the requirement
for a more flexible generation mix. That is, generation
sources that produce baseload power, such as nuclear or
coal, are unable to switch generation on and off quickly.
The ideal source of power with peaking flexibility is
combined-cycle gas turbines. In the 2020 scenario, this
implies a major level of investment in generation to create a
more flexible generation mix, which is very costly, or allow
existing baseload to run all day without being utilised in the
middle of the day, a result that would largely eliminate the
environmental benefits of solar installation in the first place!

The rapid rise of solar PV in the generation mix has the potential
to create unintended negative consequences for the health of
the electricity sector, as highlighted in the duck curve analysis
in Figure 6. The duck curve chart presents the hourly electricity
load required to be produced by all sources of generation other
than solar such as coal, gas, nuclear and hydro. The chart
shows this demand profile over different years in California,
with 2012s load profile showing little impact from solar, through
to 2020 where the impact of solar will likely see the demand
from traditional sources cut in half. There are some negative
implications for the overall electricity sector:

The duck curve and the increased system costs it implies has
the potential to exacerbate the impact of the death spiral
the fixed system costs that are to be spread over a smaller
customer base have the potential to grow. Does battery
technology offer a solution to at least part of the problem?

the reduced volumes of electricity sold at depressed

prices during the middle of the day have the potential to
significantly impair revenues for integrated utilities. This has
already occurred in Germany and Italy
network operators may be required to densify and extend
networks as solar PV assets are installed not necessarily
in the same location as large electricity demand centres.
This may require increased investments in transmission and
distribution assets to balance the system, which has the
potential to increase the cost base for the industry

Figure 6: Duck curve

2012

2013 2020e

MEGAWATTS

25000

20000
Potential overgeneration

Increased use of
solar over time

Increased
ramp-up

11pm

10pm

9pm

8pm

7pm

6pm

5pm

4pm

3pm

2pm

1pm

12pm

11am

10am

9am

8am

7am

6am

5am

4am

3am

2am

1am

12am

15000

Source: Macquarie and CAISO

Technology

Batteries

Increased self consumption

The release in April 2015 of Teslas Powerwall has highlighted

the potential for energy storage solutions to magnify the
utility of intermittent sources of generation such as solar
PV. Two elements of the release are noteworthy. The first is
the cost relative to existing battery storage solutions, with
a headline price of US$350/kWh, relative to competitors at
US$500US$600/kWh. This price reflects the scale benefits
from Teslas electric vehicle manufacturing facilities. The second
is the entry into the mainstream consciousness of battery
storage as an accessible option for future energy supply.
The factors that could drive increased uptake of batteries,
as highlighted by the Australian Energy Market Operator
(AEMO) in its June 2015 Emerging Technologies Information
Paper,include:

Increased self-consumption is a more specific example of load

shifting, one that extends the benefits of solar PV generation.
Rather than selling solar PV generation back to the grid at
a low rate throughout the day, it is stored and used later in
the day to avoid grid tariffs. It captures output from peak
generation in the middle of the day, for re-use in the evening
peak demand period.

Back-up power source

Batteries can discharge during a blackout in order to deliver
a degree of security of supply. Capacity is clearly the key
consideration, alongside the cyclicality of batteries in load shifting
ie a discharged battery will not provide any back-up capacity.
Modelling the combination of batteries and solar PV

high retail energy prices (average prices up 70 per cent in

real terms between 2007 and 2013)

The addition of batteries into a solar PV system allows for the

harnessing of self-generation to a greater degree. Figure 7
below assumes that generation from solar PV is used for both
domestic purposes during the day and to charge the battery.
This stored energy can then be used during the evening peak,
instead of drawing power from the grid. There are benefits to
both the household, and the broader energy system:

declining solar feed-in tariffs, which reduces the value of

excess solar generation exported to the grid
a decline in battery storage costs
excellent solar resources in Australia
availability of innovative electricity tariff structures

1. households can benefit from using self-generated

electricityproduced at zero marginal cost, instead of
grid-sourced power

desire by some households to be more independent from

the grid.
The benefits of battery storage include:

Load shifting
Load shifting refers to cycling the battery by charging it during
off peak hours and discharging it during higher tariff periods.
This benefit is reliant upon a tariff structure with differing prices
for different periods through the day. The traditional price
path sees higher prices during daylight hours with lower off
peak prices available during the late evening. The differential
between periods of high and low prices is clearly critical. The
longer term implications of load shifting, if done in sufficient
volume, is clearly to erode the price differential as peaks and
troughs in demand are ironed out.

2. the aggregate impact of a large number of households

not drawing on the network can reduce the need
to grow the network to service peak demand. This
would have a positive effect on the bills of all electricity
networkcustomers
3. the system could also eliminate the duck curve that
being lower electricity supplied to the grid in the middle of
the day and less demanded in the evening peak, reducing
the steepness of the demand curve in the early evening.

Figure 7: Batteries have the potential to solve duck curveproblem

10

Source: Macquarie

11pm

10pm

9pm

8pm

7pm

6pm

5pm

4pm

3pm

2pm

1pm

12pm

11am

10am

9am

20%

8am

0.5

7am

40%

6am

5am

60%

4am

1.5

3am

80%

2am

1am

100%

12am

2.5

BATTERY LEVEL

POWER FLOWS (KWH/HR)

Energy consumption Solar generation Solar export Grid consumption Battery level

Technology

Battery costs

Figure 8: Back-up energy supply

Energy storage system
Solar PV system

It should come as no surprise to any owner of a mobile phone

that batteries are becoming more efficient for the same price,
consumers are getting increased capacity, decreased physical
dimensions and an increased number of cycles. Lower capital
costs for battery storage measured on a perkWh basis are
likely over the next decade.
For the consumer, this headline cost needs to be adjusted to
assess the true cost of a battery addition, which incorporates
the associated inverters and cabling as part of an installation.
The performance of the battery also needs to be considered:
depth of discharge the effective capacity will be less than
nameplate capacity as prudent operation will see the battery
not fully drained each cycle. There is a trade-off between
depth of discharge and battery life lower depth of discharge
results in longer battery life. Assuming a recommended
80per cent depth of discharge maximum, usable capacity for
a 7kWh battery would be 5.6kWh for example
cycle life the number of cycles a battery will last before
usable capacity falls below 80 to 85 per cent
round-trip efficiency the percentage of energy that is
conserved from a full charge/discharge cycle.

Back-up energy supply

In a domestic context that sees a medium size household
consume around 12kWh per day, the potential to be a backup power source appears initially limited for a 7kWh battery for
two reasons:
1. the battery provides for around half a day of power. This
could be stretched to a day or two if energy intensive uses
such as air conditioning are switched off
2. the grid provides a highly reliable and cheaper alternative.
Within Australia the current reliability standard is that
no more than 0.002 per cent of customer demand in
each National Energy Market (NEM) region should be
unserved by generation capacity per financial year (or
10 minutesperyear). The reliability standard has been
breached only twice in Victoria and South Australia during
a heatwave in 2009. According to the Grattan Institute, the
average household would require 85kWh of battery storage
and a 15kW solar PV system costing in total $72,200
to achieve 99.9 per cent reliability, which is unattractive
relative to grid connection of around $12,910, a figure that
represents the net present value of future grid charges.

$72,200

$52,200
85kWh
$34,200
60kWh
35kWh
$12,910
10kW

7kW
95%

99%

15kW
99.9%

Grid-connected

Off-grid reliability level

Source: Grattan Institute, Sundown, sunrise, How Australia can finally get Solar
right, May 2015

Load shifting
Conceptually, the attractiveness of arbitraging lower power prices
during off peak times and avoiding consumption during periods
of higher prices resonates strongly. With an off-peak price of
around 10c/kWh and peak pricing around the 30c/kWh level,
a round trip for a 7kWh battery 80 per cent discharged would
net around $1.12 perday or $409 per year. The major practical
sticking point is whether this represents a sufficient return on
investment considering the approximately $7,000 investment
required. Assuming a useful life of 15 years, and an interest rate
(funding cost) of 5 per cent (fixed), the answer isno.
This analysis assumes no remedial action from utilities that set
off-peak prices. These rates are set in order to maximise revenue
based on an assumed level of demand in both the peak and
off-peak periods. In the long term, a rebalancing of the demand
profile would likely see utilities rebalance the pricing levels to
remove the arbitrage opportunity, and in effect capture some of
the value sought by households. A move to smart meters could
even enhance the ability of utilities to monitor the net load of
individual households to alter rates charged.

Increased self-consumption
As noted above, a key drawback of residential solar PV systems
is the mismatch between peak electricity generation and peak
demand, the former occurring too early in the day to be of use
in supporting the evening demand peak. Battery technology
represents a fine form of symbiosis whereby excess generation
can be stored at zero marginal cost. This represents a better
outcome relative to PV-only systems where excess generation
is sold back to the grid (at a low feed-in tariff). It also represents
a more attractive investment than a battery-only system
discussed above where power is sourced at off-peak rates.
11

Technology

Some conclusions. in isolation

that charges customers a higher rate during periods of

maximum grid reliance (such as the evening peak for solar
PV-only systems), or a fixed tariff based on peak demand.
The increased revenue that this would generate for network
owners would satisfy regulatory concerns regarding insufficient
investment in network reliability, but would reduce the
economic benefits of solar PV adoption.

It is possible to make some preliminary conclusions regarding

technology as reviewed in this paper:
solar PV should continue to grow as economics are favourable
with structural tailwinds, notably from lower capital costs
investment associated with solar PV should continue
to grow. As consumers become more aware of energy
production and consumption patterns, we should see
ongoing investment in smart meters, energy efficiency and
potentially micro-grids over time
battery technology is currently too costly to allow for
consumers to go off-grid, the major obstacle being the
cost of battery storage relative to the current cost of grid
connection however battery capital costs are expected to
decline in the future
in the longer run, it is likely that an increasing number
of households and businesses will take up solar PV and
battery systems.

What are the implications of batteries for the

infrastructure sector?
The insertion of batteries in the middle of the electricity sector
value chain (see Figure 9 below) creates some interesting
opportunities. Batteries allow for the storage of energy which
until now is a relatively rare phenomenon electricity is
generally produced on demand. Electricity kept in storage has
option value. For the household, the option value is derived
from the fact that stored electricity can be used in the evening
peak. Excess storage relative to requirements would be of
value to a neighbouring house, or to the network as a whole.

lower peak demand for electricity could reduce the

requirement for electricity networks to expand, which
could lower tariffs, making grid sourced electricity relatively
moreattractive

It is unlikely that batteries combined with solar PV will eliminate

the need for network assets. There exists no replacement for
close to 100 per cent security of supply, reliability for which
customers are willing to pay. We can see a close parallel
with the telecommunications industry, with widespread take
up of mobile telephony and data access, not eliminating the
majority of network connected houses. Landlines offer one
key advantage over mobile phones and landline based Voice
over IP plans they still work in the event of a power outage
or a loss of internet connectivity. Customers are willing to pay
for a service to be available when it is needed most. Over
80percent of Australian households retain a landline despite
very strong growth in mobile phone uptake.2

the electricity industry (and society more broadly) clearly has

a vested interest in the retention of a functioning and reliable
grid. It seems likely that tariff reform by regulators will lead to
less reliance on variable tariffs, and a greater percentage of
revenues sourced from fixed access charges. This could
take the form of increased prevalence of time of use tariffs

As it stands, batteries will not have a material impact on the

infrastructure sector in the short term. Batteries appear not to
offer a significant advantage as a stand-alone proposition. In
time though, we can foresee a material reduction in the capital
cost of batteries and solar PV creating a strong incentive for
their combined uptake.

Beware the feedback loops

The commercial and regulatory response to technological
innovation will create further opportunities and challenges for
consumers and utilities in a rapidly changing energy landscape:
improved economics for solar PV and renewables in
general will create downward pressure on subsidies,
lowering the speed of take up

Figure 9: What are the implications of batteries for the infrastructure sector?

Solar PV
Battery
Customer

Generation

12

2 ACMA.gov.au

Transmission

Distribution

Retail

Government policy

Governments around the world exhibit significant control over

the essential service of electricity generation, notwithstanding
the privatisation of utilities that has occurred over the last two
decades. From the perspective of re-election prospects, the
primary objective of governments is to ensure that the lights
stay on ie ensure security of supply.
A secondary objective is to ensure that power supplies remain
affordable. This can be seen as a driver of governments
spending money to subsidise fuel supply (in places such as
Venezuela), but in more developed economies, it generally
leads to regulation to ensure that monopolies are not exercising
market power too effectively.
The third objective is environmental protection, an aim much
broader than the focus on carbon emissions in recent years. It
relates to all manner of negative externalities that could impact
the environment, economy and society more broadly. These three
objectives can be difficult to satisfy, and in fact no one technology
currently can, however the three objectives can allow for
intervention to ensure a minimum level of satisfaction isreached.

For example:
security of supply a minimum reserve margin is tolerated
to ensure peak demand can be met with peak supply
affordability the adoption of a maximum regulated
tariff for lower socio-economic groups, subsidised by the
broadercommunity
environment legislation addressing the coal-fired
generation sectors contribution to acid rain.
Governments have traditionally been good at balancing the
first two objectives. That is, in the absence of an environmental
objective, energy policy can be formulated by encouraging
a balanced mix of reliable technologies with different fuel
sources. Once the environmental objective is added, there
needs to be a trade-off made as generation sources with
a lower environmental footprint can suffer from a cost or
reliability disadvantage. As it stands, no one technology can
meet all three objectives, however in the current environment
gas, and increasingly, renewables can strike a balance.

Figure 10: Government policy

Security of
supply

Affordability

Environment

Most Secure = Diversified

Thermal Generation

Most Afforable = ?

Cleanest = Renewables

13

Economics

We believe the Levelised Cost of Energy (LCOE) to be the simplest comparator for comparing the cost of the different generation
types. It represents the average cost of generating a kilowatt-hour of electricity across the assets useful life.
LCOE analysis incorporates all elements of the generators cost structure including up-front capital costs, ongoing operating and
maintenance costs, capacity and efficiency factors, cost of funding as well as cost of fuel and CO2 (where applicable). LCOE analysis
does not include the cost of transportation of electricity to the end user through transmission and distribution networks, or the cost of
managing the intermittency of generation. As a general rule the capacity factors for renewable technologies are lower, but this can be
more than offset by lower variable costs, including the absence of fuel costs.
Based on our proprietary research model the LCOE across differing technologies and regions is shown below:

Figure 11: LCOE across differing technologies and regions

US

$0.25

$0.25

$0.20

$0.20
COST (KWH)

COST (KWH)

Europe

$0.15
$0.10
$0.05

$0.15
$0.10
$0.05

Onshore Wind

Utility Scale
Solar PV

Gas

Coal

Onshore Wind

$0.25

$0.25

$0.20

$0.20
COST (KWH)

COST (KWH)

Gas

Coal

Gas

Coal

China

Australia

$0.15
$0.10

$0.15
$0.10
$0.05

$0.05
Onshore Wind

Source: Macquarie

14

Utility Scale
Solar PV

Utility Scale
Solar PV

Gas

Coal

Onshore Wind

Utility Scale
Solar PV

Economics

In all jurisdictions that we have modelled, onshore wind without

subsidies is now competitive with both coal and gas-fired
generation. The key variables for wind are cost of funding (low),
capital cost (declining), and wind resources (variable). Utility Scale
Solar PV remains more expensive, however the expected decline
in costs is the most significant across all technologies.
Coal is facing a number of headwinds around the world. In the
United States, for example, there are two specific programs
acting to reduce to the share of coal-fired generation in the
energy mix:
Clean Power Plan In June 2014 the Environmental
Protection Agency released proposed CO2 reduction targets
for US coal plants of 19 per cent by 2030 from 2012 levels.
It did this by classifying CO2 as a hazard to human health.
A final ruling is to be enacted by the states, with each state
required to submit a State Implementation Plan with specific
targets by mid-2016. The levers the EPA expects the states
to pull include: increasing the efficiency of existing coal plants,
prioritising gas plants over coal plants, reducing demand and
growing the contribution from renewables

Mercury and Air Toxics Standards this program sets

a lower tolerance level for emissions of mercury and
other chemicals. The high cost of retrofitting scrubbing
technology means it is uneconomic for some older plants
to remain in operation.
The overall impact of the three key drivers we have identified
as changing the energy mix technology, government policy
and economics can be seen in power plant data maintained
by the Energy Information Agency (EIA) in the United States.
This forward-looking database captures planned plant
additions and shutdowns based on technology type. The data,
as summarised in Figure 12 below shows some strong trends:
gas-fired generation is expected to increase materially.
Over 50,000MW of new generation capacity is expected
to open by 2023. It is the dominant fuel for new installed
capacity over the next decade
renewables over 30,000MW of new renewable
generation capacity (primarily wind and solar) is expected to
beconstructed
coal at least 25,000MW of coal-fired generation capacity
will close down.

Figure 12: US planned generation additions and retirements (MW)

New Build Retirements
60,000

40,000
20,000
- 20,000
- 40,000
Gas

Wind

Solar PV

Nuclear

Solar Thermal

Hydro

Geothermal

Biomass

Other

Coal

Source: EIA

15

Economics

Implications for the infrastructure sector

Below we explore the implications for the infrastructure
sub-sectors from the forecast growth in gas-fired and
renewablegeneration.
Electricity Generation the EIA forecasts that gas-fired
generation and renewables should continue to attract the lions
share of investment capital over the next decade. New nuclear
is uneconomic in the current commodity price environment.
The nuclear sector has faced significantly higher safety-related
capital expenditure as a result of the Fukushima nuclear
disaster. Nuclear plants in the US are being shuttered because
they cannot compete with the economics of cheap gas used
in combined cycle gas turbines.
Coal plants are suffering from regulation that requires
increased capital expenditure to eliminate noxious gases such
as nitrous and sulphurous oxides.
Renewables are becoming increasingly competitive. To the
extent that investment in generation is supported by long term
contracts or supportive regulation, then this infrastructure subsector can be considered viable for infrastructureinvestors.
Electricity Transmission the outlook for transmission
becomes a little more uncertain in an environment of increased
solar PV installation by end users. Transmission asset owners
generally benefit from increased capital expenditure as
regulated returns are based on the asset base, ipso facto
a larger asset base will generate more revenue. Solar PV in
conjunction with battery technology may act to reduce the
level of peak demand, and given networks have grown to
accommodate a rising level of peak demand, this may mean
a highwater mark may soon be reached in developed
countries in terms of peak demand.
Offsetting this, network growth is required for additional
connections and from asset replacement. Both these drivers
appear uncorrelated with the uptake of renewables, assuming
assets continue to reach the end of their useful life at a
similar rate as recently observed. Additionally, incremental
connections of new utility scale renewables assets, including
solar PV and solar thermal, and also wind turbines, will
likely drive further investment in electricity transmission to
connect these new sources to the grid. Regulated Electricity
Transmission assets are attractive for infrastructure investors.
Electricity Distribution Growth potential exists for
distribution assets as new connections and asset
replacement continues. Longer term, and assuming a more
decentralised electricity generation system, distribution
assets may benefit from the establishment of micro-grids as
smaller communities share backup power supplies (such as
gas-fired generation that benefits from economies of scale),
with the potential for some consumers to leave the grid
entirely subject to an appetite for lesser reliability. Similar
to Transmission, Electricity Distribution assets are typically
regulated and have strong infrastructure attributes.

16

Gas Pipelines incremental gas-fired generation requires

infrastructure to deliver fuel for combustion. The significant
global shift towards the cleaner burning fuel of gas will
deliver many opportunities for infrastructure investors to
finance such assets. The return profile for the highest
quality gas pipelines is underpinned by regulation or long
term take-or-pay contracts.
Liquefied Natural Gas (LNG) the rapid rise in US energy
production has depressed the prices of both oil and gas.
It has stimulated demand for gas as a fuel of choice, due
to superior economics, and it has generated demand from
countries that seek a diversification of fuel sources.
The US is expected to become a net exporter of gas in 2017
with multiple projects currently under construction. Examples
include Sabine Pass in Louisiana which is expected to export
up to 2.5 billion cubic feet per day (bcf/day), coming on in
stages from late 2015 through 2017; and Freeport LNG
in Texas that will export 1.8bcf/day in 2018. Gas sourced
locally to these projects at the Henry Hub price is very
attractive to international buyers because it is sourced from
a politically stable country, and as pricing is independent of
global oil prices, it acts as a diversifier for buyers.
Companies providing the infrastructure to facilitate the
export of LNG and without exposure to the LNG price may
be attractive investment opportunities.
Rail reduced coal consumption in the power sector
may have an impact on coal volumes transported by
rail. In recent years there has been a structural decline
in coal volumes reflecting both a displacement by gas
in the merit order and increased renewable generation.
This trend is likely to continue as economics and policy
clearly favour gas and renewables in the United States.
Thermal coal exports from countries such as the United
States and Australia are also facing headwinds as global
over-supply continues. Given these structural headwinds,
we remain cautious regarding the outlook for above rail
transportation companies with exposure to coal volumes.

Conclusions
The next decade is likely to see a change in the mix of energy consumed
across the globe. Evolving technological innovation combined with
declining capital costs is likely to see renewable energy become
increasingly competitive. Abundant natural gas will increasingly displace
coal fired generation.
An evolving regulatory and commercial landscape will present both
challenges and opportunities for renewable forms of generation. The
traditional model of centralised thermal generation remains both essential,
but also increasingly at risk from newer forms of technology. Government
policy will continue to play a role of oversight, encouraging reliable,
cleaner and inexpensive forms of energy to meet an ever present
demand. Against this evolving backdrop the infrastructure sector stands
to benefit from increased investment in assets that produce stable,
contracted cash flows. Infrastructure investors will need to remain alert to
both the emerging opportunities and potential threats.

17

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MIM110 11/15