Key takeaways

• The world is undergoing a once-in–a-century energy transition; investors should be prepared.
• Wind and solar (photovoltaic) renewables are becoming more affordable and scalable; previous limitations are being overcome.
• Investors should consider rebalancing their portfolios away from non-renewables toward wind and solar.
• Megascale edge computing data centres and battery systems offer additional and complementary fields for investment.

Energy as we know it is experiencing a tectonic shift, from energy source and generation through to how it’s ultimately consumed. This ‘revolution’ will take two to three decades to complete as the cost structures of energy production undergo major changes. Wind and solar (photovoltaic) renewables are becoming more affordable and scalable as previous limitations are being overcome and new business models such as energy as a service (EaaS) businesses will emerge and capture a significant part of the value in energy. 

Gearing up for the future, today’s investors may be well advised to revisit their current exposure to energy assets and consider business models that may offer better prospects for sustainable growth.

The energy transition

The first energy transition was from human or animal power to steam engines powered by burning coal. The second was marked by the invention of electricity and discovery of oil, enabling the rapid adoption of internal combustion engines. 

The world is undergoing another energy transition as, on the supply side, indigenous renewable energy is becoming increasingly competitive versus fossil fuel as a source of energy. On the demand side, with the growing use of sensitive electrical apparatus such as computer servers, 3D printing, and robots, the reliability of power supply is becoming increasingly important. And, given the rapid advancement and commercialisation of electric vehicle (EV) technology, the world is finally moving toward breaking its century-long reliance on oil as the costs of batteries move down. Digitally controlled battery systems are also altering the boundaries of power systems by balancing supply and demand.

Renewables met the largest share of new demand in 2019 as coal saw historic declines

Demand for clean electricity matched coal for the first time in 2019: annual change

Source: BP Statistical Review of Energy 2020.

With these advancements in energy technologies and business requirements, new business models are emerging. Investors are presented with a unique opportunity to participate in, and potentially profit from, the global energy transition. This is especially true in China, at the forefront of renewable energy adoption and application.

Many new renewables are now our lowest cost electricity producers

Since the 1880s, the world has primarily been powered by fossil fuels, but this is beginning to change as humanity considers its role in climate change and the need to preserve the environment for future generations. Advancements and scaling in renewables over the past four decades, specifically within wind and solar, make it clear that they'll play a major part in the future of energy as the world slowly shifts away from fossil fuels and toward indigenous, cleaner alternatives.

“Significant strides are being taken toward a low-carbon future powered by renewable energy.”

For example, between 2008 and 2018, the build cost of wind farms decreased by approximately 30% in China, while production efficiency increases exceeded 150%.¹

Globally, since 2010, solar cell production costs, excluding balance of plant (BoP), dropped over 80% and efficiency improved by 50%, netting a better than 80% cost reduction for solar according to the International Renewable Energy Agency (IRENA).²

Renewables also accounted for nearly three-quarters of new power generation capacity built in 2019, a record high, of which ~90% was made up of solar and wind according to the same report. In April 2019, electricity generated from renewables exceeded that of coal-fired generators for the first time.³ Significant strides are being taken toward a low-carbon future powered by renewable energy. 

Primary energy consumption (quadrillion Btu)

By source: 1949-2019

Energy Review, October 2020.

The competitiveness of renewables continues to improve as wind turbine and solar panel technologies advance. Specifically, China’s new solar renewables reached grid parity (the levelized cost of electricity is equal or less than the cost of electricity from fossil fuels) in 2018 and wind renewables will reach grid parity in 2020.⁴ As much of the world moves toward achieving grid parity, we're entering a golden era of renewables investment and an accelerated period of global energy transition.

Rapidly falling battery storage costs provide a competitive and flexible system resource

Energy storage will become an essential part of the future energy systems as it greatly improves grid flexibility, enabling the possibility of high penetration by renewables. 

In recent years, the costs of battery-based energy storage systems (battery systems) have been decreasing and are on course to soon becoming competitive as a flexible system resource for pump hydro and gas-fired power stations. Driven largely by the rapid commercialisation of the EV industry, lithium battery efficiency, longevity, and safety have increased significantly, while costs are expected to continue to steadily decrease.           

Battery systems are already being used for a number of power market applications to improve grid reliability throughout the world. Utility-scale battery systems have been paired with intermittent renewables to ensure stable grid operation. Beijing recently announced a "new infrastructure" investment stimulation strategy, in part to combat the negative economic implications of the global COVID-19 pandemic, nearly all of which creates new demand for battery-based energy storage systems. 

Looking forward, individual power consumers (whether industrial, commercial or residential) will be able to install Internet of Things (IoT) enabled battery systems to capture value in energy management and trading.

Interconnected modern grids enable the potential of renewables

Regional grids covering a few million square kilometres using ultra-high-voltage (UHV) grid transmission lines as their backbone allow energy production, storage, and consumption to be balanced across the grid. A very large, modern, and highly interconnected, bidirectional grid allows renewables in distant regional areas to be economically utilised and optimised across a vast geography by smoothing out intermittencies in power generated by individual renewable assets.

For example, over the last 15 years China has developed a new national power grid covering most of the country anchored by a web of UHV transmission lines. These efficiently connect resource-rich regions with load centres in central and eastern China that are 2-3,000 km away. 

Smart grid will link and unleash energy systems' latent potential

Power systems are becoming more complex and nonlinear with a rapidly growing number of power market participants, such as distributed wind and solar power systems, battery storage systems, EVs and EV-charging facilities, and smart meters. As power systems become less centralised, conventional grid infrastructure can no longer easily monitor and control all energy assets to maintain network resilience.

"Smart grid technologies greatly improve network efficiency and create significant flexibility within the grid."

Smart grid technologies are a new approach to managing grid volatility and delivering flexibility across power systems. Applications of 5G, IoT, machine learning and artificial intelligence technologies in smart grids enable network operators to coordinate previously isolated, and increasingly diverse, power assets. Smart grid technologies greatly improve network efficiency and create significant flexibility within the grid.

Using digital tools, a smart grid can pool, control, and optimise battery systems to improve the stability of renewable energy supply to the grid and provide ancillary services as required. It can also help local operators to manage volatility in power demand by coordinating various demand side resources, such as at-/behind-the-meter storage systems and smart thermostats. 

Smart grid management capabilities

Source: iStock.

By consolidating all these power assets into a virtual power plant (VPP), network operators can address fluctuations in power supply and demand, transforming the power system and creating the grid infrastructure necessary to support the energy transition towards a more sustainable future. In 2019, China State Grid embarked on an ambitious Smart Grid IoT and recently announced a RMB 24.7 billion big data, industrial IoT, 5G and machines learning-based investment program for 2020, while aiming to attract another RMB 100 billion in investment to further the development of the whole industry.⁵

What will the future energy system look like?

From the supply side, future energy systems will be characterised by in-depth integration of renewables and information technology, anchored by megascaled nuclear, coal, and gas power stations, interconnected by a large-scale smart grid. 

Increasingly affordable battery solutions and advancements in smart grid technology are enabling more efficient management of supply and demand, ensuring more grid resilience and allowing greater integration of intermittent renewables. As a result, increasingly competitive renewables will displace fossil fuel. The penetration rate of wind and solar energy within power grids is expected to increase from 15% to 20% in 2018 to 40% to 60% in the near future.⁶

From a demand side, given the electrification of the transport sector, especially the rapid adoption of EVs, electricity will replace oil. And as heat pump design and technologies improve, district heating and cooling will also soon be electrified as electricity replaces coal, heating oil, and natural gas. For example, the State Grid Energy Research Institute forecasts that the proportion of electricity within terminal energy consumption (terminal electrification rate) will rise from 27% in 2018 to 50% by 2045-2050, and that electricity demand will increase by over 100% over the same period.

"Data centres are expected to account for 5% to 8% of total power consumption by 2025."

With the proliferation of IoT, 5G, cloud computing, machine learning, artificial intelligence, and driverless cars, a massive amount of data will be created and the power needed to compute this data will increase exponentially. Globally, data centres are expected to account for 5% to 8% of total power consumption by 2025.⁷ Meanwhile, data centres require power that is high in quality, reliability, and availability, in order to protect data, servers and network devices from potential outages, and will pay a significant premium for it. Furthermore, the growing use of 3D printing, robotics, and electrical apparatus in advanced manufacturing will also drive demand for high-quality power.

Energy transition investment strategies

The energy revolution will continue for another 20 to 30 years, during which time a mega shift in value across the entire energy chain will be seen as electricity displaces oil, coal, and gas. Renewables with zero marginal cost will drive down base load power prices while merchant power generation and fossil fuel mining businesses will incur significant stranded assets risk. 

Electricity will no longer be a single commodity as service-level requirements increasingly differ amongst energy users. EaaS businesses such as data centres, which offer flexible, tailored power and power system management services, will emerge and capture a significant part of the value in energy. During this period, many traditional energy businesses will become obsolete and the winners will be those who embrace new business models emerging from the current energy transition. China is one of the countries to have embraced this change, not only to solve its pollution problems but also to anticipate the surge in energy consumption as the country continues to grow, finding wider application for its 5G and artificial intelligence technologies.

Seizing a once-in-a-century energy transition opportunity

Over the next decade, investors that have kept abreast of developments in energy transition  may wish to consider reducing their exposure to energy assets, such as nonrenewable power generation and fossil fuels, and focusing on energy assets with proven business models and embedded growth options, such as renewables and data centres. Megascale edge computing data centres and battery systems offer additional and complementary fields for investment and investors may also wish to stay aware of businesses that invest in EV batteries that can be used by both EVs and electricity storage.

The energy transition we're undergoing presents significant disruptions to the status quo while offering forward-thinking investors opportunities to profit from it. Those with carefully crafted and well-integrated investment strategies, in collaboration with the right partners, should be best positioned to profit from upcoming changes in the energy market and, ultimately, be rewarded by attractive returns on a risk-adjusted basis.

1 Wind Technologies Market Report, U.S. Department of Energy 2018. 2 “Onshore wind power now as affordable as any other source,” IRENA, 2019. 3 Electric Power Monthly, U.S. EIA, 2020. 4 "Achieving grid parity of wind power in China – Present levelized cost of electricity and future evolution", Qiang Tu, Regina Betz, Jianlei Mo, Ying Fan, & Liu Yu, 2019. 5 "China State Grid to invest 24.7 bln yuan in new infrastructure this year", World Energy. June 19, 2020. 6 "Global energy transformation: a roadmap to 2050", IRENA, 2018. 7 “Data center power market worth $10.77 billion by 2025,” Grand View Research, 2019.

This article has been co-authored by Raymond Fung, Co-Founder and Managing Partner of Albamen, an affiliate of Manulife Investment Management. In 2020, Manulife Investment Management announced it has acquired a minority stake in Albamen, a private equity infrastructure investment manager with a focus on renewable energy, data centers and other power-intensive infrastructure assets in China. 

Bibliography:

Myron Zhu, CFA, Head of Private Markets Asia at Manulife Investment Management

Myron leads Manulife’s private markets business in Asia. Based in Hong Kong, Myron is responsible for enhancing Manulife’s private market franchise in Asia, with a focus on developing and executing strategies that will distinguish the firm’s specialized investment capability to address investors’ needs.

Prior that, Myron was co-head of private equity Asia-Pacific at Aberdeen Standard Investments, overseeing its Asia Private Equity strategy.  Myron was a partner at FLAG prior to joining Aberdeen through the firmˇs acquisition in 2015. Prior to joining FLAG in 2014, Myron was head of alternative investments - CIO Asia, at JP Morgan Chase Bank, where he founded and built the firm's Asia business as a major player in the region. Prior to that, Myron was a vice president with DBS Private Equity in Hong Kong, where he led the firm's investment activities in Greater China.  Myron joined DBS from AIG Capital Partners in New York, where he originated, analysed, and executed on investments principally in the Pacific Rim.  Prior to AIG, Myron held risk management and marketing positions at Sumitomo Bank Capital Markets in New York after launching his career with Credit Suisse First Boston.

Myron is a native speaker of Mandarin. Myron holds a B.S. from the University of Texas at Austin and an MBA from The Wharton School at University of Pennsylvania. He is also a CFA charterholder.

Raymond Fung CFA, Founder and Managing Partner

Raymond is the founding partner of Albamen. Raymond is responsible for Albamen’s business advisory and strategic advisory businesses. Raymond gained his investment experience from being involved in financial advisory mandates, principal investments in the infrastructure sector, and operational management of infrastructure projects. Specifically, Raymond has led investments in wind, solar, coal-fired, gas-fired, hydro power generation, energy transmission and distribution, coal bed methane gas field exploration and development, and transportation infrastructure assets in Australia, China, Europe and ASEAN.

Prior to Albamen, Raymond was the head of infrastructure investments at Ping An in Shenzhen. He was responsible for Ping An’s infrastructure investment activities, including serving on the board of a number of Ping An’s private investments. Prior to Ping An, he was head of infrastructure – Asia of Babcock & Brown, a member of Babcock & Brown’s Global Infrastructure Executive Committee and Asian Infrastructure Fund’s investment committee, and he was a director on the boards of public companies Sydney Gas Limited in Australia and Don Muang Tollway Public Company Ltd and private companies in China, Singapore, and Australia. Raymond was responsible for the establishment, capital raising, and management of the AU$400 million listed Prime Infrastructure Fund in 2001-2002, the AU$174 million Global Wind Partners in 2003-2006, the AU$900 million Babcock & Brown Power Fund in 2006, the US$460 million Babcock & Brown Asia Infrastructure Fund in 2007-2009, and the RMB 3.69 billion Fund I in 2015 till to date.

Raymond holds a Bachelor of Economics, a graduate diploma of Applied Finance and Investment, and is a CFA charterholder.