Investment ‘Lock-ins’ and Technological Advancements in the Energy Sector

The future of global energy is in clean energy. In 2015, for the first time, the addition to power sector capacity by renewable sources exceeded those by all other sources (WEO, 2016). Technological advancements are fast transforming the way energy is produced and consumed. India needs to join the cavalcade of change.

Today, consumers of energy have greater choices, and are exercising their choice by happily substituting costly options with cheaper, more convenient options. There are plenty of examples, from the large scale adoption of LED to the ascendancy of solar and wind power. The preferences of consumers are impacting energy companies who must take investment decisions with great care. Indeed, in the present era of fast evolving technology, large investments in conventional sources of energy may be difficult to find. This has major implications for India, which needs to invest $100 billion every year in its energy sector until 2040, to cater to the projected energy demand (IEA). As per IESS 2047, by 2040 India’s energy supplies are likely to rise by more than a factor of three (over 2012). How technological trends impact energy sector investment is an important question. Should Indian policy makers recognize the winds of change that are sweeping the sector, and quickly devise a world-class policy regime that attracts investors?

Here, we examine two such technological developments—Electric Vehicles (EV) and solar/wind energy—that are bound to influence energy sector investments in positive and negative fashion depending on the sector in question.

Let us take EV first, which could be a game changer in a public transport-deficient and private transport dependent country whose appetite for vehicles is increasing at a fast pace. India has set an ambitious target for the adoption of EV. A Government-led initiative – the National Electric Mobility Mission Plan – targets annual sales of 6-7 million EV/Hybrid vehicles by 2020. There is an ambition, that by 2030, all vehicles sold in India may be electric-powered. This is an aspirational target. Ultimately the logic of markets will prevail. If battery costs (battery costs comprise nearly a third of the cost of an electric car) come down, the adoption of EV would zoom. It is less known that decline in battery cost has so far beaten the decline in SPV. There are several studies that indicate that lifecycle cost of an electric car in India would be the same as that of an internal combustion (IC) one by 2022 (LBNL).

Coming to the investment side of the story, there are two dimensions to it. Undoubtedly, automobile manufacturers are closely weighing the options before them. Will they have the same appetite to introduce new IC engine models at close intervals as in the past, or will there be a shift towards manufacture of EV? But the second scenario that also needs to be considered alongside is the resultant investment outlook for oil refineries. If the EV story unfolds, there is bound to be lesser demand for petroleum products. Over the last one-and-a-half decades, India has been an exporter of petroleum products, which is now changing to just self-sufficiency. There has been a buzz that India needs to step up refining capacity, to cater to the burgeoning demand arising from the transport sector. But if EV technology was to out-compete IC based vehicles in the coming years, surely the demand for liquid transport fuels would be adversely impacted, and new refinery sector investments would face a challenging, altered reality.

Of course, refineries produce a slew of products, and not merely transport fuels. India imports nearly half of its LPG requirement (and we need our refineries to augment supply), which will further increase due to demand coming from Prime Minister Ujjwala Yojana. But, even as the configuration of refineries can be tweaked to produce the desired slate of products (LPG, kerosene, transport fuels etc.), the same will have to be consciously determined. We also have the option of importing products rather than crude oil for the new refineries (we already import 80% of our refinery crude). In the last decade, the private sector set up three out of four new refineries directly or in the joint sector (Bhatinda, RIL’s second unit at Jamnagar, Bina and Paradip), but it is no longer coming forward. However, the public sector has announced its intention of setting up a mega-refinery on the west coast. What should be the refinery configuration or capacity? Should we import petroleum products? Should we not invest in refineries? These are decisions closely linked to how quickly EV is adopted.

Now, let us come to renewables—solar and wind power—and how these technologies are driving decisions in the power sector. The draft National Electricity Plan of CEA has already projected some displacement of thermal power by the 175 GW renewables agenda of the Government. It may be noted that targets of 100 GW of solar and 60 GW of wind power have been set for 2022. The draft Plan states that in the scenario of the above targets being met, there will be virtually no need for any new thermal based power plant until 2022 (barring the plants already in the pipeline). It may not be far-fetched to presume, that in the above scenario, even in the following years, the growth of renewable power may sustain and the need for new thermal capacity may be marginal. In this uncertain environment, investor sentiment in fossil-based power generation has unsurprisingly become subdued. A below 60% PLF in the thermal sector, with a number of plants (both coal-and gas-based) being stranded due to lack of fuel-linkages or absence of PPAs, has also contributed to the negative sentiment. The lack of power demand has multiple causes, and UDAY is expected to be a game-changer. On an optimistic note, despite UDAY and even if sluggish power demand were a transient feature, the massive growth in renewables is likely to exacerbate the situation for fossil technologies. Those in the business of power have sat up, and are wondering about the future of power generation technologies. Bankers, who will play a critical role in investments being realized, have already become reluctant.

Some adjustment in the conventional energy sector has begun. There is now a move to make coal-based plants ‘flexible’ so that they can balance the variable renewable power. If this were to happen, coal-based generation will receive a boost. While gas-based generation is often touted as a necessary accompaniment to wind and solar power, the example of Germany suggests that even coal-based power can play this role.

An interesting feature of the two technologies discussed here—EV and renewable power—is their working in tandem to displace fossil fuels related investments. We have discussed how EV will reduce the demand for liquid transport fuels, by substituting them with electricity. In turn, the electricity to drive EV will come increasingly from renewable sources. Over time, as EV policies and related power market develops, there will be greater clarity. As of now, there is an acceptance that ‘time-of-day’ power tariffs will support renewables by offering cheaper power for charging EV in the day when solar power is available. This underscores the argument that new technologies are now active in the market space as well, and are impacting conventional sources of power.

Additionally, the emergence of renewable technologies has also adversely impacted demand for gas by displacing it in power generation. Coal-based power plants are going in for retrofits to serve as balancing units for renewables. The net impact on new gas demand has been negative (at least in the West where gas-based power generation is preferred over coal). Even for balancing variable renewable power, a number of technologies are available which will pose a challenge to gas as their prices fall over time. Batteries are an example, which are a superior option over gas, but are presently not price competitive.

In India, public sector undertakings (PSUs) are active in the energy domain, and are often expected to fill the gap in investments. A conscious and careful consideration will be required before they get ‘locked-into’ large investments. The power and petroleum sector PSUs need to factor-in the rapid advances being made in clean energy in other parts of the world, also on the merit of better financials. In India, at the moment, the financials may not be entirely in their favour, but there will be alignment with global markets in due course. Many provinces of Germany are already integrating more than 50% renewable electricity in the grid, also supported by ‘flexible’ coal-based power. Small automobile markets like Netherlands and Norway are among the world’s 4 largest EV markets (China is the leader). India also aims to give a boost to it. The planned financial returns can only be realized if the assets can be productively operated for their entire productive life. Early retirements can upset plans. In a rapidly evolving technological and commercial scenario, energy sector ‘lock-ins’ demand a careful consideration.

The fact is that renewable power technologies have arrived, and are already challenging the domination of fossil-based power generation. In a country hitherto dominated by conventional energy supplies, this brings challenges and opportunities. Ultimately, the laws of the market, consumer preferences and government policy will determine the outlook for investment. Investors in the energy domain need to be nimble and innovative in their decisions to succeed.

Disclaimer: NITI blogs do not represent the views of either the Government of India or NITI Aayog. They are intended to stimulate healthy debate and deliberation.