"So, so you think you can tell, Heaven from Hell?" The album, Wish You Were Here, was not well received by critics during its release in 1975. Eventually, it became regarded as one of the best Pink Floyd Albums of all time. While not the top-selling album for the band, it was a project that returned significant capital and thus worthy in both the hearts and pocketbooks. While most of us are so quick to judge, before you do, contemplate how history will measure the current energy transition and the players making it happen.
The traditional energy companies are leading and driving the transition to a cleaner world as measured by invested capital. There are other sources of capital, a lot of it, pouring into this space; however, no one is approaching it as holistically as the traditional energy players. And isn't capital deployed the ultimate measurement of commitment? At the beginning of any new movement, invested capital ("skin in the game") is the measuring stick over any conjecture; however, in the long run, only return on that capital matters. Do we need to review? The transition is not simple. Many have jumped in too early and destroyed significant value for its investors and as a result for the rest of its stakeholders.
[Side Note #1: I am focusing on the role that business plays in participating in the energy transition. There are other stakeholders including governments, society, the environment itself, consumers, investors, etc. We can address them in separate notes; however, no one stakeholder can make the market.]
[Side Note #2: I am assuming that long-term focused shareholders are the most important stakeholders. As Warren Buffett writes in his 1996 letter to investors: “If you aren’t willing to own a stock for ten years, don’t even think about owning it for ten minutes." The energy transition will last much longer than 10 years...and the great debate is not if but when and is now the time. And for those that are building out new energy infrastructure will depend upon long-term investors to succeed. But long-term investors expect long-term profits in exchange. And even the Oracle of Omaha, one of the greatest investors of our lifetime, has taken a huge loss in energy.]
[Side Note #3: Why are investors the most important stakeholder? Let me explain. There is nothing new about treating all of your stakeholders well and the debate on who matters most: Investors, Customers, Employees, Suppliers, Communities, and the Environment. As a fellow "conscious capitalist", let's revisit one of my personal favorite company examples, Whole Foods, that put others ahead of its owners only to find that this led to long-term shareholder value destruction. Whole Foods became an easy target for both activist investors and more nimble competitors. I am with Milton Friedman on this: in a free society, "the social responsibility of business is to increase profits as long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud." Milton makes a few points that are important to discuss. First, "the difficulty of social responsibility illustrates the great virtue of private competitive enterprise - it forces people to be responsible for their own actions and makes it difficult for them to 'exploit' other people for either selfish or unselfish purposes." Milton explains that if an executive in the name of social responsibility reduces returns to shareholders, he/she is spending investor's money to do this. If the executive reduces wages to its employees as a tax for a socially responsible program, he/she is exploiting the employees' money, etc.. He also states that "in a free society, it is hard for 'good' people to do 'good' but that is a small price to pay for making it hard for 'evil' people to do 'evil,' especially since one man's good is another's evil." When an executive spends a private enterprise's profits on social responsibility (defined as anything not benefiting/increasing the profits of the enterprise over the long run), he/she gets fired. If you disagree on this assumption, let's take it to LinkedIn and bring data, no prattling please.]
[Side Note #4: for those of you that want to discuss The Business Roundtable's new rhetoric on deviating from the long-held belief that shareholders come first, let's take it to LinkedIn. Hype, Nirvana, Politics, Positioning?]
Back on track...This is the great debate the world has found itself regarding the energy transition. Is now the time? Will these new investments land on the right side of history? There are real challenges that many ignore, most do not want to understand, and only a few trying to solve.
For most people, clean energy and traditional energy seem like sworn enemies. The former represents the wave of the future drawing on renewable elements, while the latter focuses on the limited fossil fuels. They're like General Antonio López de Santa Anna and General Sam Houston, Bordeaux and Napa, Real Madrid and Barcelona... at least in the minds of most people. However, traditional energy companies have existing customers and investors asking for "low-calorie" solutions, see that new energy projects have the potential to return cash at or better than other investments, understand the global societal pressures, and have real people inside that live and work in the world pushing for a better way. These are a few reasons why so many traditional energy companies are trying to step from where they are to where many of us want to be.
What is Happening Now to Drive This Investment and Cautious Optimism?
There is some good news and not so good news. While clean seems to be the ambition for the majority of the world (and the right thing to say in the court of public opinion), there are real challenges driving this transition and simultaneously growing the existing hydrocarbon-based energy mix:
- Growing Population: Global population is expected to increase from around 7.4 billion today to nearly 10 billion by 2050. Over 2/3 will be living in cities. Imagine how the planet can sustain a city the size of Austin, Texas (pop ~1M), the live music capital of the world, home of the best BBQ, and my favorite college 'American' football team, popping up every week for the next 30 years.
- Rising Demand: As the population grows, global energy demand is expected to increase along with it. Some forecasts show demand growing 60% or higher by 2060 including the growth in the number of vehicles on the road from 800 million today to over 2 billion.
- Ongoing Supply: Renewable energy could triple by this same time period; however, the world will still need large amounts of oil and gas to provide the full range of energy products that the world needs if these first two bullets play out. "Wood Mackenzie forecasts that coal, oil and gas will still contribute about 85 percent of global primary energy supply by 2040." And do not forget the ~ 16% of the world that has little to no access to electricity. They need energy too, right?
- Driving Zet-Zero Emissions: even with these quantitative challenges above, net-zero emissions is a potentially achievable societal ambition (this is becoming a very active investment area from the energy-focused venture capital community).
Providing abundant, clean, and reliable energy to the world is complicated.
Excuse Me, Do You Have Something Cleaner and Lower Calorie?
As consumer preferences and tastes evolved from sugar and corn-sweetened drinks to low and no-calorie ones (and public concern about rising healthcare costs), the big consumer beverage companies went on a buying spree and R&D binge to meet the world's demands. As I was heading into making a living off of the future of energy technology, entrepreneurs that started a cool sweet tea company in Austin were working on being acquired by a large traditional incumbent that needed to get into healthier drinks. Energy companies are following the same playbook. Customers are asking for cleaner and lower-calorie solutions. And unlike beverages where consumers are willing to pay 50% more for cleaner solutions (i.e. a 1.25L of coca-cola costs $0.99, a 1.0L of smart water, also a Coca-Cola Company, costs $1.48 = 50% increase in cost), most people will only pay a very small premium (if any) for sustainability. Energy is more complicated due to the scale and time to build out infrastructure as well as having products that serve industry sectors like industrial (need high-energy dense fuels to create steel) and transportation (marine, aviation, road). This sophisticated narrative on why clean energy cannot scale quickly enough nor solve all of the technical challenges required to compete against fossil fuels does not fit within the standard 40 character limit that most of us use for news these days.
Perhaps the most basic reason that so many traditional energy companies are spending time, resources, and energy into research, development, deployment, and venture capital investing into green energy solutions is that, as The Motley Fool points out, they're well aware of how the winds of change have begun to blow. As I have written before, being early is equivalent to being wrong (or in Milton's language, using profits to fund social responsibility projects does not work). Today, we are witnessing the industry stepping up its investment signaling that the business model might be ready (transitioning from social responsibility to profit-seeking). This is good news. We are seeing that there is a great gold rush to be the first company to lock down new forms of producing and providing energy. Society needs energy. And so does your iPhone, Apple Watch, Tablet, Laptop, and now your electric vehicle...we are dependent upon energy...that is reliable and abundant. Right?
Exploring and producing oil & gas is not easy. As the world demand for energy increases (see above), the energy companies must go into more remote and difficult geographies and geologies. Many green energy solutions are not tied down to a particular area. Solar power, wind power, and waste that produces renewable fuels can be harvested all over the globe. This allows for companies with enough capital to build and support facilities near the areas they are going to provide energy for, cutting down on transportation costs and allowing the provider to serve their market directly. You thought the local food movement was a sustainable idea, wait until new energy platforms emerge enabling the ability for all of us to source, store, use, and sell clean energy all at the local level.
Permanent business platforms require permanent solutions, and no one is under the impression that fossil fuels will be the answer in perpetuity. Yes, some probably do believe this; however, I also live in Nantucket and am reminded often that it was the original oil capital of the world, whale oil. The whale oil industry reached its peak between 1845 - 1855. In 1859, the first oil well was drilled in Pennsylvania. The rest is history. Can you imagine what happened to the financiers that backed the last new whaling ships in the late 1850s? I guess being late is also equivalent to being wrong.
The switch from whale oil to petroleum was almost overnight. While I do not foresee this happening due to the challenges mentioned above and the mathematical impossibilities (if we want to keep the same or better standard of living), there is an energy transition happening and it is the traditional energy companies leading the way due to investor interest, know-how, scale, balance sheet, passion, ability to operate globally, and understanding of the entire value chain.
Changes in Price Accelerate Investment
One of the biggest barriers to entry in the past for low-carbon energy was just how expensive it tended to be. It was seen as a niche market — something that only the wealthy and elite could afford to partake in. However, as Forbes points out, clean energy is already at parity or cheaper than existing forms of fossil fuels. It should be noted, though, that as more and more sectors, pension funds, and companies (not to mention nations) invest in green energy, the less expensive it becomes. Obvious, I know, but also forces us to ask why it hasn't happened until now? Back to Milton Friedman: "In a free-enterprise, private-property system, a corporate executive is an employee of the owners of the business." No matter the pressures of society, employees, governments, and other stakeholders to force change, management is at the mercy of its owners. And owners are asking: show me the money!
Solar power has been around for decades, but it was a relatively small market until fairly recently. Now, after countries like Germany, China, India, and others have spent years investing in (and refining) the technology, it's become much more commercially viable. Making these sources of power cheaper, though, also makes them more profitable for those willing to invest in them. If a solar plant is cheaper to build and maintain than a coal power plant, and it doesn't have the same environmental regulations, then it's clearly a better investment for a company that wants to maximize profits. The two projects would both produce the same product, but one of them harvests it out of thin air. It divorces itself entirely from the requirements of the mining industry, reduces the impact on the environment (a critical stakeholder), and the need for a limited fuel source. In other words, all stakeholders benefit more, an economist's dream.
The challenge for an energy company is making sure the new investment produces better returns than existing ones. I know. I am back to the whole money thing...but what do you think pays for your salary (so that you can make a downpayment on that model 3), dividends to pay for my grandmother's livelihood, tax revenues spent by governments to pay for many of those subsidized programs, and grants given to research teams and labs to come up with new and better alternatives?
Which Companies Are Investing in Green Energy?
While it's clear to see that clean energy has strong momentum as cash, regulations, and society leans in, the question most people ask is which traditional energy companies are investing their capital toward research, implementation, and discovery of new means and methods.
The answer to that varies nearly day-by-day as the profit-seekers learn from projects on where the margin pools are moving in these massively complicated and evolving energy markets, but there have been some notable entries on the list. According to Bloomberg, a few of the European-based energy companies are leading the way (FULL DISCLOSURE: I currently work for one of them as part of the Corporate Venture Capital team).
Projects and investments include everything from the well known renewable energy sources, to hydrogen power (which has grown popular in parts of Europe, and has grown significantly cheaper to produce in the last few decades), to biofuels and to alternative sources of producing and storing electricity.
I have spoken to many of you that have a negative opinion of these companies and believe these efforts are not enough or just window dressing. I used to believe this myself. When I was asked to start Dell's first recycling program, I protested since the intent did not seem to be pure. However, my heart realized that the important thing is that in every way, whether from false motives or true if the energy transition is preached, I will rejoice. My mind and wallet also realized that in a free society, businesses must focus on increasing its profits as long as it plays within the rules of the game (open and free competition without deception or fraud).
When I was a young boy, my grandmother gifted me a few energy stocks (both utility stocks and oil & gas stocks). She lived off of the dividends being paid to her by these companies. The big debate today for the industry is if, when, and how much it needs to divert (or slow down the growth of) dividends away from my grandmother to accelerate the energy transition for my sons and daughters. Not easy, right? Amen? Amen. Do you agree?
What Will the Future Bring?
New energy development has been around for over 100 years, as have most of the alternative energy methods we're using today. What's changed is that, as technology and applications advance, these methods grow more efficient and less expensive. And as they become increasingly better investments than traditional energy generation sources, more companies are going to get in on this market. This increased attention (and cash flow) will only lead to improvements in existing methods and technologies, allowing green energy to develop even further as time goes on.
While the demand for green energy is likely to increase as old fuel sources wane in popularity, availability, and political power, no one knows what forms of energy production will dominate the future markets. However, I am willing to make a bet that whale oil is out!
One thing we can all agree on is that the increased research and implementation into alternative energy and fuels is good. It's more likely to create a world where our power comes from harnessing the nature of the cycles in our world, not from a limited resource pulled out of the earth. The light from the sun, the power of the winds, the force of the tides, and even the power of plants to suck in carbon dioxide and exude oxygen and useful materials aren't just scientific curiosities to the engineers of the future. These are the processes that will power the world. And the familiar traditional energy companies are the ones driving it.
The most important question is whether long-term profits can be maximized by jumping into the game now?
How I wish, how I wish you were here
We're just two lost souls
Swimming in a fishbowl
Year after year
Running over the same old ground
And how we found
The same old fears
Wish you were here
For more information on the developments in low-carbon clean energy, and to stay one step ahead of the industry's changing winds, make sure you check back on my homepage and sign up to get automatic updates! And let me hear your point of view.