Are the oil majors having to come to terms with the dawning of solar power and what should investors do?

16th April 2014

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The sun’s been shining these past few days. But that’s nothing compared with the amount of hot stuff shining upon power from the sun. So forget fossil fuels and fracking, and wave away wind power writes Tony Levene. The big game in town is solar energy – and this month alone has seen two major reports boosting this particular renewable and putting non-renewables into the shade.

Investors in oil giants need not worry – yet. They will be around as income plays – see later on – for many years. And many will adapt to changing circumstances just as big tobacco has learned to deal with health legislation. Some are already making tacit forays into solar.

The eclipse of fossil fuels could happen within a generation. For those who gainsay this prediction, would anyone witnessing the battles between Thatcher and the coal miners thirty years ago have predicted that the UK coal industry would now have shrunk to a government subsidised pit or two with no more than a couple of thousand employed in the industry?

Geo-political implications

The move to a solar powered world must impact on climate change. But shorter term, it has huge investment and, even more important, geo-political implications. And it indicates how the necessity to cut reliance on fossil fuels, and the relatively few – often unstable or otherwise politically undesirable – countries that supply them, is the mother of invention. Investors with a long memory will recall how the quadrupling of the oil price in 1974 brought the concept of fuel economy to United States roads. Out went the gas guzzlers and in came compact cars – with the unexpected consequence of more auto imports into North America and the eventual demise of Detroit.

Consultants back solar

McKinsey, who are international management consultants and not some far out climate cause, published a report earlier this month headed “The disruptive potential of solar power

In it, authors David Frankel, Kenneth Ostrowski, and Dickon Pinner argue that the economics of solar power are improving – and fast.

They say:”It is a far more cost-competitive power source today than it was in the mid-2000s, when installations and manufacturing were taking off, subsidies were generous, and investors were piling in. Consumption continued rising even as the MAC Global Solar Energy Index fell by 50 percent between 2011 and the end of 2013, a period when dozens of solar companies went bankrupt, shut down, or changed hands at fire-sale prices.

“The bottom line: the financial crisis, cheap natural gas, subsidy cuts by cash-strapped governments, and a flood of imports from Chinese solar-panel manufacturers have profoundly challenged the industry’s short-term performance. But they haven’t undermined its potential; indeed, global installations have continued to rise—by over 50 percent a year, on average, since 2006. The industry is poised to assume a bigger role in global energy markets; as it evolves, its impact on businesses and consumers will be significant and widespread. Utilities will probably be the first, but far from the only, major sector to feel solar’s disruptive potential.”

Prices for solar photovoltaic technology (PV) – our current best method of harnessing power from the sun although probably still at the early steam engine phase – have nearly halved over the past five years, according to McKinsey. They will probably continue this downward path, with overall costs forecast to fall again some two thirds by 2020.

This will give solar “grid parity” with fossil and nuclear fuels – and that’s before counting carbon costs or fretting about decommissioning bills. US supermarket group Walmart has done the sums – it expects to move to 100% solar by 2020 – compared with 20% now.

Who will build fossil fuel generation?

No one expects a solar-dependent world by then. But economics is all about margins – it’s the last person taking up or the first person dropping that count. Solar will still be a smallish component in total energy in a decade’s time. But that does not diminish the effect it will have on decisions to build (or demolish) coal, gas and nuclear facilities. It will also reduce the geo-political and economic power of Saudi Arabia, Nigeria and Russia. These all expect, and plan their economies on, oil prices at $100 or upwards. Brent Oil is currently trading around $109, pushed upwards by Ukraine disruption. Longer term, as oil prices are marginal, even a small fall in demand will dent values.

The oil companies have known this for a time. But previously, they denied it, just as tobacco companies refused to admit the link to cancer. In 2009, Exxon alone, for instance, spent more lobbying against US clean energy and climate change legislation than all of those in favour. BP ditched its Beyond Petroleum mantra – but that was a panic and there are signs it will have to return to it..

Shell has – cautiously – embraced solar power. Its latest New Lens report states that solar will pre-dominate by 2100. While the Shell report predicts that oil prices will continue to rise, it fears they will become “too volatile for investors and corporations. The fracking boom will peter out yielding less gas than expected, and governments will promote clean energy-friendly policies.  Rooftop or community arrays – distributed solar – will see a boom, it forecasts.

It adds: “These conditions favour distributed solar pv becoming a leading source of primary energy in the global economy,” the report claims. “From its position today as the 13th largest energy source worldwide, it grows rapidly, reaching fourth place behind oil, gas, and coal by 2040, and continuing to the number one position in 2100.”

Wall Street favours PV

US stockbrokers Sanford Bernstein reported last week that “more solar has been installed in the US in the past 18 months than in the previous 30 years.” It suggests a “new era of global energy price deflation” that will erode the viability of fossil fuel over time. It adds: “Eventually solar will become so large that there will be consequences everywhere”, an overturning of accepted energy policies and their place in the world political and economic order that could “take place within a decade”.

This will bring technological changes into areas such as storage batteries, and PV plant management.

BP upgraded to a “buy”

Oil and power generation companies that react positively to these changes will prosper while but in the short term, holding these stocks as income plays should continue to work well.

Energy giant BP Plc has just been upgraded by Canadian brokers and wealth managers Canaccord from a hold to a buy. They cite the near 5% dividend yield on this blue chip income favourite with perhaps a 13% share price upside over the next year.

It says: “The market is [still] putting too much weight into the litigation surrounding the 2010 Deepwater Horizon oil spill. There is a compelling valuation argument based on BP’s free cash flow generation potential.”

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