Does coal have a future?

CNBC viewers may have been surprised to hear NEC Director Gary Cohn say that “at some point in the cycle, coal will be competitive again”.  Really?  After all, such technological innovations as fracking and horizontal drilling caused US oil and gas production to almost double in just one decade, and natural gas to become the fuel of choice for power plants.

Cheap prices for natgas and pollution issues for coal are the big market drivers.  But both could see changes if not outright reversals.

In the US, natural gas prices broadly averaged between $8.8-$4 per Million Btu in the 2000s but dropped to $4.4-$2.7 over the 2010-2015 period.  After touching a low of $1.49 in March 2016, they rebounded above $3 this year.  Logically, such rebound in price benefitted coal: First quarter 2017 electricity generation from coal grew 5% year-on-year.

Pollution is the other key factor.  According to the Energy Administration Agency, in 2016 coal-burning power plants worldwide released around 2 lbs of CO2 per Kwh.  They also released other undesirable gases, metals and particules.  Natgas-fired plants only released 0.8-0.9 lb/Kwh[1].  As the world pushes for lower emissions and countries may tax CO2 at $30-$50/t, coal is handicapped.

But technology is beginning to change that.  High Efficiency-Low Emissions coal-fired plants are already reaching efficiency levels of 45% vs. 33% for conventional ones, and 50% is a realistic goal.  By comparison, state-of-the-art natgas power plants exceed 60%.

Today, the most advanced Japanese combined cycle plants which feed pulverized coal and burn it at very high temperatures achieve emission levels of around 1.5 lbs/Kwh.  By the early 2020s, 1.2-1.3 lbs/Kwh will likely be achieved.  Further out, fitting these plants with Carbon Capture and Storage (CCS) technology could actually transform coal into a clean fuel with CO2 emissions in the 0.2-0.25 lb/Kwh range.  Of course, such technologies will need to be cost effective, and developing them will take time (10 to 15 years).

But coal is the most abundant energy source on earth, and countries such as China, India and South Africa which don’t have much oil, do have a lot of coal.  It is easy to store and to transport.  Coal-fired plants provide cheap energy around the clock, day and night, rain or shine.  From an economic and strategic point of view, it is therefore a very valuable commodity. 

Its pollution characteristics and the great technological advances which benefitted natural gas have pushed it aside (at least in developed countries), but technology and the need to produce more electricity will likely bring it back.

A contrarian investor with a long term view should keep an eye on it.  The interested reader may take the demise of coal with a grain of salt.  Dirty coal is slowly dying, but clean coal will likely rise from its ashes.

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[1]  Depending whether one uses data from developed or emerging economies.

The challenges of renewable energy: solar

Today, Chilean mining giant Antofagasta Minerals announced that it had sold its minority interest in the Javiera photovoltaic solar power plant (though it will continue to off-take electric energy from it).  Looking at the photo provided with the press release, one can’t help reflect on the challenges facing renewable energy sources, solar in this case.

The most obvious is that solar takes a lot of space!

The Javiera plant shown here has an installed capacity of 69.5 MW, yet it covers hundreds of acres.

The largest solar plant to date is in Kamuthi, India; its capacity is 648 MW and it reportedly covers a very tight 10 sq. km (2,470 acres) for a land to capacity ratio of 3.8 acre/MW.  The most efficient large scale one in the US, the 550 MW Topaz Solar Farm, occupies 25 sq. km for a 11.2 ratio.

Concentrated Solar Power (CSP) plants use parabolic mirrors to heat a fluid which then generates steam to drive traditional turbines.  They are more efficient than the photovoltaic types.  Yet even in the most favorable environments they still occupy a lot of ground:  Mojave One with a nameplate capacity of 280 MW covers1,765 acres for a 6.3 ratio.  The ratio is 6.8 at Solana, 15 at Crescent Dunes and 4.5 at SEGS.

In comparison, a 56 MW GE LM6000 combined cycle gas-fired power plant has a much smaller footprint than Javiera, as evidenced by the photo on the left.

Nuclear plants too are far more space efficient.  And they generate a lot of electricity.  The Millstone Nuclear Plant, CT, has a capacity of 2,037 MW on a 500 acre site for a ratio of 0.25 acre/MW.  The ratio is 0.16 at Peach Bottom, PA, and 0.4 at Susquehanna, PA.

Clearly, the desert of Northern Chile is ideal to find ample space for a solar farm, but not all lands are so devoid of potential use.

The second great challenge is capacity utilization.  In the US, nuclear plants produce energy more than 92% of the time.  By contrast, solar photovoltaics average 18% and CSP types can exceed 30%.  Javiera is probably in the mid 20s ballpark given the extremely favorable climate of Northern Chile.  But how many places in the world offer ideal climatic conditions and a ready customer (in the case of Javiera, a copper mining concern)?  Instead, generators in desolated places will need to build hundreds of miles of transmission lines to connect with populated areas.

Finally, there is the cost factor.  A popular methodology is the “levelized cost of electricity” or LCOE whereby initial capital costs, operating costs and fuel costs are combined over the useful life of a generating plant to calculate a lifetime cost of generating a MWh.

In the US, the EIA has the following LCOE estimates for plants entering service in 2020:

(in US$/MWh)	Minimum	Average	Maximum
Solar- photovoltaic	97.8	125.3	193.3
Solar- CSP	174.4	239.7	382.5
Advanced Nuclear	91.8	95.2	101.0
Coal-conventional	87.1	95.1	119.0
Coal-IGCC	106.1	115.7	136.1
Natural gas-advanced	68.6	72.6	81.7

It should be noted that these projections depend on the assumptions made, in particular, the future price of fossil fuels.  Nevertheless, some patterns are apparent:

1.     Natural gas is by far the cheapest fuel for electricity generation,

2.     Solar energy is cheap in places like the Mojave Desert and Arizona because of exceptional climatic conditions, not so elsewhere,

3.     Coal, natgas and nuclear plants costs don’t vary much with location.

However, the above LCOEs are imperfect in two fundamental respects:

1.     They do not include the cost of standby plants for solar, which is substantial since solar capacity utilization averages under 20%, and

2.     They assume that all plants sell their electricity at the same price.  In reality, an intermittent producer like solar doesn’t have the luxury to pick when to sell electricity and could well be stuck with off-peak demand and prices more often than fossil fuel fired power plants.

Still, solar technology has made great progress in the last decade.  It likely will continue to do so.  However, it is crucial for these producers (and the taxpayers) that energy storage technology advance to improve the economics of the system.  Rather than paying out excessive subsidies, the states and the federal government should invest, or encourage more investment, in R&D.

“There you go again…”

Earlier this week, the manifesto of the British Labour  Party was leaked, and it contained some eye-popping revelations, among them, the pledge by its leader Jeremy Corbyn to renationalize British Mail, the railroads and the electric distribution and transmission companies. 

In their early years, newly privatized railroad companies in the UK did have customer and maintenance problems.  But to imagine that public sector status is the panacea takes one’s breath away when there are such glaring examples to the contrary.

Across the Channel, Areva, the French government-controlled nuclear reactor builder, went almost bankrupt and had to be rescued by the state and EDF.  EDF itself, because of government-mandated electricity pricing policies, saw its debts balloon and needed a large capital increase.

But the most graphic demonstration of the damage government meddling brings to national champions is Brazilian giant oil and gas producer, Petrobras.  Until 2005, it was a company famous for its technological excellence in deep water drilling and its ability to navigate the Brazilian political and commercial waters with ease.

All that changed when global oil prices soared, Petrobras made huge offshore discoveries and President Lula decided that the company’ riches should accrue exclusively to Brazil and bankroll his political movement.

In 2010, a $70 billion capital increase[1] and a new Hydrocarbon Law gave the government a very tight hold over the company.  That control pushed Petrobras to the brink: its debts ballooned from $21 billion in 2006 to $132 billion by the end of 2014 through a combination of excessive investments, “diworsification” and corruption[2].  Meanwhile, the company systematically missed its production targets.

The steep fall in oil prices, the discovery of the vast corruption scheme and a change in government forced Petrobras and the state into a hard restructuring.  The results have come quickly for a company of this size, and have left many analysts incredulous;  this was evident in the quarterly conference call this morning.

The company has already shed $13 billion worth of assets, cut its workforce by 17%, and reduced its annual capex by close to $10 billion.  Crucially, while its capex used to far exceed its operating cash flows, Petrobras is now looking to generate free cash flows of over $14 billion this year and next.

In France, Emmanuel Macron has been less sanguine about nuclear energy than his opponent François Fillon, but it is fair to expect that he will not want to pony up billions into Areva and EDF.

Mr. Corbyn’s manisfesto is unlikely to come to fruition, but it is amazing that the lure of nationalization remains so strong for educated people who should know better.  But when a politician wants to change society rather than making it better (whatever this means), sound economics rarely stand in the way.

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[1]  Actually the exercise was not as successful as the government expected as the Brazilian state did not win a 2/3 majority as a result.  While minority investors contributed cash, the state contributed rights to produce deep offshore oil.  In itself, this capitalization was a model of bad governance.

[2]  The cumulative amount of the bribes was not in itself life threatening, but the massive cost overruns and uneconomic projects that corruption allowed clearly was.

First thoughts on Emmanuel Macron’s election

Emmanuel Macron was elected today president of France.  While this didn’t surprise anybody, a few observations are in order.

The margin of victory, 65.2% to 34.8% for Marine Le Pen, is wider than even the most optimistic estimates made just after the first round (see previous post).  I have little doubt that the debate of May 3^rd accounted for most of this shift.  Le Pen’s behavior and tactics were so awful as to turn off many uncommitted voters.

Le Pen still scored the most votes and the highest electoral percentage that the Front National ever got in a national election.  She succeeded in attracting some votes from the Extreme Left and from the Right.  But more than an endorsement of her leadership, this reflects the deep frustrations and the anger felt by a large minority of the population.

Faced with a choice between anger and gradual change, abstentions (at around one in four) were 25% higher than normal[1].  Blank votes[2], at an estimated 12%, were two and a half times the 5.4% average of the last twenty two years.  In all, compared to historical trends, an extra one in seven voters refrained from expressing a choice.

It would be easy to show that only half of the registered voters chose Macron[3] while the other voted against him or not at all.  That would be overly pessimistic.  He has three big things working for him:

One is momentum and the fact that, with the possible exception of Les Republicains[4], the political opposition is both fragmented and in disarray.  This should help him score very well at the forthcoming legislative elections in June.

The other is that he has read the political scene and the French population better than anybody.  It is easy to forget that, when he announced that he would run without the support of any established party, he was laughed at by almost everybody[5].  This probably explains why his program seems so gradual, some will say timid:  the French want change but are not ready yet to pay the price for it. 

Last but not least, Macron seems ready to depart from his predecessors in one very significant way.  He seems willing to spend the time to explain his policies to people, in simple terms, again and again.  This is something that US audiences are familiar with (think of Reagan or Obama), but it is a novelty for the French.

After five years of hectic buzz under Sarkozy and five years of frustrating stagnation under Hollande, France is about to try a new approach.  I think that Macron is best suited for it.  In his speech to his supporters tonight, he repeatedly stressed how “immense” the task ahead will be, implying but not expounding to his audience its inevitable costs.  He acknowledged the frustrations that led people to vote for extremism, promising to address the underlying issues.  Finally, earlier in the week, he stated that he would seek to reform the European Union failing which extremism in France would win.  Echos of de Gaulle famous “Je vous ai compris”[6]?

The French want change, but what change and at what price, this remains unclear.  Macron seems to have grasped this situation and offered a palatable way forward.  One of his biggest challenges will be to convince voters on the Left to accept more economic liberalism and to convince voters on the Right to give the European Union another chance.  Both Left and Right will be unforgiving as far as security is concerned.

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[1]  Abstention rates at presidential elections have been trending up over the last 40 years.  Except for an abnormal 31.1% in 1969, they rose from the mid-teens in the ‘60s, ‘70s and ‘80s to around 20% since 1995.

[2]  First estimate for blank votes is 12%.

[3]  65.2% x 0.75=48.9%.

[4]  Fillon and Sarkozy’s party.

[5]  I didn’t think he stood a chance.

[6]  I heard you.

The world most exclusive club?

The world of golf was shaken to its core yesterday when Prescott Bullnose, a prominent businessman from Raleigh NC, announced that he would quit the famous Augusta National Golf Club on the pretext that “he was fed up with the sadistic juxtaposition of blooming magnolias and slippery bentgrass greens”.  Members also recalled that he had complained repeatedly about the sour béchamel sauce in the eggs Benedict served at the club restaurant, and about the lack of response from the chef who famously cracked that he “answered to higher authorities”.

Lamartine Talmadge, the acting club president and mayor of nearby Lumenville, didn’t mince his words: ”Nobody walks away like that from the greatest golf club in the world! Nobody! All y’all mark my words, that dog won’t hunt! Now, I declare we will teach this man a lesson!”

Whereupon Talmadge mentally added the money that he could shake from Bullnose, his share of the next three years of clubhouse maintenance, the projected redesign of the eight, tenth and thirteenth holes, the expansion of the press room and the resurfacing of Route 28 from the Berckmans intersection:” no less than $1 million he owes us, no less!”

“Darn it…God!” The mayor howled in pain; he had smacked his hand on his desk and pierced his palm with a brass tack.  That got him angrier still:” Nobody skedaddles out of this club to live the happy life, and least of all this high cotton feller!  No siree, he ain’t gonna grin like a possum eatin’ a sweet tater when I’m done with him.”

Now, there is no Prescott Bullnose at Augusta National, the béchamel there is likely superb, and even if it were not, surely, it is most unlikely that it would cause a member to walk out from one of the world’s most sought after golf clubs.  A switch to pancakes or waffles would make more sense.  

Save for personal or financial reasons, nobody quits great clubs, unless these clubs fail massively in the services offered.  There is no need to threaten retribution for exiting members as many more applicants are waiting to get in, possibly willing to pay higher fees for the privilege.    

So when the UK decides to exit the European Union whose member countries then try their hardest to make that exit as painful as possible, and when the president of the European Commission behaves badly with the UK prime minister, alarm bells should be ringing.

A small majority of Britons judged that membership in the EU carried no net benefit.  A large minority of Dutch and French people agree.  Indeed, pro-Europe candidate Emmanuel Macron recently declared that, if elected, reforming the Union would be one of his priorities and that failure to do so could trigger Frexit (exit by France).

Club Europe is in crisis.  As often in such circumstances, the reaction from the top is denial, fear and punishment of the critics.  No doubt that one more exit from the EU by a core member would be lethal.  Change is as inevitable as it is necessary.  Would it entail a “two-speed” structure?  A more decentralized government?  Effective enforceability of sanctions against non-conforming members?

There is time to reflect on all of this.  EU members must also realize that the UK could counter their excessive demands by threatening to simply break away and rely on WTO provisions; this would be even more damaging to their goals of keeping everybody in line.

Pressure is mounting.  The clubhouse is growing restive.  Core member France might well be the ideal one to promote domestic as well as union-wide reforms, offering to reduce spending in exchange for Germany to move in the opposite direction.   2017 will be interesting.

Update on the quest for the Graal

As we get closer to the second round of the presidential elections, the deep divisions within the population and the political parties are getting starker. 

-         -  55% of the population voted neither for Macron nor for Le Pen; what will they do on May 10[1]? 

-         -  Traditional parties and their candidates gathered just 27% of the votes; how will they rebuild, starting with these elections?

-         -  84% of the French were unhappy with the Hollande government and presumably wanted change, but for many Le Pen offers too much and Macron not enough.

The above 55% have a choice: pick another candidate or abstain.  It is always difficult for a losing candidate to recommend that his supporters vote for somebody else, unless of course this helps him advance (or save) his career.

So far, this reluctance combined with voters’ ambivalence about the remaining candidates has led to a rise in abstention expectations for the second round.

Melanchon refuses to endorse either Macron or Le Pen while Dupont Aignan is rallying Le Pen.  The most recent polls indicate that 28% of Fillon’s, 45% of Melanchon’s, and 29% of the Hamon’s voters intend to abstain.

At present, Macron is currently holding to a greater percentage of left-wing voters (40% of Melanchon’s) than Le Pen is to Fillon’s (29%).  Combined with the above abstention levels, this makes Macron difficult to beat. 

If we assume that those who voted for the outliers (Poutou, Asselineau, Arthaud[2]) will vote for Le Pen, then the second round should yield a 59%-41% victory for Macron[3].

This clear margin of victory is not rock solid, for several reasons:

-         - Besides his 24%, Macron needs votes from Les Républicains (which probably views him as too soft and linked to the cabale which plotted the fatal attack on its champion, Fillon), from the revolutionary Left (which has even less in common with him) and from the socialists (who have nowhere else to go if they want to salvage a future, but who probably feel betrayed).  In other words, Macron needs the votes of people who don’t share much with him except a dislike of Le Pen. 

-         -  He is not a seasoned campaigner, he doesn’t work a crowd like Marine Le Pen and yes, he is very young and it shows at times. 

-         -  The May 3 debate with Le Pen will be a high stake one.  If he loses 4% of the Fillon votes to her, and if she convinces half of the Melanchon voters tempted by abstention to vote for her, she wins by the narrowest of margin.   

-        -   Even if he were to squeeze by, he needs a clear victory to herd the parliamentary cats into a working coalition.

    The election is Macron to lose, he shouldn’t, but he could.

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[1]  Date of the second round of the presidential elections.

[2]  Representing respectively the New Anticapitalist Party, the Republican Union and Workers’ Struggle).

[3]  We also use the same polls'estimates of how Macron and Le Pen will win over supporters of the candidates who lost in the first round.

The Leap of Faith

In the movie Indiana Jones and the Last Crusade, the hero must cross an abyss, but the only way across is a stone bridge which will materialize after he takes a step forward on faith alone.

With the first round victory of Emmanuel Macron yesterday, global financial markets seem to have taken such a step.  To a lesser extent, so have French voters.

However, let us consider a few sobering facts:

1)- Four candidates scored within a few  points of each other [24% - 21.3% -20% - 19.6%], highlighting how divided the country’s political system really is;

2)- Populist/Demagogic candidates gathered 41% of the votes.  The score rises to 47% if we include leftwing socialists; this is hardly the basis for liberal reforms;

3)- Most Macron voters would be hard-pressed to summarize the key themes of his platform.  Rather, they rejected the other options as too extreme (Le Pen, Melanchon) or discredited (Hamon as the standard bearer of the Socialist Party, Fillon with his wife’s controversial parliamentary job).

Fillon and Hamon have already announced that they will vote for Macron in the second round and encouraged their followers to do so.  Presumably, most of the supporters of Dupont-Aignan (a gaullist-type candidate who got 4.7% and finished 6^th) will do likewise. That would give Macron 55%.  Le Pen’s voters are likely to stick with her.  Melanchon’s will either abstain or vote Le Pen.  Another 4% of votes earned by minor candidates will either join the top two contenders in roughly equal proportions or stay home.

While Macron should win, abstentions will play a key role: they could make the race very tight if Les Republicains (LR, Fillon’s party) voters stay home or a blow out if Melanchon’s abstain.  A back of the envelop estimate gives Macron a likely 57/43 victory, but the score could vary from 51/49[1] to 63/47[2] depending on abstentions.

Then what?

The new president will need a majority in Parliament to work with.  Macron has launched his own party, En Marche, which will field its own candidates at the June legislative elections. 

How many seats can it win?  Will it absorb former socialist deputies?  Probably as the socialists are in disarray and lack an obvious leader.  It will be harder with centrists as François Bayrou, president of the MoDem[3] and the earliest major supporter of Macron, will want to protect his power base.  Some LR bigwigs rallied Macron before the first round, and the party needs to find a new leader (always an excruciating challenge), but I expect it to fight to preserve its own identity.

As always, the Front National of Marine Le Pen will have trouble translating its 20%+ electoral support into seats in Parliament.  This should favor Macron who has momentum as well as Melanchon’s Parti de Gauche (Left Party) for whom it will also be the first solo legislative election. 

Fillon’s program was clear, to some extent radical, and easy to understand.  It also called for sacrifices in order to reform France.  Melanchon’s fascination with socialism Venezuelan-style was toxic, but the man was a great entertainer.  Le Pen’s economics were vague and unrealistic but her message on immigration and security resonated with many voters. 

On the other hand, Macron stuck to a middle course, often meandering to avoid controversy.  He has good ideas on immigration, education, the work place, public spending, energy, etc.  They seem calibrated to make the right "buzz" without providing much push-back.  The question is: is it enough to move France forward?  Is it clear enough to mobilize voters and form a governing majority in parliament?

With 47% of the voters opposed to the kind of economic reforms that are necessary for France to recover (49% if outliers are included), the next president’s task will be very tough.  Macron is best positioned to have a go at it, politically speaking.

Given his meteoric rise and political success, Emmanuel Macron should not be underestimated.  So far, he has read the politicians and the voters better than anybody else.  From a US perspective, he is also the best candidate.  All in all, a small leap of faith is probably warranted.

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[1]  If 50% of Les Républicains and of the Dupont-Aignan voters stay home while everybody else shows up as in the first round.

[2]  If 50% of Melanchon’s voters stay home but everybody else shows up to vote.

[3]  The Movement Démocratique, the largest centrist party.