Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Chief Cross-Asset Strategist for Morgan Stanley.
Stephen Byrd: And I'm Stephen Byrd, Head of Morgan Stanley's North American Research for Power and Utilities and Clean Energy.
Sheets: And today on the podcast, we'll be talking about lessons learned from last week's power grid issues in Texas, and implications for the U.S. clean energy transition and markets. It's Thursday, February 25th, at 3:00 p.m. in London.
Byrd: And 10 a.m. in New York.
Sheets: So, Stephen, I wish we could be talking under better circumstances, but as many listeners no doubt heard or experienced firsthand last week saw a terrible winter storm hit much of the country, and Texas was particularly hard hit. So as somebody who spends your day focused on utilities and the challenges that they face, what happened in Texas and what are the unique issues there that you think matter for how energy gets delivered to people?
Byrd: Yes Andrew, it was really a very upsetting situation in Texas, and our heart goes out to Texans impacted by the terrible grid outages last week. So let's talk about what happened and what we know and what we don't know.
Byrd: So starting very early Monday morning, really at the start of the day the power grid operator, was forced to resort to blackouts of parts of the grid because essentially there simply wasn't enough power. Now, to give you a sense of the magnitude of the issues here. So first, on demand. Demand, because of the incredible weather, was much higher than forecasted. About 11 gigawatts above the expected maximum demand that the grid operator would have expected for this time of year. And then in terms of the sort of thermal power plants, this would be nuclear, coal and natural gas, there were close to 30 gigawatts of those plants that tripped offline. And this time of year the grid operator would have expected something more like 14 gigawatts maximum offline due to repairs, due to unforeseen problems. We had a lot more thermal plants offline.
Byrd: And then in terms of wind, the wind output was perhaps 1 to 2 gigawatts lower than expected. So while many wind plants were also frozen, the grid operator had not baked in an expectation of having a lot of wind plants. So we had a number of operational issues hitting all at once. And that caused the grid operator to have to shut down parts of the grid. It was a very upsetting situation.
Sheets: Now, another thing that happened with the Texas power outages is not only where people left without electricity and heat, but then you also saw just some really astronomical increases in power prices. Could you talk a little bit about what caused that? And is there a precedent for power prices rising that much in your experience?
Byrd: Yeah, it's fascinating. In Texas, we have what's called an energy only market, meaning power plants have one source of margin and only one source, which is the sale of power. So the grid operator has a system in Texas where if demand is very close to supply, the price of power goes to very high levels. And you're right, I mean very, very high. Typically, the price of power in Texas might be 10, 20, 30 dollars a megawatt hour. It quickly went up to $9,000, to the cap. That's an unbelievably high number. Now, the design of that is supposed to provide incentives for enough power plants to be around to achieve that very high margin. In practice, what happened in Texas was many plants were not available. They were offline, so they weren't able to achieve that very high power price. As a result, many of those power plant owners are going to face large financial losses.
Byrd: Now, on the other side of the equation, we have retail energy providers that are there to provide customers with power at any time. Now, of course, the challenge for those retail providers, if they were short power, they would have had to have bought power at $9,000 and sold that power to customers at, for example, perhaps, you know, certainly less than $200. So tremendous losses on the retail side as well.
Sheets: So, Stephen, I feel like in the aftermath of this crisis two polar opposite narratives have emerged. You know, one is that this highlights the importance of the transition to clean energy, that we're going to see more climate change going forward. We need to see more investment in the grid, more kind of different sources of energy. And another that actually it's kind of the opposite, that this shows the danger of transitioning to new power sources, to cleaner power sources. So, you know, as you step back. What are you looking at as you think about that debate and what do you think we know and kind of don't know about where that debate stands?
Byrd: Maybe one of the most important questions in my sector, is really charting the future of the industry. And I'd say at a high level, it does look like we do need to adapt to a climate reality that involves much greater weather volatility, greater weather extremes. So I think a lot of what we've learned in Texas is that the physical infrastructure, power plants, gas pipelines, gathering and processing, that equipment was really not designed to withstand the extremes of weather that we saw, but it can be. In many other parts of the United States equipment is weatherized to handle extremely cold weather conditions and hot weather conditions, other extremes as well.
Byrd: I'd say when we come to the question of the growth of renewable energy, you know, I think there are ways to grow renewables while not sacrificing grid reliability. We have many of our utilities that think very, very carefully about this. They take reliability extremely seriously. One example of what's necessary is keeping their natural gas fired power plants operational. There will certainly be times, especially in the winter, when there's very little wind output, very little solar output, and you need those natural gas power plants, you know, plus a certain amount of energy storage to ensure grid reliability.
Byrd: So I think we can achieve a grid transition towards cleaner energy without sacrificing reliability, but we need to do that in a thoughtful way. A lot of what we've learned, though, is really the physical changes needed to ensure that our system can withstand, you know, increasingly volatile weather conditions.
Sheets: And let's talk about that, that green energy transition, because it's safe to say, I think this has been a major theme in the markets. You know, when you think about renewables as a percent of generation at the moment, and kind of where that's going. Could you put some numbers around kind of the scale of the transition that you and your team is thinking about over the coming years.
Byrd: Today, about 13% of our power comes from wind and solar. And we expect that by 2030, that numbers get up to about 40%. So a very dramatic increase. And why are we seeing that increase? It's almost completely driven by economics.
Byrd: In many parts of the United States, either wind or solar or both are cheaper than coal fired generation. And so what we see many of our utilities doing is going to their constituents and laying out this economic case. And I think it's fairly compelling. The argument is we have a coal plant today whose cash operating costs are very high, for example, could be as high as $50 or $60 a megawatt hour. And what we could do is shut down that coal and build wind or solar. And the all in revenue required, for example, for a wind farm could be 10, 15, 20 dollars a megawatt hour. For solar, could be 20, 25, 30 dollars. Far below coal.
Byrd: So that's a win for shareholders because that means greater growth. For consumers that means lower bills. And it also means, of course, lower carbon emissions, good for the planet as well. So that's really a win for all constituents. And that's the primary driver for this incredible growth in renewables we see is the economics. Wind and solar have become very, very cheap in much of the United States.
Sheets: You know, when you think about the companies that you cover, what are the qualities, in a utility that your team is looking for, the qualities of the companies that you're currently overweight relative to the qualities that you're more worried about, or advising investors to be more cautious on.
Byrd: Yeah, Andrew, this is fascinating because I think in days gone by, many investors would have thought of U.S. utilities as fairly homogenous, fairly low risk. And I think that's changing. And we have some of our companies that really are quite low risk and others that are higher risk. And let me walk through some of those criteria. So some of our lower risk, better companies, they have low power bills versus others where the bills have become very high. The problem for companies with very high power bills is they are going to likely lose some of their customers to distributed generation - to solar and fuel cells and batteries. So then the bills go up even faster and that accelerates the desire of utilities to move to a distributed resource away from the utility. Whereas in the Midwest, for example, power bills are very low. The risk of customer loss is also very low.
Byrd: Also, we look for utilities that are located in places of the country where renewables are very cheap. So, for example, the middle third of the U.S. wind is very, very cheap because wind conditions are strong. The bottom third of the U.S. solar's become very cheap, obviously because solar conditions are very strong. If you're in those regions, then you have this opportunity for this win/win where you can shut down coal, build renewables. If you're in the northeast, unfortunately, first, most of the coal is gone. Secondly, incremental renewables are fairly expensive. The differential can be as much as four or five times the cost. So that does not lower customer bills. It doesn't create that virtuous cycle that we see in the Midwest.
Byrd: And then lastly, I'd say increasingly, and in Texas shows this, resilience against the impacts of climate change. So we've seen impacts on the West Coast with the wildfires, in the Gulf States with dramatic storms, flooding. Now, we've seen in Texas extreme cold temperatures and that impacts much of our coastal utilities. Whereas in the Midwest, for example, while there's some risk from climate change, generally the risks are lower. We haven't seen as much extreme damage to the grid as we've seen in other parts of the United States. This is becoming, of all the criteria mentioned, increasingly important to our investors overall and certainly for our ESG investors.
Sheets: Stephen, thanks for taking the time to talk.
Byrd: Great speaking with you, Andrew.
Sheets: And thanks for listening. If you enjoy Thoughts on the Market, please leave us a review on Apple Podcasts and share the podcast with a friend or colleague today.