Climate Change

Sunshine Hotels and Trillion Dollar Bubbles

By: Chandu Visweswariah

Editor’s note: this blog marks the 50th piece contributed by Croton100 in this series since Croton100 was launched on “Leap into the Future Day,” February 29, 2020.

If you own a mutual fund or retirement account, this might be a good time to make sure you are not investing in stranded assets. Otherwise, you could be the victim of a huge and growing financial bubble.

Imagine you have an option to invest in a new property called “Hotel Conventional” in a promising location. The developer tells you that over the next 30 years, you will have 85% occupancy. You add up the total cost of building and running the hotel and decide that the “levelized” (or average) cost for you to operate the hotel is $40 per room per night.

All that looks promising, but there’s a fly in the ointment. Across the street is Hotel Sunshine. Like you, they offer clean sheets and good service, but their break-even is $20 per room per night, and is predicted to go even lower. Lower occupancy due to this competition would mean either higher prices or lower return on investment. The immediate realization is that on an average day, Sunshine will get business and you won’t. During holidays and the peak tourist season, the only way you will get 85% occupancy is if Hotel Sunshine is full. What is more, there’s a new Hotel Wind planned down the street, and both of them are national chains.

Thus, your Hotel Conventional will only be useful as an overflow or “peaker” hotel, and therefore the 85% occupancy assumption used to justify your initial investment will not be met. There will be just two choices: either operate the hotel at a steep loss (which is unsustainable) or struggle along at lower occupancy (which also won’t pay the bills). The valuation of Hotel Conventional, in reality, is therefore nowhere near the valuation on the books that was used to justify investment – this is the classic definition of a financial bubble, especially if over a trillion dollars were spent in investments like Hotel Conventional in the last decade.

You’re thinking, “Why am I being strung along? What do hypothetical hotels have to do with my retirement account?” Here’s the point: conventional electricity production plants like nuclear, coal, gas and hydro are being disrupted just like Hotel Conventional in our parable. Solar and wind energy have zero incremental cost to produce a unit of energy – the “fuel” (sunshine or wind) is free. Hence whenever there’s demand for a unit of electricity, if solar or wind can supply it, renewables will win because of the lower cost. Thus, conventional sources of energy will increasingly be relegated to “peaker” status – i.e., occasional use during periods of peak overflow demand. As I wrote in previous blogs here and here, 100% Solar, Wind and Battery (SWB) systems with rapidly declining costs will completely disrupt our electricity grids with cheap, abundant “super power.”

Hence, the capacity factor (or productive utilization) of conventional power plants will plummet, leaving behind stranded assets. Ratepayers, shareholders, mutual fund investors, pension fund subscribers and retirement fund holders will be left holding the bag.

The evidence is laid out in a recent report analyzing energy markets called “The Great Stranding: How Inaccurate Mainstream LCOE Estimates are Creating a Trillion-Dollar Bubble in Conventional Energy Assets,” by Tony Seba and Adam Dorr from the think tank RethinkX.  LCOE refers to an industry term, Levelized Cost of Energy, which is simply the total cost of building and operating a power plant over its lifetime divided by the useful energy produced by the plant.

Disruption of coal in the United States
Shrinking capacity factor of coal in the United States

Let’s take the example of coal power. The plot above on the left shows the rapid decline of coal power in the United States. The grey lines show repeatedly inaccurate projections by the U.S. Energy Information Administration (EIA) while the blue line is the writing on the wall. Consequently, the plot on the right shows the capacity factor (equivalent of occupancy in our hotel analogy) for coal power. The blue line is an astonishingly coal-centric projection by EIA, while the green line is more realistic – and neither justifies an 85% capacity factor assumed when the plants are built. In fact, some gas plants are being built today assuming capacity factors into the 2040s that aren’t even prevalent today! Much more realistic is the complete collapse of coal power in this decade, as has already happened in the UK. It is no surprise that the Dow Jones U.S. Coal Index fell from a high of 500 in 2011 to less than 5 in 2020 and was quietly discontinued by S&P Global!

As a result, electricity from coal will be uncompetitive by at least a factor of 20 compared to solar and wind by 2030. Unfortunately, this is true for all conventional electricity sources: coal, nuclear, gas and hydroelectricity. In all cases, by the end of the decade, energy from these sources will be completely uncompetitive. Thus, they will serve as “backup generators” at best, be used increasingly less often, and therefore end up being stranded assets. The cost per unit of energy will be so high that they will be unable to compete with solar and/or wind paired with battery storage.

Let’s circle back to where we started: your investments. Check the ESG (Environmental, Social and Governance) scores of all your investments and divest any conventional electricity investments before this bubble bursts!

At the same time, for all the environmentalists out there, there is some really good news in this report. The advent of Solar, Wind, Battery (SWB) systems and “super power” will reduce the cost of electricity and completely disrupt conventional energy sources. What this means is that decarbonization is possible at a much more rapid pace than thought possible or predicted by agencies like the EIA, and we can look forward to a carbon-free electricity grid by 2030. At the same time, non-carbon energy sources like nuclear and hydro may also fall victims to these powerful disruptive forces.

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