By Charles Ellinas
Even though natural gas demand is forecast to continue its ascendancy over the next 20 to 30 years, supported by low cost and the drive for cleaner fuels, new evidence shows that it faces challenges from fast penetration of renewables and stubborn coal maintaining its role in power generation, particularly in Asia.
A new market report just released by the International Energy Agency (IEA), Renewables 2017, highlights some of the challenges natural gas faces. Even if renewables cannot yet transform the entire energy business, they are becoming very disruptive in global electricity markets.
This report shows new records for renewable energy, which accounted for two-thirds of all global net electricity capacity growth in 2016 and this is expected to increase further over the next five-years, the forecast period of this report. The cost of solar photovoltaics (PV) and onshore wind is now comparable or even lower than new-built fossil fuel alternatives. This is attracting the interest of emerging economies, which are now looking at renewables as attractive options to sustain their development.
China has now become the undisputed leader in renewable energy. It is also becoming a market leader, creating a strong renewables manufacturing industry that is producing a dramatic reduction in costs. India is also about to overtake the EU in renewable electricity capacity growth for the first time. And despite policy uncertainty, the US remains the second-largest growth market for renewables, driven by federal tax incentives and strong state-level policies.
But the surprise is that in the EU, renewable growth over the forecast period is 40 per cent lower compared with the previous five-year period. Overall, weaker electricity demand and overcapacity remain challenges to growth. The exception is Denmark, which by 2022 is expected to be the world leader, with almost 70 per cent of its electricity generation coming from variable renewables.
The EU and Japan were the only two major economies where renewable capacity additions declined between 2015 and 2016.
However, wind and solar together will represent more than 80 per cent of global renewable capacity growth in the next five years. And as growth of wind and solar accelerates, system integration becomes increasingly important.
While undoubtedly these developments are good news for renewables, the poor relation is natural gas. Net electricity capacity additions from natural gas were the lowest of all fuels in 2016, only half those from coal, and amounting to only 17 per cent of renewable energy capacity additions. In other words, natural gas in power generation is being squeezed by cheap coal and subsidised renewables.
Given that the forecasts in IEA’s report are over a short period, five years, they have a better chance to be accurate in comparison to the long-term scenarios in the BP, EIA and DNV GL Energy Outlooks. For this reason, the IEA forecast impact of renewables on natural in electricity generation merits serious consideration.
As a recent article in the Financial Times states, ‘Renewables are no longer an afterthought in the energy business. They are a growing, competitive sector in their own right, and a source of disruption and risk to the incumbents,’ ie to coal and natural gas.
Solar PV leads the way
The IEA headline is ‘solar leads the charge in another record year for renewables’, with solar capacity growing much faster than any other fuel.
For the first time, solar PV capacity is growing faster than hydro and wind and is predicted to carry on doing so at least over the next five years. This is driven by continuous policy support and cost reductions.
Renewable electricity generation is anticipated to grow by 36 per cent over the forecast period, with its share of the global power mix increasing from 24 per cent in 2016 to reach 30 per cent by 2022. But despite slower capacity growth, by far the biggest contribution to renewable generating capacity is from hydro followed by wind. Hydro should not be underestimated as it still has huge potential in Asia and Africa.
Impact on natural gas and coal
Over the five-year forecast period, growth in renewable generation will be twice as large as that of gas and coal combined. While coal remains the largest source of electricity generation in 2022, renewables close in on its lead. In 2016, renewable generation was 34 per cent less than coal but by 2022 this gap will be halved to just 17 per cent.
However, the same cannot be said for gas. Growth of natural gas in power generation remains anemic over the reference period, slower than that from coal and the gap is widening.
Interestingly, between 2014 and 2016 coal fired power generation declined, but since then and over the reference period it is on the ascendance.
The contribution from renewables to global electricity generation has already surpassed that from natural gas and by 2022 it will be one-third bigger.
It is a remarkable transition, with the contribution from fossil fuels declining rapidly, while the contribution from renewables increasing dramatically. Fossil fuel additions dominated in 2005 to 2010, but over the forecast period the roles are reversed, with renewable additions taking the dominant role.
While in the 2011 to 2016 period gas additions accounted for 56 per cent of fossil fuel electricity and coal 44 per cent, in the 2017 to 2022 period the roles are dramatically reversed, with gas contributing only 30 per cent and coal 70 per cent.
Bad news for natural gas? More worrying than bad. Gas-fired power generation will still be increasing, albeit at slow rates. As a result, gas is still one of the main fuels in global electricity generation.
The IEA says that renewable policies in many countries are moving from government-set tariffs to competitive auctions with long-term power purchase agreements (PPAs) for utility-scale projects. In some countries, increased competition has reduced remuneration levels for solar PV and wind projects by 30 per cent to 40 per cent in just two years. This has squeezed costs along the entire value chain making tenders a cost-effective policy option for governments.
The IEA adds that auctions can also enable a better control of deployment, total incentives and system integration aspects. Almost half of the renewable electricity capacity expansion over the reference period is expected to be driven by competitive auctions with PPAs, in contrast to just over 20 per cent in 2016.
Auctions are also proving effective in rapidly reducing costs of offshore wind and concentrated solar power (CSP). Auctions suggest that expanding competitive pricing could result in even lower average costs in coming years, but this remains to be seen.
However, with wind and solar together expected to represent more than 80 per cent of global renewable capacity growth in the next five years, without increases in system flexibility variable renewables become more exposed to risk. Market and policy frameworks need to evolve in order to cope with this. However, the role of renewables has the potential to be strengthened even further if storage technology solves the problem of intermittency.
Implications for natural gas
If these policies do indeed result in even lower renewable costs, the impact on fossil fuel contribution to electricity generation could be even more dramatic. With coal retaining its position, this impact is likely to be stronger on natural gas.
So, apart from lowering gas prices even further and counting on China to lead gas demand growth, what else can be done to boost the use of natural gas. One key remaining option is to increase carbon pricing to levels which can have a meaningful impact on the price of coal relative to gas. But apart from Europe, would such policies gain ground elsewhere? Experience shows that this would be a challenge. Coal becomes vulnerable mostly where emissions are regulated, e.g. in Europe.
But the risk is that carbon pricing may help renewables even more at the expense of gas, which of course is another carbon emitting fossil fuel, even if, albeit, cleaner than coal.
Nevertheless, it is hoped that air pollution and environmental concerns in China and India will eventually reduce reliance on coal and lead to increases in gas consumption.
Lower natural gas prices have helped open up new markets. Maintaining lower costs or even lowering them further will be a challenge, but may become important if gas is to compete against coal and renewables. This was highlighted by Yuji Kakimi, the head of Japan’s JERA, who warned producers that they need to become more competitive on price if they want to usher in a ‘golden age’ of gas in Asia.
“Compared to coal, as a fuel source for electricity, gas is about 1.5 times more expensive, even at $6 per mmBtu,” he said. “Can emerging markets, which are looking to grow, really push for environment over economics? At $10…it isn’t economically competitive at all.”
But even though lower prices have contributed to the creation of more demand, they are challenging developers and suppliers and of course sanctioning of new LNG plant, especially large greenfield liquefaction projects – such as, for example, a new LNG liquefaction plant at Vasilikos. As a result, emphasis is shifting to brownfield expansions, but also to smaller and modular LNG projects, especially in the US. These may lead the next wave of LNG liquefaction.
Wider use of floating storage and regasification units has helped the spread of LNG, especially in Asia. Partnering with local companies and investing in LNG import terminals and downstream projects may also help bolster LNG sales.
Natural gas has to adapt and compete in the new, lower cost, electricity market environment if it is to realise its potential as the cleaner fossil fuel, driven by abundance of resources.
The relentless penetration of renewables in the global electricity market and their impact on keeping gas prices low would pose further challenges to the development and export of East Med gas. With Europe already out of reach, long-term low gas prices would also make Asian markets a challenge.
Dr Charles Ellinas is a nonresident senior fellow at the Global Energy Centre of the Atlantic Council