Markets analyst Michael Cembalest put himself in energy school because “when we talked about energy, I started to get a headache because none of it made any sense.”
He quickly found out why: None of it made any sense.
Cembalest, chairman of market and investment strategy for J.P. Morgan Asset & Wealth Management, took an audience through his journey of deciphering the U.S. energy complex and finding the facts while speaking at the annual Kay Bailey Hutchison Energy Center Symposium at the University of Texas.
“I wanted to make sure that people are able to understand when people are misrepresenting information—either deliberately or because they don't even understand it [themselves],” said the nearly four-decade asset manager and adviser.
Consumers hear that wind and solar are the cheapest forms of power, but Cembalest says they don’t have all the information and proper context to make an accurate conclusion.
That isn’t the true cost. “That cost analysis doesn’t include the thermal-generated power, utility-scale storage and regional transmission expansion that’s required for an operator of high-renewable grids.”
So the “cost of energy is basically junk science, masquerading as somebody doing math. And the ISOs (independent system operators) understand this [and] the utilities understand this.”
For the consumer, it is “kind of like you go to dinner and they hand you the bill for the appetizer and then they hand you the bill for the rest of it on your way to the car. I don't think you'd like that very much.”
‘Two drunk guys’
The bottom line is that the electrification of the U.S. requires a better U.S. grid that does not exist today. “The challenge is the infrastructure that you need to make all of these electrifications work,” he said.
The grid is currently designed for households that are going to draw a typical kWh of power. Charging electric vehicles, “all that localized infrastructure is going to have to get upgraded and replaced,” Cembalest said.
A heat pump can replace a gas furnace, but “heat-pump performance tends to degrade in cold temperatures.” The call on the grid is greater. “So you have a double-whammy spike in electricity” demand.
“You have 100 years of existing infrastructure that was built based on the assumption that you're not going to be electrifying transportation,” he said.
For long-haul transportation, “we'll see who wins the battle between hydrogen and electric batteries. Right now, it's like watching two drunk guys fall down the hill because it's not a lot of penetration in either one of them.”
‘Dysfunctional’ U.S. Northeast
And then, the economics: “Electricity also costs a lot more per megajoule than natural gas does, which is another reason why it's hard to electrify.”
As for this “Manhattan Project” for wind and solar, “which I think is a fair way to describe the ambitions of the energy bill,” it’s a big ask, Cembalest added.
But it could work, he said.
“Theoretically, you could do it, and I think the country certainly has the production capacity to build it. I don't think the United States has the politics, the temperament or the ability to connect it [to the grid].
“It’s one thing to build the generation; it's another thing to connect it to the grid.”
Meanwhile, “the grid is expanding more slowly, rather than accelerating. This is going in the opposite direction of which it's supposed to go.”
There is no federal eminent domain for power transmission. Cembalest lives in the Northeast where “you can't get anything done.”
“We kicked out Amazon. You think we're going to allow people to build power lines and pipelines? No way.”
Energy-wise, New York law- and policymakers don’t understand the state’s dire situation, he said. The state ranks last in wind capacity and solar is half of what Arizona generates.
“I'd be willing to bet that most New York congressmen and probably even the governor don't even know that's happening because somebody would have to tell them.”
A project, the Northwest Express, that was to bring Canadian hydropower to Massachusetts “got scrapped because Massachusetts’ friends in Maine and New Hampshire refused to allow the construction of a high-voltage direct-current line” through their states.
“They're sandwiched between the Marcellus [Shale] and 5-cents-a-kWh Canadian hydropower, and they are politically unable to do anything about it,” Cembalest said.
“I don't think I've ever seen anything this dysfunctional ever because, in their own self-interest, they could solve the problem in one of the two simple ways: build a connection to import Canadian hydropower at low cost or natural gas.
“And yet New England—and Massachusetts in particular—are going to be facing rolling brownouts because they can't get more generation,” he said.
Even in the U.S. interior, new power lines have been a problem, he said. “Texas has had a lot of wind projects that were designed to go to other states canceled by neighboring states who didn't want the power lines,” Cembalest said.
Even when developers offer to bury them at three to four times the cost, people still say they don't want them.
“And without having [eminent] domain on that issue, I think the transition's going to go much more slowly, and the U.S. needs to double down on its natural gas development and pipelines because, otherwise, where does the energy come from?”
Nuclear ‘on paper’
Nuclear power is a solution, but “on paper,” Cembalest said.
There is still no permanent storage for spent nuclear rods. And new plants are “wildly expensive, wildly over budget, wildly late. The same thing’s happening in Europe.”
There are various solutions that are underway, but not enough. “I'm a big supporter of whatever public policy can be done to try to help us, but the facts on the ground are very, very challenging.”
With a renewable-reliant grid, the initial question was “How much natural gas backup thermal capacity can we unplug? Right? And, a few years ago, there was a misunderstanding about this. People thought these numbers would be 50% to 70% to 80%.
“They're not.” The state of New York claims 30%, Cembalest said, but he argues it is likely no more than 15% for the foreseeable future.
“You need reserve margins and redundancy. You need to deal with times when there's no wind and solar.”
Emissions will fall, “but your energy bill is going to have to reflect the cost of building new generation capacity—wind and solar—and building and maintaining backup thermal capacity unless you want rolling blackouts.”
Cembalest said he doesn’t have a problem with this. “It is going to be expensive, and it's something that is I think necessary when you think about the long-term consequences of the climate.
“But we should be under no illusion of what this is going to be about.”
‘Doing it honestly’
Germany entered its transition with no illusions. “Germany as a society has collectively decided that they're willing to pay that price.”
Germany cut its emissions by more than a third in the past 15 years and its installed electric-power generation capacity has doubled. “And their electricity prices for industrial and households were off the charts.”
That is “the epiphany that you have to have about a high-renewable penetration grid that needs a lot of backup capacity.”
Transparency about the expensive transition is key, he said. “At least in Germany they're doing it honestly because all that duplicative capacity is generally passed through, not to the taxpayers, but to the rate-payers in their energy bills. So you can see the cost.”
In the U.S., though, “electricity prices will no longer reflect the true cost of the energy ecosystem because it's being financed by taxpayers. … And it's going to be much harder for people like me and you to figure out what is the whole cost of this transition.
“Because a bunch of it's just going to be large fiscal deficits modified by the Federal Reserve.”
‘You just won’t eat’
Would a carbon tax produce better results?
“There's no political support,” Cembalest said. “A lot of good economists spend time thinking about different ways of structuring carbon taxes and things like that. But I'm an investments person and there's nothing for me to sink my teeth into.”
Europe has carbon taxes and is putting in carbon-border adjustment taxes. “And they're doing that unilaterally, which is pretty brave because they're going to be doing that when nobody else is doing it.”
Meanwhile, the U.S. doesn’t “even have a significant [gasoline] tax, right? Higher gasoline taxes would be a logical next step.”
Cembalest estimates that by 2032, 100% of U.S. federal revenue will be consumed by mandatory entitlements and interest on debt.
“Obviously that's an untenable situation. It's like saying you're going to spend 100% of your income on rent and you just won't eat. So that doesn't work.”
Before then, “there's going to have to be some kind of grand compromise to restructure government spending relative to taxes. My goal is to be retired before that.”
Yet, the emissions-reduction numbers need a look from another perspective, Cembalest argued, specifically on the topic of transferred emissions.
In the U.S. and in Europe, during the past 25 years, “there's been a massive exodus of energy-intensive manufacturing from the developed world to the developing world,” he noted.
This includes ammonia, steel, cement and plastics.
“So part of what's happening in Europe is [that] the shedding of energy-intensive activities is making or flattering their emissions profile because it looks like they are achieving something when all they're doing is advocating high-paying jobs and exporting those [other] activities.
“The de-industrialization of the West is also part of the story. We should not lose sight about it.”
He said an Electoral College based on a state’s energy, mining and food output would result in only a few votes in California and the U.S. Northeast. Most of the votes would be held by the central U.S.
Unicorns and hawks
As for hydrogen, people talk about it like it’s a “unicorn or fairy type of thing in the future.”
Instead, there is already a hydrogen economy in oil refining and manufacturing ammonia. It’s known as blue hydrogen and it’s produced by hydrocarbons, particularly natural gas.
Green hydrogen, which is made from water electrolysis using electricity generated by wind, solar, nuclear and other non-hydrocarbon feedstock, is decarbonized hydrogen.
Current U.S. blue hydrogen production is 10 million tons a year. If it were replaced with green hydrogen, “it would take all of the wind and solar currently installed.” Plus, some 80% of current U.S. nuclear power.
In the past year, many U.S. and European hydrogen projects “were scrapped because people started to get closer to the real-world costs of that hydrogen production.”
‘Get a drink’
Cembalest had more to share on carbon sequestration: “The highest ratio in the history of science is the ratio of academic papers written on carbon sequestration divided by actual carbon sequestrations.
“That’s called ‘the CCS ratio.’ You can't even put it in a spreadsheet. You have too many digits.”
CCS is thermodynamically hard to do. Why? The CO2 concentration in the flue-gas stream is high in many ammonia-processing and ethanol plants, but pretty low in standard coal and natural gas.
The biggest sources of CO2 emissions are small and spread out and, therefore, difficult to capture.
And the answer to this question begs another: What is the concentration of CO2 in the atmosphere? “Somebody in this room has to know,” he said.
An attendee shouted, “It’s 0.04%.”
Correct, Cembalest said. “So when anybody talks about the miracles of direct-air carbon capture, get a drink.”
Cleaning up natural gas
So the economic signals keep pointing at natural gas. But one of the advantages of natural gas over coal in power generation “is eroded by methane,” he said.
The U.S. gas industry reports its methane emissions to the EPA. But, “I don't think we should take those numbers super seriously because there's a lot of aerial drone studies … that are doing spot measurements that are much higher than what’s reported to EPA.”
Producers are using more technology to solve those problems by identifying methane leaks and remediating them in real time, he added. The vast majority of the natural gas industry is committed to doing this, he said.
But more progress “has to be made on that before the industry can really make a compelling case that its emissions benefits versus coal are durable.”
There’s always that 20%—the operators who aren’t stepping up. “So they may have to continue to tighten the screws.
“But I don't think there's any question that the United States is going to need material amounts of natural gas through 2035 or 2040 at least."
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