Changing climate in the energy sector

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Changing climate in the energy sector

a new wave of sustainable investment opportunities arises

Elwin Ter Horst

Technical Business Studies

Master’s thesis 2002

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Preface

This report is written for two purposes. First, it is a graduation thesis to obtain a Masters degree in the field of Technical Business studies. The second goal is to support future investment decisions of GreenPartners BV. During my workplacement at GreenPartners research project, I encountered some problems that had their origin in these sometimes (in my opinion) ambivalent goals. At these times, I always had the opportunity of asking my mentors, at the university as well as at GreenPartners. They have made clear to me how a scientific approach can be applied to a business problem, hereby helping me through difficult times.

For teaching me this, and of course for the great time I had the last eight months, I would especially like to thank Albert Fischer, Ben Spaanenburg and Ton Schoot Uiterkamp.

I hope you’ll enjoy reading this report as much as I enjoyed writing it.

Elwin Ter Horst

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List of abbreviations

ICT Information and Communication Technology ISO Independent System Operators

IPP Independent Power Producers IOU Independent Supervisors UPS Uninterruptible Power Supply

PEM Polymer Electrolyte Membrane (type of fuel cell)

CHP Combined Heat and Power (efficient energy generation with both heat and power as outputs)

CC Combined Cycle (type of engine / turbine) IEA International Energy Agency

PV Photo-Voltaic

CR commonrail (technique for gasoline motors)

GDI Gasoline Direct Injection (technique for gasoline motors) LPG Liquid Petrol Gas

RE Renewable Energy

REFIT Renewable Energy Feed in Tariff (German capital grants) SUV Sports Utility Vehicle

ktoe kiloton of oil equivalent (used to express energy usage) mtoe million ton of oil equivalent (used to express energy usage) MB Megabyte

kW Kilowatt (1000 Watt) (energy generation capacity) MW Megawatt (1000 kW)

GW Gigawatt (1000 MW) TW Terrawatt (1000 GW)

kWh kiloWatthour (concrete energy amount) mpg miles per gallon

kWe Kilowatt electric (used if the output of a process is heat and electricity) kWp Kilowatt peak capacity (maximum energy generation capacity

kV kiloVolt

IEA International Energy Agency SAM Sustainable Asset Management

ECN Energy Research Foundation The Netherlands EWEA European Wind Energy Association

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1 Introduction

1.1 GreenPartners B.V.

GreenPartners was founded by Frank van Beuningen and Albert Fischer in 1989. She controls the venture capital fund Pymwymic (Put Your Money Where Your Mouth Is Company). In addition to this she provides services to fast growing companies with a need for venture capital. One of these services is to help prepare a business plan or a road show, where the company in question presents itself and its need for capital. GreenPartners can also establish relationships between company and investor(s).

Green Partners is characterized by her strive for sustainability. The “triple P” approach (people, planet, profit) is an important factor in her management. This mainly implies that all decisions must meet the durability criteria. The underlying thought is that the only way long term economic growth can exist, is if the company environment and its employees are managed in a sustainable manner.

The venture capital fund Pymwymic was founded by GreenPartners in 1990. A number of stockholders raised the capital needed. This capital is divided over eight companies.

At this moment Pymwymic has reached its full capacity, which means there is no more room for additional investments. Pymwymic’s management actively supervises her interests by residing in the board of directors of the companies she has invested in.

Because a new wave of sustainable investment opportunities has risen in the energy- and water sector, GreenPartners has decided to found a new venture capital fund specially for these sectors.

1.2 Planet Capital

Albert Fischer’s new investment fund is called Planet Capital. At this moment the directors are working on the fundraising. In other words they are looking for stockholders who are willing to provide capital. The goal of this research is to support the investment decisions that are to be made by the management of Planet Capital.

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2 Methodological Framework

2.1 Research objective

The objective of GreenPartners BV is to set up a venture capital fund in the near future, under the name Planet Capital, to provide early stage financing to small innovative companies with major growth prospects in the energy sector. This sector is expected to provide excellent investment opportunities. However, objective scientific research is required to validate this hypothesis. Two mentors from the university, prof. dr. ir. Spaanenburg and prof. dr. Schoot Uiterkamp help achieve this goal.

The objective of this report is to provide policy supporting information on investment/business- opportunities in the energy sector for GreenPartners BV. Furthermore, this report will be the graduation thesis for Elwin Ter Horst. For this purpose, research must be on a Master of Science level, which means the sources must be traceable, and the discourse must be structured, logical and reproducible. Next to this, there should be enough technical as well as business aspects in it. The objective of the energy report can be stated as follows:

2.2 Central research question

The central research question is the translation of the original problem into a more tangible starting-point. Here the questions are formulated that must be answered to solve the problem and fulfill the objectives. Bases on the problem background and the objectives, the central research question can be stated as:

2.2.1 Sub-questions

In order to be able to give an answer to the central research question, several subquestions must be considered:

- What are the drivers for change in the energy sector ? - How can these drivers influence the energy industry ? - How will the energy industry look like in the future ?

- Which investment opportunities do these changes bring with them ? - Which ventures are active in the most promising market segments ? - What are the market characteristics of the different European countries ? 2.3 Research design

The research design is a framework for conducting the market research project. It specifies the details of the procedures necessary for obtaining the information needed to structure the formulation of an answer to the central research question.

This study is an explorative study. Since nothing is fixed beforehand and the area is relatively new to the venture capitalist, a conceptual framework is to be developed.

To identify good investment opportunities in the European energy sector.

What are good investment opportunities in the European energy sector ?

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2.4 Conceptual framework

This research is twofold:

2.4.1 Top down research

First an assessment of the political, macro-economical and societal developments with regard to the European energy sector is made. Privatization, liberalization, population growth and an increasing dependence on electricity are key-drivers for change in the energy sector. These (and other) drivers and also the implications they have on the energy value chain will be discussed: what new business opportunities could arise because of the developments in the energy sector ? In other words what are the meso- level implications of macro-developments.

2.4.2 Bottom up research

Second, research is conducted at the micro-level. To accomplish this, first a database needs to be filled with names of companies that are active in the energy sector. The information that these companies expose, will be used to evaluate in how far the predicted developments in the top down part are turning out in practice, and thus to evaluate if the predicted investment opportunities are real or just theory.

The goal of this is to obtain a comprehensive overview of possible concrete investment opportunities in each interesting segment of the energy industry.

The gathered data can also be used to evaluate in which countries the industry base is strong for a particular segment of the energy sector. This knowledge can be used to analyze in which country one should look for particular investment objects in a particular business segment, making the search for concrete investment opportunities less time consuming.

2.4.3 Conclusion

After this, we’ll search for business segments and countries where both forms of analysis result in good business opportunities. These will be promising business segments in countries that are leaders in these segments, and where small ventures with a need for venture capital are most likely to be found.

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2.5 Data collection method

The data for this thesis is collected in several ways. Prof. Dr. P.S.H. Leeflang outlines in his book “Probleemgebied marketing, een managementbenadering” (1987) several methods to get the required data (see figure 1).

Most of the information for the top down approach is gathered from external publications of the European Community. We also made use of market research of third parties.

Bottom up information is all information from companies, which is gathered mainly from the internet, and in some cases by personal interviews.

DATA

Primary Secondary

Internal External

Market re- Administration

search that has Publications

been realized and Market research is in possession realized by third

parties that can be bought

Communication Observation

Personal Telephone Written

of people of material business

Fig. 1 Source: Leeflang (1987)

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3 Top down approach

3.1 Drivers for change in the energy sector

Various trends are reshaping the energy sector. Identifying these change-drivers and understanding their impact is important for an energy sector venture capital fund. During the evaluation of business plans, one should look at the impact these trends have on the venture’s business. This forms the foundation of a successful investment strategy.

Companies should look at the changes in the energy sector as opportunities, not threats. This way they can anticipate on the upcoming changes, define new strategies and achieve a competitive edge in the fast changing environment.

The following trends are expected to have a long-term impact on the sector:

1. liberalization

2. conventional energy resources scarcity 3. increasing environmental awareness

4. increasing energy demand from the developing world 5. technology pull

6. technology push 3.1.1 Liberalization

Technological progress and positive experiences in other industries have caused a widespread liberalization of the energy sector throughout the world. Technological progress has reduced the optimum size of power plants with regard to economies of scale and at the same time generators in the smaller power range are simplified and mass produced, making small scale generation more cost-competitive¹. The developments in the ICT sector have also influenced liberalization, they are discussed in the fifth paragraph.

The process of market liberalization leads to the break-up of monopolistic, vertically integrated structures and creates a market-driven environment. This opens up space to new players such as Independent System Operators (ISO's) and Independent Power Producers.

The old vertically integrated power industry The new horizontal electric power industry

Utility A Utility B Utility C Fig.2 Source: CERA

1 Dunn, 2000

Energy services Utilities Facility Mgmt. Service prov. ? Sales/Marketing Utilities Aggregators Marketing ? Billing/Metering Utilities Telep. Credit card Metering

Distribution ISV’s Co-ops Non-utilities ?

Transmission Utilities ISO's Merchants ?

Power Marketing Utilities Power marketers ? Generation Utilities Wholesale Self generat. ?

Fuel Producer Marketers Services ?

Customer service

Distri- bution

Trans- mission

Generation

Fuel

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In contrast, there are indications of a consolidation process among established utilities, NUON and Electricité de France are good examples of aggressive expanders.

Another effect of liberalization that cannot be ignored is increasing price volatility. Although falling prices can be observed in most markets, price fluctuations are increasing at the same time. A comparison of these price levels with the generation costs of new energy technologies such as wind turbines or fuel cells clearly highlights the falling barriers to market entry and growing competitiveness of these sources. However, the increasing volatility and associated costs also show the growing need for technologies and players that create a more efficient market and avoid or bypass supply bottlenecks.

The process of liberalization is already at an advanced stage in Great Britain, Scandinavia and Germany, while in other countries it is just starting. The Netherlands are somewhere halfway, for details see figure 3.

Degree of liberalization of the electricity markets in Europe

0 20 40 60 80 100

United Kingdom (1990) Finland (1995) Sweden (1996) Germany (1998) Denmark (1998) Spain (1997/98) Netherlands (1999) Belgium (1999) Austria (1999) Luxembourg (2000) Italy (1999) Portugal (1999) France (2000) Ireland (2000) Greece (2001) Slovenia (2003) Chechia (2002) Poland (2003) Ungaria (2001)

Percentage

2000 2003 2007

Figure 3 Source: Electrabel annual report 2000

Liberalization of the energy markets is followed by privatization, governments are selling their shares in utilities. In the Netherlands, the major part of the generating facilities has already been sold to (foreign) private companies. This process is going slower for distribution companies.

More decentralized, small generators will soon make their way to the market. The average size of a new generating unit in the United States declined from 200 megawatts in the mid- 1980s to 21 megawatts in 1998, roughly equal to the electrical sizes of the World War I era².

2 Dunn, 2000

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3.1.2 Conventional energy resource scarcity in Europe

Energy resource scarcity seems unlikely to happen on a global scale, but for the European Union (EU) it is an important driver for change, because the EU is relatively poor in conventional energy reserves, as figure 4 shows.

The basic facts about energy

EU Energy self sufficiency is impossible to achieve

An energy-intensive economy:

consumption + 1 to 2%/ year

Europe-30: final energy consumption (in mtoe)

0 250 500 750 1000 1250 1500 1750

1990 2000 2010 2020 2030 Industry Transport

Households, services

The EU’s resources are limited

Europe-30: energy production, reference scenario (in mtoe)

0 250 500 750 1000 1250

1990 2000 2010 2020 2030 Oil Natural gas

Solid fuels Renewables Nuclear Coal: cost of production is 4 - 5 times the world price

Oil: cost of production 2 - 7 times the world price, 8 years’ reserve

Natural gas: 2% of the world ’s reserves, 20 years’

reserve

Uranium: 2% of the world ’s reserves, 40 years’ reserve Renewables: potential abundance

Fig. 4 Source: EU Green Paper, towards a European strategy for the security of energy supply

However, the scarcity of resources has not affected the rise in energy demand over the previous decades and is not expected to act as a brake on consumption for the future. As a result, Europe is becoming increasingly dependent on imports. The European Commission estimates that under business-as-usual assumptions the overall import dependency will rise from today’s 50 % to about 60 to 70 % in 2020.

Decreasing dependency of Europe can only be realized by means of investing in renewables.

Renewable energy resources are adequate to meet all potential energy needs, despite competing with food and leisure for land use. Although the costs of renewable energy have fallen dramatically over the past two decades, this also accounts for conventional energy, so renewables still meet no more than 1 % of the worlds primary energy demand.

3.1.3 Increasing environmental awareness

Greenhouse gasses and the related climate problem make a new attitude towards the energy sector inevitable. During an international meeting in Bonn this summer the Kyoto protocol was ratified by all nations, except the US. It says that in 2020 40% less emissions should be transferred into the atmosphere. To accomplish this, the “trias energetica” methodology is developed, consisting of three strategies to reduce emissions:

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Fig. 5

According to studies by the International Energy Agency (IEA), the contribution of natural gas to overall energy production would rise from 15 % at present to 50 % in 2020. By 2050, the World Energy Council envisions the global energy mix to contain at least seven different sources. Such a widespread portfolio reduces concerns over the availability of primary resources to meet the demands of continued growth and also contributes to the Kyoto targets.

Customer demand for green electricity is growing at a fast pace, various utilities worldwide are now recognizing this demand and providing green electricity options. These can take two forms: Green Supply Tariffs, where every unit of electricity used by the customer is matched by generation of green electricity, or Green Fund Tariffs, where the customer makes a donation to the supplier for them to invest in renewable energy projects. The bulk of the tariffs consist of the first option.

3.1.4 Increasing energy demand in the developing world

Many regions in emerging economies have no or only insufficient grid infrastructure.

Although in some countries rural electrification programs are in place, they are often overtaken by decentralized generation alternatives, because their governments are often unable to finance expensive national grids (see also table 1 for examples). This discrepancy, and the rapidly growing demand for electricity, leads to attractive new markets for distributed energy technologies

China over 150.000 small-scale wind turbines operating; more than 500.000 people served more than 200.000 home solar systems installed

Kenya more than 120.000 small solar Photo-Voltaic (PV) systems installed; over 250.000 people served by PV, 400.000 people are served by the national grid

South Africa more than 50.000 solar PV-systems in place, including in 1300 rural schools, 400 rural health clinics; more than 100.00 PV-modules ordered for wireless rural phone systems

Source: Micropower, the next electrical era (2000), by Seth Dunn

The huge growth of decentralized systems in regions of the developing world suggests that many regions may “leapfrog” to the new downsized power technologies, just like some areas have moved directly to wireless phones, bypassing the stationary power grid-era and its expensive distribution networks. It is unclear however, whether the governments will undermine the position of these systems by aggressive grid expansion programs.

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3.1.5 Technology pull

Electricity directed innovation is a condition for economic growth, because electricity is necessary for nearly all businesses in the modern world. If we continue generating electricity the way we’re doing now, we will have an even bigger environmental problem in the near future. That is the reason why a lot of money is invested in energy research every year. We also see that nowadays almost all research is directed towards cleaner, more reliable and more efficient energy supply.

Another stimulating factor in the demand for new energy technology is the quick pace with which ICT has conquered the western world. In spite of generally more efficient apparatus our energy demand is still rising, because of the energy swallowing Internet and fast growing computer usage. 4 % of total energy consumption in the US is dedicated to Internet activities.

This is not as strange as it may seem, if one notices that it takes half a kilo of coal to send a 2 MB email. ICT not only demands a lot of energy, it demands electricity of high quality and reliability, and the sector is willing to pay for it (e.g. data-centers). Electricity is the single source of energy that ICT is using, therefore we see an increase in the relative amount of electricity.

Because customers will demand more and better electricity, there will also be a demand for new electricity technology, especially for conversion techniques that move closer to the customer.

3.1.6 Technology push

A new infrastructure is emerging from the convergence of electricity and communications.

This will give rise to a lot of opportunities in the field of “intelligent electric services” and redefine the core business of utilities.

The microprocessor is infiltrating every aspect of economy and society, not in the least the transmission of electricity. This implies a shift in core-activities for utilities, from the supply of electricity as a commodity to the delivery of value-added services through intelligent service networks. A new “omni-directional” grid will develop, other than the current one-way street between central plant and end-user, thereby decreasing energy transportation costs. New business opportunities are emerging in this field, for example starting and running generators at customer’s sites when the grid is overloaded. Transmission will become more intelligent, giving rise to business opportunities both upstream and downstream of the meter.

In this more competitive customer-managed surrounding, energy users will choose for the supplier with the best value-added services. As a result, utilities need to direct their efforts to the supply of value-added services to the customer, hereby changing their core business.

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4 Scenarios

Now that we have identified the change drivers in the industry, we will have a look at their implications regarding investment opportunities in the sector. This is accomplished by means of scenarios. These are a tool for helping managers plan for the future –or rather for different possible futures. They help focus on critical uncertainties. On the things we don't know about which might transform the energy business. And on the things we do know about in which there might be unexpected discontinuities. They help us understand the limitations of our

‘mental maps’ of the world – to think the unthinkable, anticipate the unknowable and utilize both to make better strategic decisions.

Scenarios are alternative stories of how the world may develop. They are not predictions – but credible, relevant and challenging alternative stories that help us explore ‘what if’ and ‘how’.

Their purpose is not to pinpoint future events – but to consider the forces which may push the future along different paths. They help managers understand the dynamics of the business environment, recognize new possibilities, assess strategic options and take long-term decisions.

The scenarios are presented as roadmaps to the future of the energy sector. A roadmap consists of five basic elements and a vision. Each scenario has its own vision, which is a storyline along which the energy sector will evolve. Scenarios have in common that they consist of the five basic elements of the figure.

Fig. 6 Source: Next generation manufacturing report

The drivers, discussed in the last chapter, are the forces which shape the needs of our society.

Some of these needs can be fulfilled in the present, others can’t because of technological, social or other barriers. If the barriers are of a technological nature, there are sometimes technologies that are not fully developed, but which have the potential to solve these problems. These are called enabling technologies. In these scenarios a lot of enabling

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technologies can be found. This is in particular interesting for a venture capital fund, because the ventures that are working to improve these technologies, tend to be small new entrants in the industry. Venture capital can give these ventures the necessary means to commercialize their technology, thereby helping to shape a sustainable world, which forms the ultimate goal.

Each scenario ends with a paragraph named “conclusion for investors”, in which the attractive investment clusters that arise in the particular scenario are summarized.

4.1 Hydrogen future scenario

4.1.1 Introduction

In the early twentieth century a new engine technology appeared on roads already full of horse drawn carriages. The new engine was initially powered by fuel in a box, sold in local hardware stores. A century-long development of fuel infrastructure was triggered by efficiency considerations. This has resulted in today’s fuelling infrastructure – now a valuable asset as well as a barrier to change. Fuel cells’ reliability, convenience, flexibility and clean nature make it the engine technology of the coming decades. This scenario’s storyline is about the way the transition to a hydrogen economy can take place.

Transitional paths to fuel cell-powered vehicles and to a wider hydrogen economy are conventionally assumed to be slow, costly, and difficult, due to two main obstacles:

- A large new infrastructure for the production and distribution of hydrogen is needed before widespread adoption of hydrogen use. This requires enormous investments, with long payback periods and high risks.

- Technological breakthroughs in hydrogen storage are presumed to be needed, because the tanks in which the compressed hydrogen gas is carried these days, are too heavy, too costly and too big to fit into medium and light vehicles.

These barriers are commonly assumed to be overcome by carrying onboard fuel processors, which convert gasoline, methanol or other hydrocarbons into hydrogen. Onboard reforming however, would entail slow and niche-focused adoption of fuel cell-vehicles, especially if a new infrastructure were to be required for safe handling of methanol, or if reformers required new high-purity forms of gasoline or other input fuels. Besides, converting gasoline into hydrogen harms the environment as much as burning it in a conventional combustion engine.

These discouraging conclusions, however, are based on two initial assumptions:

- that the vehicles must be inefficient – in essence conventional vehicles converted from gasoline-fired engines to liquid-reformer-fueled-fuel cells – and

- that the deployment of fuel cells in stationary and in mobile applications can be considered independently.

Neither of these widespread assumptions adequately reflects today’s technological and market opportunities. This scenario, starting with very efficient vehicles, and properly integrating the deployment of fuel cells in vehicles and in buildings, can yield a transition to hydrogen that is rapid, relies on established technologies and avoids most of the normally presumed barriers, giving rise to a wide range of investment opportunities.

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4.1.2 Influence from car manufacturers on fuel cell applicability

The concept of “Hypercars” ³ plays a key role in this scenario and is therefore explained first.

During the 1990’s a revolutionary new automobile-concept is suggested, that could make any road vehicle several fold lighter-weight and lower-drag than the conventional versions. A highly integrated ulralight design, typically using a body molded from advanced polymer- composites, plus close attention to design synergies, mechanical simplification, and open- architecture software and electronics, are features of this design approach that lead to a 2- to 3-fold mass reduction, a 2-fold aerodynamic drag reduction, and 3- to 5-fold rolling resistance reduction. These developments could in turn trigger overall fuel-to-traction efficiency by about 4-8 fold, so that:

• several fold less fuel-cell capacity is required: ~25–30 kWe for a 4-passenger sedan

• this reduced capacity makes a fuel-cell price on the order of $100/kW^e competitive - a several fold higher price than could compete in a less efficient conventional car;

• on normal experience-curve assumptions, that higher tolerable price is likely to be achieved a few years (doublings of cumulative production theory⁴) earlier than the several fold lower price normally required;

These characteristics are achievable without compromising any others desired by car owners or manufacturers: on the contrary, design synergies can make such a vehicle equal or superior in all respects to current market offerings. Manufacturers also gain key competitive advantages, including up to an order of magnitude decrease in product cycle time, investment requirements, body parts count, and assembly effort and space. Many key elements of this design approach (called by Rocky Mountain Institute’s trademarked term "Hypercar™") have already appeared in concept cars and market platforms in the late 1990s. The Honda Insight and the Toyota Primus are two currently available vehicles that share a similar design and technological approach, but these are so-called hybrid-electric drives, which means they have an electric generator and a battery onboard as well as a gasoline engine. The next steps are to remove the gasoline engine and to replace the electric generator and battery with a fuel cell.

Figure 7: Honda Insight Hypercar prototype

3 www.hypercar.com

4 It is a truism of modern manufacturing, verified across a wide range of products, that every doubling of cumulative production volume typically makes manufactured goods about 10–30 percent cheaper. There is every reason to believe that fuel cells will behave in the same way. These reasons are however not explicitly stated here.

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Of course, a Hypercar could make its traction onboard from any liquid fuel, including gasoline, methanol or biofuels, using a turbine-driven generator. It would simply not be as clean or efficient as a direct hydrogen fuel cell version, because of the extra weight and costs of the reformers.

Thus the market-driven adoption of a super efficient car unlocks the many benefits of compressed hydrogen gas fueling. The major drawbacks remaining are the cost of the fuel cell and the buildup of hydrogen refueling infrastructure. Relieving these drawbacks requires an interdependent deployment of fuel cells in both vehicles and buildings.

4.1.3 Deployment of fuel cells in buildings and vehicles

The average price of the cheapest fuel cell, the Polymer Electrolyte Membrane (PEM) fuel cell, is currently about $ 1000 per kWe, far too much to be competitive in a hypercars.

However, when fuel cells are manufactured in very large volumes, using innovative designs as (for example) molded roll-to-roll polymer parts glued together, they could become extremely cheap—probably less than $50 per kilowatt⁵, which is about a fifth to a tenth the cost of today’s cheapest combined-cycle gas-fired power stations.

The major companies that are active in fuel cell business, expect to commercialize fuel cells starting in 2002 to 2005. Every chance that this means that the cells are mass produced by then. If we apply the “doublings of cumulative production” theory to the fuel cell market, this means prices are to drop to around $ 500 to $ 800 in early mass production and, as production expands over the following few years, to around $ 100. That’s only several fold more than the cost of today’s gasoline engine / generators (after more than a century of refinement !), about tenfold cheaper than a coal fired power station, and several fold cheaper than just the wires to deliver that station’s power to a building, where the fuel cell could already be (because it is quieter and cleaner).

With the introduction of the hypercar, the maximum tolerable cost per kW rises from $ 50 to about $ 100, thereby speeding up commercialization of automotive fuel cells. To reach this price fall from $ 1000 per kW (current) to approx. $ 100, fuel cells need to be serie- or mass produced for that other vast market: buildings. For these reasons, several large makers of cars are crossing traditional boundaries and quietly launching significant ventures to commercialize fuel cells in stationary as well as mobile applications (For example Ballard Power Systems, owned by Daimler and Ford, is present in mobile, stationary as well as automotive fuel cell development, and Toyota is developing a residential fuel cell of 1 kW).

The main reason to start with buildings is that fuel cells can turn 50 or more percent of the hydrogen’s energy into highly reliable, premium-quality electricity, and the reminder into 70°C pure water - ideal for heating and cooling of buildings. In a typical building, such services would help pay for natural gas and a fuel processor. With the fuel expenses thus largely covered, electricity from early-production fuel cells should be cheap enough to undercut even the operating cost of existing coal and nuclear power stations, let alone the extra cost to deliver their power. Announced market entrants for packaged, natural-gas- reformer-fueled fuel-cell cogeneration systems include General Electric, which plans to bring the household-scale Plug Power system to market in mid 2002. Initial clients are most likely to be datacenters, hospitals and hotels, where constant, uninterruptive, high quality power supply is of great importance. Other initial clients will be buildings in those neighborhoods where the electrical distribution grid is fully loaded and needs costly expansions to meet growing demand, or where it is nearing the end of its service life and needs life-extension or

5 Several independent studies (e.g., Lomax et al. 1997) have used standard industrial engineering techniques to calculate costs around $20–35/kW for the PEM fuel-cell stack at high production volumes.

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replacement. Over 100 North American utilities are already prospecting for such "hot spots"

where local generation or load reduction can be targeted by "Local Integrated Resource Planning" specifically to avoid or defer costly distribution investments. In addition to avoiding distribution costs and losses, fuel cells can offer the utility such valuable "distributed benefits" as reactive power support, stability support (via very fast ramp rates), improved distribution circuit management, simplified fault management, and reduced reserve margin and spinning reserve. Moreover, customers benefit from enhanced reliability and unsurpassed power quality.

Even a modest subset of the in-building generation market can yield an aggregate fuel cell capacity larger than should be required to achieve a cumulative production consistent with the

$ 100 / kW system costs needed for hypercars. Once fuel cells become cost-effective for, and are installed in, a hypercar, it becomes more than just a car. It is also, in effect, a clean, silent, ultrareliable power station on wheels, with a generating capacity of at least 20 kilowatts. The average car is parked about 96 percent of the time. During this time, you plug it inas a generating asset. While you sit at your desk, your power-plant-on-wheels is sending 20+

kilowatts of premium-quality electricity back to the grid. You’re automatically credited for this production at the real-time price, which is highest in the daytime: you’re probably running the power plant at the place and time at which its output is most valuable. Thus your second-largest, but previously idle, household asset is now repaying a significant fraction of its own costs. Considering that the US car fleet, with 150 million vehicles, with an average generating capacity of 20 kilowatts has a total capacity of 3 TW, which is three times more than the total installed generating capacity of the current power plants, all generation plants could eventually be switched off. It should be clear that this scenario is an important opportunity for a sustainable world, especially since cars, unlike central power stations, tend to be located very near the electrical loads resulting from human activity.

[…] Hundreds of microchip fabrication plants, plus another $169 billion worth on the drawing boards as of 1997, each use an average on the order of 15 MWe with a capacity factor over 90%.

Such a "fab" typically loses about 6–8% of its $5–10-million annual electric bill to the standby losses of a giant and very costly uninterruptible power supply (UPS) required by its ultra precise processes. That UPS can be eliminated by a suitably configured array of fuel cells and inverters designed for the desired level of reliability. Moreover, the fuel cells’ ~70°C waste heat is well matched to the fab’s requirements for process heating and cooling; the clean hot water created by the fuel cells is an ideal feedstock for the fab’s ultra pure water system; and the manufacturing process requires pure hydrogen as a reagent, offering the opportunity to share the hydrogen source.

These features appear to make even early production PEM fuel cells (or competing types such as the onsi phosphoric-acid stacks) strong candidates for immediate retrofits into many existing fabs, and the power supply of choice for all new ones. Nor is chip making the only important industrial niche application. […]

Source: Rocky Mountain Institute, a vision of a hydrogen future

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Fig. 8 Source: Future of energy markets, British Petroleum

4.1.4 Barriers 4.1.4.1 Safety

The key to this revolutionary sustainable energy system is how the fuel cells’ source of energy, hydrogen gas, will be manufactured, distributed and stored. Two important hurdles are commonly described in literature: safety and the evolution of infrastructure for hydrogen fueling.

In contrary to the often expressed concerns about safety when a hydrogen tank is carried onboard a vehicle, there are also reports⁶ which state that hydrogen tanks are safer than conventional gasoline tanks, when they are made of an extremely strong carbon-fiber. If the hydrogen leaks away during filling or otherwise, it will dissipate quickly, unlike spilled gasoline. It does ignite easily, but this requires a fourfold richer mixture in air than gasoline fumes do. Moreover, a hydrogen fire can’t burn you unless you’re practically inside it, in contrast to burning gasoline which emits white hot particles (ashes) that can cause critical burns at a distance. As a result of the gas’s unique properties, no one was directly killed by the hydrogen fire in the 1937 Hindenburg airship disaster. Some died in a diesel oil-fire or by jumping out of the airship, but all passengers who rode the flaming ship back to earth, as the clear hydrogen flames swirled above them, escaped unharmed.

This is all true, but the public remains worried. This is considered as an important barrier, which can only be broken through by means of proper enlightenment, by the government as well as by companies.

6 Lovins & Williams, 2000

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4.1.4.2 Infrastructure

A lot of reports state that a large scale introduction of fuel cells in cars is not yet to come, because first their price has to decrease by means of mass production. Fuel cells would be introduced in cars only after the demand from high-tech factories, hospitals and datacenters has decreased their price enough. This is however, not necessary, nor likely. A new hydrogen infrastructure for cars and buildings could be built step by step, using established methods and markets that could each be profitable, and even more, they could profit from each others side- effects.

There are two ways to produce hydrogen, namely electrolysis and hydrocarbon reforming.

Both options can be carried out effectively and efficiently to provide energy for apartment sized buildings, office or retail buildings, or even a complete neighborhood. One water- heater-sized, mass-produced "fuel appliance" can produce enough hydrogen to serve the fuel cells in one big building or dozens of cars. This has two strategic advantages:

First, it is the cheapest way to deliver hydrogen to the consumer, for upstream bulk supply requires new pipelines or other distribution means. Second, "hydrogen is produced where and when it is needed, in quantities that match the incremental growth of fuel-cell sales, minimizing the need for multi-billion-dollar investments prior to the introduction of sufficient numbers of fuel cells to provide adequate return on investment."⁷

The hydrogen appliances initially installed to serve fuel cells in buildings represent a constellation of hydrogen sources available also to cars. In particular, suppose fuel-cell Hypercars are leased first to the people who work in areas with buildings where fuel cells have already been installed. (The same utility could even lease both.) As you park your fuel- cell Hypercar at work⁸, you plug into both the electricity grid and a snap-on fuel line bringing surplus hydrogen from the fuel appliance from the building into your car. Since that device isn’t normally kept fully occupied, in its spare time it makes a surplus of hydrogen, reducing the need to build a whole new infrastructure of hydrogen sources dedicated solely to cars.

This approach makes the profits of cars-as-plug-in-power-plants promptly available to a set of drivers far larger than those who operate centrally fueled vehicle fleets. In addition, the high purity of the hydrogen required for long life, low catalyst loading (hence low cost), and high efficiency in the buildings’ fuel cells also supports the same qualities in the mobile fuel cells fueled by the same hydrogen appliances.

4.1.4.3 Future hydrogen supply methods

The bigger the total hydrogen market becomes, the more interested the energy industries will become in serving it, expanding bulk hydrogen from an onsite reagent in refineries and petrochemical plants into an offsite commodity. Though offsite shipment, typically in pipelines, may require special arrangements, many existing natural-gas networks appear to be adaptable for this purpose.

An especially attractive commodity-market opportunity is to reform natural gas at the wellhead, where a large plant can efficiently strip out the hydrogen for shipment to wholesale markets. The other product of the separation process, carbon dioxide, could then be reinjected into the gas field (a common practice today in oilfields), adding pressure that would help recover about enough additional natural gas to pay for the reinjection. The carbon would then be safely sequestered in the gas field, which can typically hold about twice as much carbon in

7 Thomas et al. 1998

8 Or at your house or apartment. The workplace example is given to capture the value of daytime generation.

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the form of CO² as it originally held in the form of natural gas. The world’s abundant resources of natural gas—more than a century’s worth—could thus be cleanly, efficiently, and profitably used in fuel-cell vehicles, and in fuel-cell-powered buildings and factories, while reducing the threat to the earth’s climate. The hydrogen provider could be paid three times:

for the shipped hydrogen, for the enhanced recovery of natural gas (often about enough to pay for the reinjection), and under Kyoto Protocol trading, for sequestering the carbon. This triple profit opportunity, among other value propositions, is already leading several major energy companies to move aggressively into the hydrogen business⁹.

4.1.4.4 Implications

Retail price competition will be strong, because at least four main ways to make hydrogen—

upstream and downstream, from electricity (especially renewable electricity) and from natural gas—will all be vying for the same customers. Bets should be placed not on the supply or price of a single fuel such as oil, but on the entire, expanding, and highly dynamic portfolio of ways to make cheap electricity and gaseous fuels.

Practical application of this strategy will require quantitative, site- and region-specific analysis of such issues as the population of buildings suitable for early conversion to fuel cells, those buildings’ best hydrogen sources, technical and institutional arrangements for hydrogen-appliance/parked-vehicle interfaces, distributed benefit, pipeline and gas- distribution conversion details. But despite the diversity and complexity of these remaining issues, no technological breakthroughs are required: The needed technology already exists.

The implied shift from oil and electricity to hydrogen as an increasingly dominant energy carrier has equally important implications for vehicle and fuel strategy. The key issue is to deploy extremely efficient cars as a matter of urgency. Early signs can already be seen that dramatically more efficient vehicles will soon be entering the marketplace, but helping this to happen faster and more aggressively could be highly consequential. Without such hydrogen- ready cars, the very low costs of a direct-hydrogen fuel-cell propulsion system would become unavailable. That lack, in turn, would lock in extra capital costs for the next car fleet and its liquid fueling infrastructure5; would lock out a highly diverse portfolio of competing fuel sources (i.e., the hydrogen production portfolio), perpetuating dependence on a narrower, less competitive supply base; and would greatly retard the evolution of an affordable, effective, and benign fuel-cell- and hydrogen-based energy system. Thus the cost of not adopting the rapid commercialization strategy is the major delay and compromise of competitive advantage. But starting aggressively down the hydrogen path offers the full benefits of the rapid commercialization of fuel-cell vehicles and the promise, at last, of a more sustainable transportation and electricity system.

4.1.5 Conclusion for investors 4.1.5.1 Indicators

To find out if the above path to a sustainable future is the one the world is entering, attention should be given to the prices of fuel cells, and hence to the cumulative production of these devices. These data can be found in annual reports from the companies that are active in this segment. As soon as fuel cells reach a price of $ 100 / kW, introduction in the automotive market will be likely. Another important factor to determine if the storyline above will

9 E.g. Shell’s involvement in Proton Chemie, de Wit, 2001 p. 4-9

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become reality is the Hypercar introduction. When do automotive companies achieve the necessary reduction in drag, weight and air resistance to an extent that makes an engine of less than 30 kW in a family car convenient ? At this moment, a lot of companies have prototypes that approach these limitations. When will these become commercially available ? It is my opinion that the most important indicator is the fuel cell price forecast, calculated with the

“doublings of cumulative production” theory. Research on the foregoing themes is carried out in the bottom up approach of the sector in chapter 5.

4.1.5.2 Investment opportunities

Fuel cells are gradually conquering niche markets, like high-tech factories, datacenters and hospitals. For these markets, they will most probably serve as base-load generators, with the existing grid as backup. The most appropriate fuel cell technologies for these applications are the following:

• Solid Oxide fuel cells

• Polymer Electrolyte Membrane fuel cells

• Phosphoric Acid fuel cells

• Molten Carbonate fuel cells

As soon as the above mentioned indicators point in the direction of the hydrogen scenario, investment opportunities will arise in the production of hydrogen, the production of fuel cells and their components (materials technology), and the plug-in systems that are necessary for making a home electricity generating unit out of a car. For automotive applications the most appropriate fuel cell technologies are the following:

• Polymer Electrolyte Membrane fuel cells

• Alkaline fuel cells

4.1.6 Winners and losers

Thanks to Hypercar^TM vehicles, industries and activities gaining major new markets should include:

• Automanufacturers—traditional or virtual, new or old, from within or outside the auto industry—that adopt the Hypercar^TM strategy early and well.

• Manufacturers of auto parts who adapt, singly or in joint ventures, to the wider markets of auto making, to which they bring many needed skills but few of the sunk costs, either physical or psychological, in traditional methods.

• Manufacturers of power electronics, microelectronics, advanced electric motors and small engines, alternative power plants and storage devices, and software.

• Firms involved in composite materials, structures, and tooling and manufacturing equipment.

• Providers of polymers, fibers, coatings, and adhesives for the composites industry, and possibly providers of light metals and of metal-matrix and ceramic-matrix composites.

• The natural gas industry, which provides most polymer feedstock and could also be the cheapest initial source of fuel-cell hydrogen.

• Aerospace and high-tech military-conversion firms if they can adapt to the high volumes, low costs, and market discipline of consumer products.

• Textile companies that can adapt their techniques to advanced-composite high-speed lay-up and preforming, as some are already starting to do.

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Industries losing important markets could include:

• Iron and steel (note, however, that automotive markets account for only one-seventh of their total volume).

• Heavy machine tools.

• Oil for motor fuel (but not for the much smaller use to make petrochemical feed stocks).

• Platinum-group metals (unless certain types of fuel cells were adopted, though even their catalyst loadings are already comparable to those in a normal catalytic converter and are being further reduced).

• Miscellaneous automotive fluids and lubricants.

This scenario has identified the investment opportunities that arise during the transition to a hydrogen society. We have also stated that this transition will occur in the next two decades.

In the meantime, a lot is happening in the renewable energy industry. The expected developments in this industry segment are the subject of the next chapter.

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4.2 Renewable energy scenario

4.2.1 Introduction

Although the EU’s energy resources are limited, this has not affected the rise in energy demand over the previous decades and is not expected to act as a brake on consumption for the future. As a result, Europe is increasingly dependent on imports. The European Commission estimates that under business-as-usual assumptions the overall import dependency will rise from today’s 50 % to about 60 to 70 % in 2020.

According to the European Commission, decreasing this dependency can only be done by means of investing in the only abundant energy source, renewable energy. These resources are in theory adequate to meet all potential energy needs, but scarcity of space and, in some occasions high generation costs make a 100 % clean energy sector practically impossible.

Although the costs of renewable energy have fallen dramatically over the past two decades, this also accounts for conventional energy, so renewables still contribute no more than 6 % to the Union’s overall gross inland energy consumption, of which 4 % is hydropower.

There are signs, however, that this is changing, although at slow pace. The resource base is better understood, the technologies are steadily improving, attitudes towards their uses are changing, and the renewable energy manufacturing and service industries are maturing. But renewables still have difficulties in “taking off”, in marketing terms. In fact many renewable technologies need little effort to become competitive. Moreover, biomass, including energy crops, wind and solar energy all offer a large unexploited technical potential.

Current trends show that considerable technological progress related to renewable energy technologies has been achieved over recent years. Costs are rapidly dropping and many renewables, under the right conditions, have reached or are approaching economic viability.

Signs of large-scale implementation are also appearing in wind energy and solar thermal collectors. Some technologies, in particular biomass, small hydro and wind, are currently competitive and economically viable in particular when compared to other decentralized applications. Solar photovoltaics, although characterized by rapidly declining costs, remains more dependent on favorable conditions. Solar water heaters are currently competitive in many regions of the Union.

Under prevailing economic conditions, a serious obstacle to greater use of certain

renewables has been the initial investment costs. Although comparative costs for many renewables are becoming less disadvantageous, in certain cases quite markedly, their use is still hampered in many situations by higher initial investment costs as compared with conventional fuel cycles (although operational fuel costs are non-existent for renewables with the exception of biomass). This is particularly the case due to the fact that energy prices for conventional fuel cycles do not currently reflect the objective full cost, including the external cost to society of environmental damage caused by their use. A further obstacle is that renewable energy technologies, as is the case for many other innovative technologies, suffer from initial lack of confidence on the part of investors, governments and users, caused by lack of familiarity with their technical and economic potential.

On the other side, the expected growth in energy consumption in many Third and Second World countries, which to a large extent can be satisfied using renewable energies, offers promising business opportunities for EU based companies, which are world leaders in many areas of renewable energy technology. The modular character of most renewable technologies allows gradual implementation, which is easier to finance and allows rapid scale-up where

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required. Finally, the general public favors development of renewables more than any other source of energy, mainly for environmental reasons.

4.2.2 Incentives for renewables

The European commission has set a target to increase the contribution of renewables in the energy supply portfolio from 6 % to 12 % by 2010, i.e. a four-fold increase if large hydro is excluded (now 4 %). However, present market conditions do not favor the competitive position of renewables. The Kyoto protocol and other government regulations such as the green certificate trading favor their position by including external (environmental, health, social) costs in energy prices. These externalities are likely to be an incentive for energy efficiency and investment in renewable energy technologies, as can be seen in the figures 9 and 10.

Figures 9 & 10 Source: EU Green Paper Technical Background, 2000

Much renewable energy (RE) technology is still at a relatively immature stage of development, compared with conventional energy technology. Moreover, new entrants often have a difficult task in entering traditional markets, and energy is no exception. Against this background, without strong customer incentives and mass-marketing, government pressure

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and publicity, the full potential contribution of renewable energy to energy supply will probably only be fully realized in the medium to long term (> 10 years).

Concerning government policy, the European Union has adopted their Strategy for Renewable Energy, as a result of which high levels of investment are anticipated in renewable energy – an anticipated increase of almost 30% between 1987 and 2010. If this is coupled with funding in research, technology development and demonstration for renewable energy technologies, the prospects for renewable production over the coming years are good.

Renewable Energy Production in EU (ktoe) 1989 1996 1997 1998

Increase 89-98

Wind 46 417 631 1.037 2154%

Solar 146 294 318 347 138%

Hydro 21.859 24.814 25.452 26.262 20%

Geothermal 2.215 2.747 2.815 2.992 35%

Biomass 39.979 47.777 52.552 54.175 36%

Total RES primary Energy Production (ktoe) 64245 76049 81768 84813 32%

Total RES electricity generation (GWh) 273.290 321.436 334.642 352.805 29%

Source: EU Green Paper Technical Background, 2000

Now that it is clear that the renewable energy sector is growing rapidly and will remain to do so in the near future, it is necessary to look at the different renewable options in more detail.

The following paragraphs therefore evaluate the potential of the most important renewable energy sources in Europe. We will have a look at the various value chains, and present the most interesting investment opportunities.

4.2.3 Investment attractiveness of the different renewable energy sources

4.2.3.1 Hydropower

Of all renewable sectors, the large-scale hydro sector is the best exploited and perhaps most mature. Hydro represents about 90% of all EU renewables production and supplies some 14%

of electricity demand in the EU. In Europe, however, most economically feasible sites have already been exploited. Although small hydro currently represents only 3% of all hydro production, the main growth in this area is likely to be in small-scale hydro (< 10 MW) for local, decentralized generation.

Small-scale hydro has high efficiency and potentially low installation costs (depending on the size of installation and location). Despite the long pay-back times for investment (10-15 years), the future value of hydro power plants is very high due to low operation costs and long life span. Some are more than 70 years old and still in operation. Investments in hydro power have proved to be safe and secure over several decades. This, and the availability of good spots for small hydro, are reasons for the European Union to expect 2500 MW of additional small hydro capacity by 2010.

Barriers

The high investment cost is the largest barrier in development of small hydro power schemes.

The available financing is therefore often crucial for success.

Environmental impacts can also be a barrier for development of small hydro power plants, because there will always be some damage to the ecosystem.

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4.2.3.2 Wind

Installed capacity for wind energy more than doubled in the 1990’s and the potential is for a further dramatic growth. It is estimated that a quadrupling of market potential is possible by 2020 (world-wide the potential growth is even more dramatic). In the long term, and subject to tackling technical and local planning barriers, wind energy could have potential to contribute up to 30 % of the current electricity demand (15% of the overall primary energy in the EU). As new technologies for offshore installations, lighter structures and variable speed generators come on stream, the contribution of wind to the energy balance is likely to grow significantly, with greater capacity wind turbines and large dispersed wind farms. This makes wind energy an interesting investment opportunity.

In Germany and Denmark, small wind farm developers are playing an important role in the development, installation and to some extent operation of wind farms. The market structure in other EU countries is different, however, as the development of wind farms is dominated by the major utilities. In the near future it might be strategically necessary for global utilities to acquire wind farm developers as these companies have access to the most attractive wind sites. The scarcity of wind hot spots will increase their value.

The main skill of developers is the project know-how in getting the approval and the technical necessities ready to place wind turbines onto wind sites. This involves the documentation of the ownership of the site, the agreement or permission of the local government for erection of a wind farm and the setting up of technical preconditions such as grid access, accessibility of the site etc. For offshore plans wind farm developers are of particular interest as they can help to reduce the timeframe of the set up due to additional contacts and knowledge about the environment.

These are all reasons to expect that the valuation of wind farm developers will rise in the near future, making them an excellent investment opportunity.

Investments can be made in the following four parts of the value chain (see figure 11):

Wind value chain

Turbine Development Electricity Distribution of development erection and generation electricity to

and service customers

manufacturing

Fig. 11

There are signs¹⁰ that the bulk of the value is created by the manufacturers rather than the developers. As the wind industry is still experiencing rapid improvements in technology, turbine technology lifecycles are getting correspondingly shorter and manufacturers have to adapt to this. There is substantial pressure to develop bigger and more efficient turbines. The emergence of the offshore market also necessitates increasing focus on reliability and minimum service requirements. Above 5 MW turbine capacity it is widely believed that the existing turbine technology is no longer reliable as the physical factors on all components are too immense. The existing turbine manufacturers therefore spend a lot of money on research and development activities.

10 Dresdner Kleinwort Wasserstein Research, 2001

Wind turbine manufacturer

Utilities energy trading Wind farm

operator Wind farm

developer

Changing climate in the energy sector