Industry Insight

Networks – the foundation of decarbonisation


A few weeks ago, we wrote on the importance of renewable energy technologies in efforts to decarbonise the global economy. Certainly, renewables are the star of the decarbonisation show, grabbing headlines for their stellar growth and their increasing cost competitiveness versus traditional, fossil-fuel based sources of energy generation.

However, in this week’s piece we discuss electricity networks and how, while less exciting than renewables, they will be the bedrock of the decarbonisation movement, without which achieving the goals of the Paris Agreement and building a net zero world will prove to be extremely difficult.

Networks are the critical infrastructure used to move energy, whether it be gas or electricity, around an energy system and can be split into two main types; transmission and distribution. The transmission network carries energy over relatively longer distances from where it is generated to areas in which it is needed. The distribution network then carries the energy from the transmission grid to industrial, commercial, and domestic users.

The companies that operate this infrastructure have natural monopolies as there tends to be only one transmission or distribution network in each area and therefore they are regulated to prevent them from overcharging end users for their services and to ensure that they provide a reliable and safe source of energy. In many jurisdictions the regulator allows network businesses to earn a specific return as a percentage of a company’s regulated asset base, with some additional incentives. This return is aimed at ensuring that customers receive value for money but also to incentivise investment in this incredibly important infrastructure

Investment in energy networks, particularly in electricity transmission and distribution grids, is arguably more important than ever. We expect networks to be crucial in decarbonising some of the highest polluting parts of the global economy, including power, transportation, and buildings.

In the power sector, renewable energy technologies such as solar and wind are replacing heavily polluting sources of energy such as coal. Notable differences between renewables and traditional energy sources make investment in the grid crucial for several reasons. First, traditional coal-based power plants can be built anywhere, as they are not reliant on being close to the feedstock to produce energy. Often, they would be built in the centre of a country or region and transmission networks would transport the energy that was produced out to the areas that needed it. In contrast, the location of renewable energy production facilities is dictated by where natural resources like the sun and wind are favourable, and therefore ongoing investment will be required to connect the increasing number of renewable assets to the grid.

Second, and more importantly, coal and other fossil fuels are dispatchable sources of power – that is they can be turned on and off as required and will produce a consistent and predictable level of energy. Renewables on the other hand are non-dispatchable. Solar only produces energy when it is sunny and wind farms only generate electricity when there is wind, and therefore, they cannot necessarily be called upon to fill gaps in supply. An energy system that is increasingly built on renewable sources  for its power generation will need to have greater flexibility in order to deal with the associated intermittency, including a smarter, more digitalised network and one that has better storage solutions and demand side response capabilities.

The transportation sector, particularly light passenger vehicles looks set to be decarbonised by electrification. EV adoption has grown strongly in recent years, with passenger EV sales increasing from 450K in 2015 to 2.1m in 2019, according to Bloomberg New Energy Finance. However, they still represent a small proportion of new car sales, and the size of the global EV fleet is expected to rise from 8.5m in 2020 to 116m by 2030. This also represents a challenge to energy networks as rising EV adoption levels will change the electricity demand dynamic, specifically by increasing demand overnight when historically it has been low. There is also the potential that the batteries from electric vehicles, when not being used, could supply energy back into the grid.

Finally, energy networks will play an important role in the decarbonisation of buildings. Most buildings in Europe and the US are heated using gas-fired boilers, but there are other lower-carbon alternatives, including electric heat pumps and hydrogen boilers. The former would increase electricity demand and potentially increase the strain on electricity networks, while the latter could potentially be facilitated by distributing hydrogen through existing gas pipes. Another way to reduce building emissions is to make them more energy efficient, which a more sophisticated network could help to deliver, in part by leveraging the huge scale of data available to them.

All of the above provide a multi-decade investment opportunity for energy networks to upgrade and add to infrastructure that, in many regions, was built a number of decades ago and therefore is not currently equipped to handle the complexities that will come with efforts to decarbonise the global economy. These investments, depending on the regulatory regime, should support growth in the asset base on which network companies earn a return, which should in turn support long-term earnings growth for a sector which also has a number of defensive characteristics.

Should you have any questions about anything raised in this article, please don’t hesitate to contact us via email, or on 0207 337 0777.

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This note has been produced by Killik & Co on the basis of publicly available information, and all sources are believed to be reliable, but we have not independently verified such information and we do not give any warranty as to its accuracy. Some of the stocks mentioned in this note are covered by Killik & Co’s Equity Research team and others are not. The mentioning of the stocks does not represent a recommendation to buy or sell any securities, and the note is intended as a marketing communication rather than research. This note does not purport to be a complete description of the securities, markets or developments referred to in the material. All expressions of opinion are subject to change without notice. Nothing in this note should be construed as investment advice or as comment on the suitability of any investment or investment service.  Prospective investors should take advice from a professional adviser before making any investment decisions. There are risks with almost every investment that you may not get back the original capital invested. The value of your investments may fall as well as rise and the past performance of investments is not a guide to future performance