Oil power - an anachronism in the making
There they go …
Long established power structures face a bleak future
Over on FB, a friend points to a new article about the incoming US government's plan to increase oil and gas production.
We used to see the power of a nation as being a function of their fossil resources. Got lots of oil? You’re powerful. No oil? Not powerful. This idea that oil or gas reserves are emblematic of a nation's status or a proxy for power belongs in the past.
For most of the modern era, oil has been wealth, and more importantly, power. Oil has been a proxy for money, leverage and strength. With oil, you could do anything a modern economy needed -- combustion engines power everything, everywhere. With oil as the source of your energy, you could do things that required lots of energy -- make steel, build ships, develop space shuttles, and wage war.
These nation-building, nation-powering activities required oil as the starting point. The blast furnaces, the plastics, the electricity -- they all ran on oil, and a sprinkling of coal. The products your nation made, the weapons you created and consequently the power you projected -- all a function of your fossil fuel reserves. If you did not directly manufacture your own weapons (Saudi Arabia for example), you subtly controlled the flow of the oil that the larger powers needed to make their weapons. You could make them pay for the privilege of power. If you didn't use your own oil to project power, you paid others for that oil.
Indeed, the balance of modern geopolitical power has hinged on the ebb and flow of oil [1]. Those who had oil could ask dear payment for it, those who did not had to reach deeply into their pockets to pay the toll needed to participate in the highway of modern commerce. This has been the situation since the early twentieth century, when oil rapidly became a key resource.
Setting sail for Valinor
Now, at the turn of the first quarter of the twenty-first century, the time of oil is passing. Indeed, like that of Middle Earth, the battle of our age has been fought and the outcome decided. Fossil fuels are sailing into the sunset and the time of renewables is at hand. Fossil fuels will rapidly become out of place, anachronistic, clearly belonging to a time that has passed. This is most obviously true of cars, but all mechanized transport is on the same trajectory.
Oil, like gold, or other resources, is easily controlled. If your country has oil, you get to sell it to whomever you choose, at [mostly] a price of your choosing. It’s a physical thing that is on your land. If someone wants it, they have to take it from you, or pay you for it.
Sunshine, unlike oil, is not easily rationed or controlled. You put up some panels, wire up a battery and from that point on, you can run your refrigerator for free. You won’t break the bank setting the thermostat up in winter, or down in summer. You’ve created your own resource and you get to say how it’s used. Just like petrostates, you get to sell your energy to whomever you choose, at a price of your choosing. Of course, there are market considerations, but nobody can take your panels away from you.
Wind, similarly, is not a thing you can take in war, or by theft. Certainly, favourable locations are not evenly distributed around the globe, and unlike sunshine, your nation may well be more blessed with wind resources than your global competitors. Denmark is blessed with lots of windy, shallow, sea real estate, and they have indeed wasted little time in building out vast fields of wind turbines. [2]
The end of long-established hegemonies
Coal, oil and gas have long enjoyed an unassailable monopoly as the sources of energy powering modern commerce, with the exception perhaps, of nuclear. The extraordinary challenges surrounding nuclear fusion have limited its impact, barely affecting the fossil fuel-based generators. The causes and consequences of nuclear’s rocky road through the late twentieth century are worthy of further analysis, but for the purposes of this discussion, let’s focus on the de facto domination of the fossils.
With government support, energy companies have long enjoyed a profitable position. The bargain made in the early days of electrification between the utilities and government made sense, given the size of investments needed and the uncertainties (i.e. risks) associated with very large infrastructure like coal-based power plants. The deal was simple — the power companies would borrow government money and build large facilities where they would make electricity, pledging to do so responsibly, to offer customers a fair price and to manage their enterprises in accordance with the principles of good governance suiting that of a key provider of the lifeblood of business. In exchange, the government would provide loan guarantees, tax credits, land and rights of way. In addition, the power companies were to be insulated from the vagaries of the market - they were guaranteed a minimum return on their capital.
A guaranteed return on capital is as juicy a deal as any oil-blooded capitalist could want. Fat profits in the good times (no cap! [3]) and a comfortable safety blanket in the bad times (minimum return!) meant that energy company stocks were a safe place for people with money. Those guaranteed profits made for predictable dividends as well, giving pension funds a safe place to park their funds, without requiring a lot of risk analysis work, because after all, government-guaranteed returns, amirite?
Capture, prisoners, defectors and death spirals
The autonomy of self-owned power sources such as solar panels and batteries threatens some long-established arrangements, most notably that of the electric supply companies. Energy supply companies have long had a reliable source of revenue from customers — they generate electricity (or provide gas) and customers pay for that energy. Energy companies don’t need to worry about customer defection because there’s only one energy company. At least, that has been the situation since the energy utility model became the arrangement for most consumers in the US. The arrangement has traditionally been that utilities won’t gouge their customers because the regulators set the energy price and in return the utility companies can remain monopoly providers.
In theory, the regulator-set price protects customers. In practice, regulatory capture means that the customers’ interests are de-prioritized in favour of the utilities’ profit margins. Generally, economic orthodoxy suggests that treating one’s customers poorly incentivizes them to seek out alternatives. Until recently, electricity customers have had precious few alternatives. Cheap solar panels and expensive electricity offer interesting new opportunities to electric customers. Solar panels’ price trajectory has followed a widely-predicted downward trend, surprising only on the lower bound. Just when you thought panels couldn’t get any cheaper, some Chinese factory finds a way to shave a few more cents off the cost, all the while squeezing out a few extra fractions of a percent increase in output. While panels have been costing less, regulators have been using their cozy regulator relationship to keep increasing electricity prices.
What was a seven year break-even period for panels a year ago is now a six-year (or fewer) break-even. For many (most?) potential solar customers, the decision has been about break-even and payback. How long will it take to recover my outlay? The “must pay back” mandate is baked into most installer discussions with potential customers. It drives most purchasing decisions because, in the US at least, installation costs are high. As the cost per kWh from the utility goes up and the cost per kWh for panels goes down, it doesn’t take long before customers that were previously not able to recoup their costs are looking back and thinking “if only I’d installed those panels two years ago, I’d be in the black already”.
The more the utilities tightens their grasp, the more customers slip through their fingers [4]. This is a very real and very serious problem — for each customer that begins generating their own power, the utility must find some way of making up those lost revenues. Practically, that make-up revenue must come from the existing customers, because there are precious few new customers being minted. Instead, already burdened customers must shoulder a larger burden of the costs, which are now spread across fewer consuming households and businesses. This, in turn, decreases the marginal threshold of defection — the point at which it is more economic to leave the grid and produce one’s own power than to stay and pay ever-increasing rates. Again, in turn, the next marginal defection is realized, and onwards, each defection seeding the next. Very quickly, the utility begins losing customers at a rate that makes it hard to perform essential system maintenance tasks, imperiling the stability of the generation and delivery infrastructure for the remaining customers.
It is only a matter of time before customers see the arbitrage opportunity and enter the electricity generation marketplace as competitors, for after all, who doesn’t like guaranteed returns?
This is the Utility Death Spiral.
Capitalists will probably clutch their pearls and bemoan heartless and greedy customers, and the irony in that would certainly be heavy. There is an easy solution to this problem though — as a utility, take advantage of the cheapness of solar panels. Install fields of panels and use that extremely cheap energy to lower rates, and thereby raise the marginal threshold of defection.
While we could spend a few more paragraphs on this interesting problem, we’ll leave a more detailed exploration of the defection problem for the future. Instead, let’s return to problem of dissolving hegemonies, which is the death spiral problem write large. Energy companies are overwhelmingly, today, fossil fuel companies, in reality if not in name. A gas peaker plant needs to burn gas, which it prefers to buy from a friendly supplier. Coal plants, while generally in decline, still need coal and someone’s coal mine is still digging it up. These supplier relationships are very old, some dating back to the beginning of the previous century. Those profits have founded dynasties, funding generations of wealthy families. Those folks are not keen on losing those guaranteed profits.
This is problem of anachronisms in the making. Old fossil fuel wealth pipelines are going to be extremely resistant to change. In all likelihood, they will continue being fossil fuel companies long after the world had chosen to leave them behind. They will become anachronisms, manifestations of a prior age, reminders of a profligate past.
The oil burners in our neighbors’ garages, more death spirals
Similarly to the coal, oil and gas companies, traditional ICE companies will stare into a future that will not come to pass, until they too collapse. As we now see the EV migration gaining momentum, several second-order effects are beginning to emerge. Slowly now perhaps, but soon more rapidly.
Marginally profitable gas stations will close as the gasoline car customer base shrinks. Soon, gas car owners will find it becoming more difficult to get gas. There will be fewer and fewer stations open. Once a certain threshold is passed, even die-hard holdouts will simply choose an EV and begin charging at home like everyone else. For each ICE owner that defects to EV, the marginal cost of EV defection drops, effectively creating a gas station death spiral.
With each additional home charging station installed to support a new EV, solar panels become ever more enticing, for the real value, the “killer app” of home rooftop solar, is home EV charging. It won’t take long for a new EV owner to realize that simply installing solar panels makes their driving free, forever. It is this ineluctable sequence of decisions that will change the landscape of rooftops everywhere. As people transition to EVs, they will install panels. As they install panels, they will also install batteries. Once they have batteries, they will become de facto power generation companies.
Once enough EVs are sitting connected to the grid, we’ll find that neighborhoods have enough batteries to effectively form their own grid. At this point, the utility companies will become anachronisms, for decentralized, community-scale generation and storage will be sufficient to run entire communities. At that point, the lumbering fossil behemoths will be nothing more than ghosts from a past that we have left behind. They will become the modern equivalent of the horse drawn carriage. We may even keep one or two of them around to show our children what we did.
The time of oil has passed.
[1] Ignoring, for the purposes of this discussion, the complexities of nuclear deterrents and other non-oil influence mechanisms of geopolitics. That’s not to say those arguments aren’t valid, bur rather that they do not materially dilute the argument made here.
[2] As of 2023, 63% of Denmark’s energy comes from wind and solar. Notably, their energy demand decreased year over year from 2022 by 1.1%. Decreasing energy demand due to efficiencies in generation is a topic we will explore in more detail.
[3] Actually, there is effectively a cap on direct profits due to the utility needing to get regulatory approval for price increases, thereby fulfilling the “fair price to customers” part of the deal. While this is theoretically a cap on profits, there are several other avenues for revenues that don’t carry the same kind of oversight, or less rigid oversight. One of these approaches is to keep adding additional capex, like adding a turbine or building a reactor, the costs for which are added to customers’ bills. Several nuclear plants have been financed this way (Vogtle, we’re looking at you).
[4] As Princess Leia so presciently forecast.