No. 42 - One-Trick-Pony Investing, An Energy Investment Framework.
One-Trick-Pony Investing
There's many ways to make money in the investing business.
One way is to immerse yourself in a high growth field, spending a lot of time to find the right company that crushes it over time. Usually high growth fields come with high variance in returns - i.e. for every Tencent, there is a graveyard of thousands of Chinese internet companies.
Tencent created billions of dollars of value. The graveyard destroyed billions.
If you knew that Search and Advertising would become massive fields, you'd do well to specialise and look for a future Google. (Of course many people who invested in Google really had no idea what they were doing, but are still wildly respected for their investing acumen. That's another story altogether!).
The other way is to learn many different little tricks - the Swiss-army-knife approach - and use a different one when the opportunity arises. This way is obviously harder to use in the beginning of an investing career. After all, you most likely don't know more than one trick in the beginning (i.e. buying an index fund, or shares in a local company you know well).
Over time, with a generalist approach, you add new tricks to the bag. Each year you probably get a chance to learn a new trick, and maybe even use one or two. This way I believe that a good generalist investor gets better over time. However, paradoxically, if they're too good, the size of capital they have to manage grows - and reduces go-forward returns. Or the tricks that worked in one year, but is not repeatable in a future context (e.g. the Graham net-net strategy worked in the US in 1950, but probably wouldn’t work as well in the US in 2023).
The game never gets boring!
Energy Investment Framework
We want to find the right ideas to change our energy system, rather than ideas which sound good but in reality do the planet harm.
I recently read "The Unpopular Truth About Electricity and the Future of Energy" and finally understood how we can move beyond the LCOE (Levelized Cost of Energy) calculation to then find the true cost of energy sources - primarily when we pit fossil fuels against renewables.
The book suggests employing a more detailed EROI (Energy Return on Investment) calculation to look at the full costs of manufacturing and running an energy asset.
There are many factors which are important to pay attention to (per TWh of energy produced) when choosing which type of energy makes sense in which context:
Cost of building equipment - E.g. the construction costs of a gas plant, or the cost of building wind turbines.
Cost of Fuel - E.g. uranium to power a nuclear plant. However, with wind and solar, the fuel is free.
Cost of Operating - cost of people, maintenance and repair, and any other running costs.
Cost of Electricity Transportation/Balancing Systems - This cost rises with renewables, given they are inherently unreliable in both amount of electricity produced, and the timing of it.
Cost of Storage (and the full cost of building it if incremental storage is required for incremental wind/solar) - A massive cost with renewables, and involves the full cost of a battery supply chain. Storage cost is far lower in an energy system running on dispatchable power (e.g. coal, gas, nuclear).
Cost of Backup (VRE typically requires more since it is neither reliable or predictable) - diesel generators or other such plants are usually awful for the environment, but can be fired up immediately if the major power sources fail. Typically they are called upon when, for example, a nuclear or gas plant fails. However, increasingly they will be called upon more as solar and wind increase as a % of the total grid.
Cost to the environment (both GHG-related, and other costs) - Here the cost of coal vs. LNG is highlighted because while LNG has a lower CO2 component, it might actually have higher methane costs to the environment than coal). In addition, the environmental cost of building out conventional plants, or the battery or transmission supply chain that accompanies increased penetration of renewables in the grid.
Cost of Recycling and Decommissioning - E.g. Large costs to decommission nuclear power plants, and surprisingly large costs also to decommission and recycle old wind and solar parks.
Cost of Room (space considerations and trade-offs). - Solar and wind take up space - and while they are a small % of the total grid, this cost is not high. Trade-offs start to occur when land needed to produce energy start to take space from other important land uses such as agriculture. The same goes for the fuel supply chain. It might be that a coal plant doesn't take up space - but the open-cast mine used for fuel takes up large amounts.
Cost of materials over their lifecycle (not to double-count other costs mentioned above) - many energy installations require replacement of parts or large structures, and these costs have to be counted in over the lifecycle of a plant or wind/solar park.
Economic and geopolitical considerations - For example, Germany's deindustrialization due to high power prices will have adverse consequences for decades to come. This has consequences for standard of living over the long run. In addition, if a country totally relies on one source of fuel (even if low cost) they are geopolitically vulnerable to supply shocks if their relations sour with key fuel-producing countries…. Ahem… Germany again.
It's hard to get accurate information for each variable, but then (and only then) can we definitely say which energy source is actually better for the environment - and which is better in each context. But here’s how the current data looks:
Nuclear, Hydro, Coal and Gas provide high EROI.
Wind, Solar and Biomass, as a group, fall below the energy requirement (red line) required to run a modern society. In other words, they’re not large net energy contributors to civilisation.
Another set of facts that was quite concerning was the sheer material cost of renewable energy sources, per unit of electricity they actually produce. Of course, this is only one element of the EROI calculation - but eye-opening nonetheless!
Though the authors of the book are clearly pro-fossil fuel, I quite like that other diverse opinions are finally being heard in the climate debate. However, I disagree with their assertion that wind and solar won't work in any case. I have seen a few instances where solar and wind can be a very sensible addition to the grid. However, it's still true that as they increase in % grid penetration the overall electric system becomes more expensive and potentially environmentally unfriendly due to transmission, balancing, and storage investments.