Disruptive Tech I: Decentralizing Power.
More and more electric devices are cordless, but you still need a cord for their recharging docks.
There certainly are more and more cordless electric-powered devices that must be recharged—phones, tablets, watches, and personal assistants, to say nothing of electric cars. It’s turned the power going into the cord into a hot commodity. Our addiction to these electrified gadgets combined with a growing global economy should mean these are the glory days for companies producing turbines that turn gas and coal into electric power.
However, both GE and Siemens recently reported their power turbine divisions have fallen on tough times. So this seems like an opportune time to plug into the current state of the electricity market.
I asked Jackie to investigate. Here is her enlightening report:
(1) Shocking results. GE’s new CEO John Flannery hosted an investor day recently to explain why results have been disappointing and to give investors some guidance about what the future under his leadership might hold. One of the company’s problem areas is its Power division, where operating profit is expected to fall by 20% this year and another 25% in 2018. The number of heavy-duty gas turbines it sells in 2018 is expected to drop to 65-70 units, which is down by about 30-40 units from this year, according to a transcript of the company’s 11/14 investor presentation. GE’s business of servicing its installed base of turbines is also under transactional and pricing pressure.
Russell Stokes, president of GE’s power business, laid the blame on the impact renewables have had on the power market. “Look, we understand very clearly that the gas markets are challenged by renewable penetration, but we still believe that gas is going to be an important contributor to the energy mix going forward, even though we believe that we’re going to see some significant declines on the need for gas and the utilization of gas in the short term.”
Siemens recently announced plans to cut 6,100 jobs, or 13% of the workforce in its power and gas unit, which manufactures turbines for utilities. Siemens said that worldwide demand for new, large turbines has fallen to about 110 units a year, while manufacturers have enough capacity to supply 400 turbines. In the fiscal year ended September 30, profits fell in Siemens’ power and gas unit.
Both companies find themselves with large exposure to the turbine market after making major acquisitions in recent years. GE’s purchase of Altsom in November 2015 for $9.5 billion made power its largest division. Meanwhile, Siemens announced in May 2014 the $1.3 billion acquisition of Rolls-Royce’s aeroderivative gas turbine and compressor business, followed by a $7.8 billion deal to acquire the oil and gas equipment supplier Dresser Rand in 2015.
(2) Power glut. An 11/16 article in Handelsblatt came up with two reasons for the glut: “When it comes to big power plants, a hoped-for global transition from dirtier coal to clean gas power plants has yet to materialize (perhaps that’s why Siemens joined other German companies in demanding an end to coal power last week). And when it comes to renewable energy, many companies favor smaller, decentralized power solutions to the massive gas turbines that Siemens once thought were the future.”
An 11/16 WSJ article concurred: “Siemens, like GE, has been caught unprepared for governments’ and companies’ shift away from large, fossil fuel-powered plants to renewables, which make electricity in a decentralized way and without the need to move massive amounts of steam through one of Siemens’s mighty turbines. Meanwhile, gas-powered plants haven’t picked up the slack from embattled coal and nuclear businesses as quickly as both Siemens and GE had anticipated.”
The number of global coal plants that started construction in the 12 months prior to January 2017 fell by 62% compared to the year before, according to a report published by CoalSwarm, The Sierra Club, and Greenpeace. Likewise, the number of announced, pre-permit and permitted coal plants fell 48% in the 12 months prior to January 2017 compared to the year before.
The reduction took place primarily in China and India, which together represented 86% of the coal power built globally from 2006 to 2016. “Over 300 GW of projects in various stages of development were put on hold until after China’s 13th Five Year Plan (2016–2020), including 55 GW of projects that were already under construction. A typical coalfired generating unit is 500 MW, or 0.5 GW, in size, with most power stations having two or more such units. In parallel with China’s government-imposed slowdown, India also experienced a slowdown in coal plant development, driven primarily by the reluctance of banks and other financiers to provide further funds,” the report stated.
(3) Where’s the growth? The overcapacity in the power business is even more notable because it’s occurring as the world’s economy is growing. The US economy picked up steam this year, with Q3 GDP coming in at 3.0% (saar), following a nearly identical 3.1% during Q2 (Fig. 1). Meanwhile, global GDP growth should be 3.7% this year, according to the International Monetary Fund.
Historically, rising GDP growth has led to increased electricity usage as populations grow and generate more goods and services. But that hasn’t been the case in recent years, particularly in developed countries.
The Energy Information Administration (EIA) attributes this new development to developed economies’ shift toward service economies and away from manufacturing, which is more energy-intensive. “As more economic activity shifts from lower-skilled manufacturing to services and higher-skilled advanced manufacturing, additional economic activity can be generated without requiring as much electricity use,” according to an 11/20 EIA report.
Indeed, the energy intensity of US manufacturing has been decreasing, according to a 10/19 EIA report. It states: “From 2010 to 2014, manufacturing fuel consumption increased by 4.7%, while real gross output increased by 9.6%—or more than twice that rate—resulting in a 4.4% decrease in energy intensity. … Although many manufacturing establishments are taking steps to reduce their energy consumption, the energy intensity decrease for total manufacturing is mostly the result of a shift of manufacturing output from energy-intensive industries, such as the manufacture of metals, chemicals, paper, and petroleum and coal products, to less energy-intensive industries. If major industries had maintained the same proportions of the manufacturing sector, the energy intensity decline between 2010 and 2014 would have been 0.7% instead of 4.4%.”
As a result, electric demand among the OECD nations is expected to grow 0.9% annually, while non-OECD countries are expected to show 1.9% annual increases through 2040, the EIA projects.
(4) Not so fast. If electric cars get adopted and go mainstream, this slow-growth prediction could quickly need an upward revision, estimates National Grid, which owns the UK’s national transmission network for electricity and gas. In England, electric cars could reach 9 million by 2030, up from 90,000 in July. If that occurs, it could reverse the UK’s falling electricity demand that resulted from increased efficiency of electric items. Demand could surpass the capacity of the Hinkley Point C nuclear power plant by 2030 if cars aren’t charged at off-peak hours, warned National Grid, in a 7/13 article in The Guardian. GE and Siemens certainly hope so.
(5) Charged up numbers. The S&P 500 Electric Utilities index has had a respectable year, gaining 13.9% ytd (Fig. 2). The industry is expected to enjoy 3% revenue growth and 2.7% earnings growth over the next 12 months (Fig. 3). But despite the slim earnings growth, the industry’s forward P/E has risen to 18.0, which is near the highest levels the industry has seen over the past 20 years (Fig. 4). Perhaps investors are instead focusing on the sector’s dividend yield.
Going forward, the industry’s fate may be determined by which grows faster: the electricity supplied by solar power or the demand for electricity to run electric cars. Had GE bought Tesla instead of Altsom, it would have been able to hedge its bet.
Dr. Ed Yardeni is the President of Yardeni Research, Inc., a provider of independent global investment strategy research.
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