European utilities: The second age of electrification

In McKinsey’s Transformation of Europe’s power system until 2050 the consulting firm lays out its assumptions which is only 40% power demand increase until 2050 as it assumes an annual 2% energy efficiency improvement. McKinsey sees a slightly bigger role for nuclear but it is still renewables that will drive the transition. Europe’s supply and demand regions will also decouple and McKinsey expect the current power pricing mechanism to be broken as the mix of renewable energy increases. In a Nordic energy report it is expected that electricity demand will rise 60% until 2050, so there is a wide range of forecasts on electricity demand.

All the forecasts above indicate a slow smooth progression to the end point in 2050. However, technology has a tendency to surprise and our view is that electrification will accelerate at a much higher rate than expected above. In this analysis from Denmark in 2020 the expectation is that electricity consumption will double towards 2030. Current Danish electricity consumption is 35 TWh with the following increase by 2030: +10 TWh from power-to-X, +9 TWh from heat pumps, +7 TWH from data centres, +4 TWh from cars, busses, and trucks, +3 TWh from other transportation, +2 TWh from expansion of North Sea oil and gas production (running production platforms) until 2030, and finally +1 TWh from trains.

The forecast above indicating a doubling seems more reasonable given the adoption rates we currently see from EVs and heat pumps. The average household electricity consumption in Europe is around 3.7 MWh. It is estimated that a heat pump use 4 MWh of electricity annually and the US Energy Department estimates that one electric vehicle requires 3.8 MWh per year of energy generation. Excluding any efficiency gains one household in the EU replacing gas heating with heat pump and replace one gasoline car with an EV will increase electricity consumption by almost 200%. Many households have two cars which over time will be EVs, so that is another increase. Electricity power generation will undoubtedly enter its second age of booming.

Opportunities in Europe’s utility sector

The utility sector can be broken into different parts. Utilities generate the main part of their electricity from an energy source which is either natural gas, hydro, solar, wind, or nuclear. Some companies are big in distribution while others have a lot power generation assets. Other companies are more project oriented such as Orsted which means that they deploy know-how and capital in building out a power generation asset such as an offshore wind power farm and then they sell it to infrastructure investors such as pension firms. Finally there are the electric equipment manufacturers.

One of the main features of the forecasts mentioned in the first section is that they all assume wind power to dominate the transition which might be the case if electrolysis costs come down enabling large scale green hydrogen production. It seems many are still underestimating solar which actually expected to grow in annual capacity from around 200 GW in 2022 to around 500 GW in 2026. Solar in many ways have shown better technology improvements that wind and it is less complicated to build out than wind power with less maintenance. In any case, the future is difficult to predict and an investors should be bet on many different energy sources.

As we have highlighted in other previous equity notes the electrification will create opportunities in other areas such as copper mining, lithium mining, electrolysis equipment, electric vehicle makers, wind, solar, fuel cells, batteries, and charging stations.

Electrification went into hyper growth with AC

The history of electricity is fascinating. It started in the years 1831-32 with Michael Faraday discovering the operating principles of electromagnetic generators. Later came the incandescent light bulbs invented by Joseph Swan in 1878 in the UK and by Thomas Edison in 1879 in the US with Edison’s proving to be more efficient. The first central power station is believed to be in Godalming, Surrey, UK in late 1881, and was hydroelectric power station illuminating streets of arc lamps and incandescent lamps. Then came the UK’s Electric Lighting Act 1882 setting up the regulation of power generation.

The first large scale power station in the US was Edison’s Pearl Street Station in New York in September 1882 which was powered by steam engines and by 1884 it supplied power to 508 customers with 10,164 lamps. The New York banker J.P. Morgan had been an early investor in Edison’s electric light company seeing the potential of this new technology. On Thursday, June 8, 1882, Edison Electric Company president Major Sherbourne Eaton wrote to Edison: “Morgan’s house was lighted up last night. I was not there but I am told that the light was satisfactory and that Morgan was delighted”.

The initial problems of electrification in the late 19^th century was the use of low-voltage direct current (DC) power stations which are not very efficient in transporting electricity over long distances. However, Edison’s many DC power stations would soon get a competitor in the form of high voltage alternating current (AC) power stations which could transport electricity efficiently over long distances and then use transformers to reduce the voltage so it could be safely used in households. This massively increased the efficiency of power generation and especially distribution enabling explosive growth in electrification. The competition between DC and AC has also been called the “War of the currents”.