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Perspectives

The UNC Kenan-Flagler Energy Center- What We Do and Don’t Do

collage of various energy sources

by Stephen Arbogast

This January will mark the 5th anniversary of the Energy Center’s creation and the launch of its associated Energy MBA curriculum.  During this time, our missions have crystalized.  We can now offer this articulation of what we do, and don’t do, for the benefit of prospective students, our event participants, readers of our research and firms recruiting our graduates.

Our program is built around certain needs not being filled by other players in the field.  These needs concern two topics: 1) the Energy Transition; and 2) the Business of Energy. We see the former as not being approached in a clear-eyed fashion.  As for the latter, it is largely neglected at MBA schools.

The Energy Transition is a term applied to a necessary evolution in how energy is created and supplied to the global economy.  Today’s dominant narrative defines this as the changes needed to stave off global warming.  Typically, this is depicted as requiring a massive shift away from using fossil fuels, one requiring dramatic buildouts of wind/solar/storage, energy conservation and life style changes.  In our view, the pathways offered to achieve this are characterized by shaky assumptions and wishful thinking.

As for the Business of Energy, it is undefined at today’s business schools.  There are several Energy MBA programs, but these typically cluster around a sub-set of the industry.  Some schools feature numerous courses on renewables, but few on oil and gas.  The converse is true elsewhere.  Despite the fact that these are ‘business schools,’ there is no systematic effort to distill what uniquely characterizes energy as a business, and what are the keys to making money across its value chain.

There are understandable reasons why these gaps exist.  Many faculty care deeply about climate risk; they feel it is imperative to be part of the solution by promoting transition.  Other schools have deep historic ties to oil and gas, and legitimately believe these industries will continue to contribute to modern economies.  In almost all cases, there is a belief that different segments of the value chain are so different that there is little point in generalizing about the business of energy.

We however believe that the enduring existence of these gaps handicaps our understanding of the Energy Transition and our training of the next generation of industry executives.  To overcome these hurdles, we have made several changes in approach.

As regards the Energy Transition, we do not reason backwards from the desired climate outcome and lock into a pathway that might succeed.  Such an approach ignores the fact that other very big issues contend with climate for priority.  Poverty, economic growth and development, and energy security are examples of very existential issues which cannot be ignored when navigating the Energy Transition.  Attempting to do so invites resistance, backlash and ultimately lost time and effort.  Second, there needs to be more humility around the viability of proffered solutions.  Those, for example, espousing economies based on ‘100% renewables’ need to be more realistic and honest about what this will cost, how they will back up intermittent power, and the time and political changes it will take to impose massive disruptions on existing industries and consumption patterns.  A more ‘clear-eyed’ approach would see these obstacles as so formidable as to suggest new thinking is needed.

As for the Business of Energy, we disagree with the view that segments are so distinct as to render generalizing about the energy industry of little value.  We see all segments engaged in both competition and cooperation/integration with surrounding sectors.  Commercial success often lies in determining which adjoining segments offer opportunities versus posing serious threats.  Understanding these fundamental realities can be the key to profitability and even survival.  That understanding requires a basic knowledge of all value chain segments and the characteristics shared in common.  Only then are each segment’s distinct features placed in proper perspective.

To distill the Business of Energy fundamentals, we focus on the full value chain and those commercial characteristics shared by all segments.  This begins with recognizing that energy is a commodity business.  Business schools neglect commodity businesses.  They find them unflashy industries characterized by basic blocking and tackling.  Despite its importance, energy gets caught in this business school blind spot.  We seek to correct this by applying a commodity business framework across the energy value chain and seeing what it tells us about the keys to making money.

Like all commodity businesses, energy competition takes place on a ‘unit cost of production’ basis. Left to compete, the low cost producer will typically win. Like other commodity businesses, there is also an absence of product differentiation.  This leads to price competition and dramatic price fluctuations over the economic cycle.  These characteristics promote a ‘high death rate,’ i.e. a long list of energy firms no longer in business. Sustaining long term financial strength is thus a critical success factor when competing in energy.  Commercial and financial strategy must be long term in nature and integrated.

Energy however is a special kind of commodity business.  It is strategic, the building block for all other economic activity.  This fundamental importance attracts a high degree of government attention.  Sometimes this takes the form of intense webs of regulation, sometimes of intentionally de-regulated free markets.  In various times and places, sanctioned monopolies and state firms are allowed to dominate the market.  These realities create a new dynamic – sometimes market place competition is replaced by optimizing within regulatory frameworks while seeking to influence regulations in one’s favor.  Energy firms must thus integrate public policy goals into strategy, both for their own sake and as a necessary component of successful interaction with the authorities.

Finally, all energy segments are characterized by large ‘externalities,’ i.e. costs not recognized in market pricing and which are transferred to society at large.  Climate risk and pollution are two examples of such externalities.  Their existence heightens government interest in regulating the industry.

Thus we teach The Business of Energy as a commodity business whose foundation is unit cost competition. The keys to commercial success lie in a firm’s long term unit cost strategy, its financial soundness and a constructive engagement with the authorities.  All segments of the energy business share these characteristics.  What varies is the intensity and focus of government intervention by location and segment; however, even the most regulated firms will ignore unit costs at their peril while those least regulated must always consider how industry dynamics may invite governments to alter their market’s laws and structure.  Ignoring externalities intensifies this invitation.

How then does our ‘Business of Energy’ framework inform our approach to the Energy Transition?  This starts with noting the capital intensity of unit cost competition in energy.  Said differently, the energy business is hugely about increasing scale in pursuit of lower unit costs.  This means that strong cash generation is essential to accomplishing an energy transition.  Sustaining low unit costs is essential if energy firms are to realize the capital formation necessary to finance transition.  Costs will also matter to ensure that energy consumers do not feel growth is being sacrificed or that the burdens associated with future climate benefits are too heavy to bear in the present day.  Getting this wrong will lead to intensified political resistance, slowing the changes needed for timely progress on climate.

This perspective emphasizes that priority should today be given to those actions which a) achieve demonstrable GHG improvements at the lowest cost and b) lower the costs of impactful solutions, rendering them cost effective.  Examples of the former include continuing the substitution of natural gas for coal in power generation, growing the international LNG business, extending the lives of current solar and wind farms, promoting continued regional integration of the electricity grid, and avoiding the shutdown of sound nuclear plants with remaining economic life.  Examples of the latter include removing excessive review and recycle from the new nuclear plant licensing process, embracing a national storage solution for nuclear waste, revisiting the regulatory framework around hydroelectric projects, mandating an urban buildout of electric vehicle recharge stations and ceasing undifferentiated opposition to all pipelines in favor of facilitating those which safely transport natural gas and C02.

Collectively these actions would enable dramatic progress on GHG emissions on the basis of sound economics, largely carried out by the private sector entities who would then operate the new facilities.

The energy business’ cost trajectory also shows that technology is evolutionary rather than disruptive.  Energy is not I-phones.  One need only look at IEA forecasts showing 2040 global coal demand hardly changed from today to realize that energy is very resistant to technical disruption.  This means that energy transition plans built around rapid disruptions via new technologies likely rest on shaky assumptions.  If so, they are illusory and point away from achievable progress.

This view of energy technology leads to a final point – we need to admit we don’t have all the technology and policy approaches we need.  Admitting this out loud enables the Energy Center to take a ‘learning approach’ to the energy transition.  If we don’t have all the necessary answers, let’s begin asking the right questions without a preferred solution in mind – this lets us attack the questions with an open mind and see what a straightforward approach to inquiry can uncover.

This approach is the core ethic of the UNC Kenan-Flagler Energy Center.  We reembrace the university’s traditional mission – open minded inquiry – to follow the facts where they lead.  Our conferences are built on this foundation.  In 2016, we asked if the U.S. fracking revolution would ‘go global.’ The answer – not any time soon – has been confirmed by subsequent events.  In 2018 we sought to calculate the ‘all-in costs’ for wind/solar plus storage when used as baseload generation.  The answer – not declining; rather, increasingly costly and ultimately excessively so – has slowly become accepted in the public domain.  We also cited the Energy Information Administration’s and Lazard’s reported ‘Levelized Costs’ of wind/solar as seriously understated.  This too has increasingly been recognized. Most recently we examined emerging technologies in carbon capture utilization/sequestration (CCUS), and found them facing formidable challenges; consequently, we identified the tax credits incentivizing CCUS as structurally flawed and argued they will not work as planned.

Approaching key Energy Transition issues in this fashion promotes ever sharper clarity about what will and won’t work.  It also identifies the next set of questions which need inquiry.  Our recent events identified long duration electricity storage as an important enabler of greater wind/solar penetration. That led to a question – is there a potential storage breakthrough in the pipeline?  Our next event will examine possible breakthroughs, to include new battery designs and very long duration options like pump-storage hydro and compressed/liquid air.  This event will happen in November 2019. Another set of questions concerns whether any electricity de-carbonization plan can work without new nuclear energy. Next year we plan a conference to reconsider the role of new nuclear and the need for a renewed dialogue among the nuclear utilities and their historic critics.

This approach to energy issues and education will not make everyone happy or comfortable.  It means that the Energy Center is not on ‘anyone’s side.’  What we do is seek out to most effective means for carrying out an Energy Transition that also serves the traditional needs of energy consumers.  Our approach rests on the belief that the means for doing this are not obvious, and need to be figured out by asking the right questions in a clear-eyed manner.  This is what we do.  What we don’t do is believe that the answers revolve around a single issue, that we know then what needs to be done, and that our principal task is one of conversion rather than research and education.

10.11.2019