Decarbonisation and the Energy Transition

By Perennial Partners | More Articles by Perennial Partners


Perennial Partners Portfolio Manager and Resources Analyst Sam Berridge discusses price caps on coal and gas, the energy transition, and decarbonisation opportunities for 2023.

Tim McGowen: We’re talking today with Sam Berridge, who is the Portfolio Manager and Resource Analyst at Perennial Partners. Now, the last time we caught up with Sam, we discussed the energy transition. We’ll continue with that theme today and also bring in the decarbonisation theme.

Sam, always good to talk to you. Thanks for your time.

Sam Berridge: Thanks very much, Tim. Pleasure to be back on.

Tim McGowen: Now, Sam, energy ministers have met in regards to price caps on gas and coal. What are your thoughts there?

Sam Berridge: This is going to be a disaster for energy security in Australia in the medium and longer term. I know that there’s a great deal of scepticism in the community about the oil and gas majors, and they’re only interested in their own profits. But when they say that there are going to be serious consequences for the energy price and energy security for Australia as a result of this policy, they’re absolutely right. And that’s because there is a clear precedent for what happens when you try and put a cap on prices in a particular market. It disincentivises supply, and we do need more supply. So there’s often a misconstrued or misunderstood view out there that we have enough gas production domestically to see us through this energy transition. And we don’t. Gas wells, oil wells and all commodity production has a natural decline. And, for gas wells, I mean, it varies between conventional gas and coal seam gas, but it’s somewhere around, on average, 8 per cent per annum. And that rate of decline is far faster than this transition from carbon-based energy to renewable-based energy is going to take place. And that means we need more wells drilled just to sustain supply of gas while we go through this transition period.

But putting this cap in place is going to disincentivise supply. We’ve already seen the gas majors pull back from offering gas under this mechanism. They’re going to need more clarity on what the price realisation is going to be. They’re going to need more clarity on their costs, being that they have a price cap that they need to operate under. And also, longer term, they need some clarity on what this reasonable margin is that the government’s alluded to in this piece of legislation. So, they’re not going to go and throw billions of dollars at developing new wells to replace the existing wells, which are running off, without some certainty around this. And this means there’s going to be a pause in investment, and Australia can’t afford that. We’re short of gas now, and if we don’t incentivise domestic supply, over time Australia will become more and more reliant on LNG imports to meet its own needs. And those imports are going to have to be at the market price.

So, it really is an own goal by the government on this one. It’s proven not to work the world over, and it’s going to cost Australians dearly, albeit more in the medium and longer term.

Tim McGowen: And, Sam, how does this all feed into Australia’s energy transition?

Sam Berridge: It complicates it. So, if gas is running out, then we’re going to have to replace that with something. I mean, people cannot go without electricity. And the options we’ve got at the moment are batteries and pumped hydro storage. But if we are looking at batteries as a firming mechanism or part of this capacity mechanism the government announced the other week, the cost of these batteries still isn’t anywhere near low enough to become a viable alternative to gas supply.

So, to put some numbers around that, if you wanted a battery that was big enough or a series of batteries that was big enough to supply the NEM with power for one hour, you’re looking at around about $25 billion per hour of storage for the NEM at the moment

And then the question goes, “Well, how much storage do we need?” And there’s numbers out there tossed around of one hour or two hours just to deal with the intermittency of renewable energy. But intermittency is not the big issue here. Seasonality is. And by that I mean, when we go into winter, people switch on their heaters, and the amount of energy that is required to replace that gas heating with electrical heating is monstrous. And we’ve seen Europe go through this exact same problem at the moment, where they hoovered up LNG cargos from all over the world to try and get them through the winter. To try and replace that with batteries or wind or hydro is completely unprecedented.

So, it does complicate the transition, and I think it’s probably going to make electricity more expensive than it needs to be through the medium term as we go through this process. And, when that happens, the political ramifications of that are going to be quite material, I think. And governments need to realise that you need to bring everybody along on this transition. You can’t sort of disregard the hardship that the lower-income-earners in Australia will experience through higher power prices, otherwise they’re going to start voting against it, and that’s going to slow the whole process down.

Tim McGowen: And of course, looking globally, where are the opportunities in 2023 given this kind of decarbonisation theme?

Sam Berridge: I think, in calendar ’23, the big stories in decarbonisation is, one, going to be stationary storage. I think that as a theme is going to start to displace EVs as the big driver of metals demand for the decarbonisation process. We’re starting to get little glimpses of that at the moment. Companies like Gangfeng and others in China have been referring to very strong demand in stationary storage. And that’s being driven by the fact that, from between 2019 to now, power supply the world over is becoming more expensive and it’s becoming intermittent. And so by that I mean we have had instances of load-shedding events where market regulators the world over are forcing companies and industrial enterprises to reduce their power draw.

So, if we start looking at power storage, not through the lens of cost saving, but through the lens of foregone revenue, the economics of storage change remarkably. And that’s why we’ve seen power storage go exponential in installations in the US, in China, in Europe. And there is a huge backlog of applications in Australia for stationary storage grid connection.

So, it’s coming off a low base at the moment. I estimate it’s only about 5 per cent of lithium demand. But it is doubling year on year, and it is a huge addressable market. Transport is roughly 20 per cent of global energy demand. Stationary storage speaks to pretty much everything else. So the other 80 per cent there is the addressable market. So, it’s much bigger than EVs and it’s just getting started.

In terms of other commodities to look out for, I think that graphite is looking very interesting for calendar ’23. The proportion of graphite demand attributable to batteries is pushing up towards 50 per cent. And it’s at about that stage that the lithium price really took off. When battery demands got to about 50 per cent of overall lithium demand, that price really started to move. The graphite price has started moving, and I think it could really outperform over calendar ’23.

Tim McGowen: And just to finish, Sam, how are you playing these themes from a stock-specific basis given the mix of commodities used in this kind of decarbonisation and energy transition theme?

Sam Berridge: Well, we’re certainly putting a few fingers and toes into earlier-stage graphite companies. I mean, we prefer to invest a little bit later on down the path. I mean, Syrah (ASX:SYR) is the big graphite play on the ASX, but I mean, we’re just a little bit wary of Mozambique exposure. So, try as we might, we try and invest in probably a safer geopolitical jurisdiction. But being that these companies are reasonably early stage and they’re only quite small, I’ll probably leave the tickers for another time until we’ve got ourselves established in these positions. But, certainly, there’s some stocks to look out for.

But also, in terms of bigger plays throughout calendar ’23, this China reopening is really big news for the base metal space. Base metal inventories are at record lows in broad brush terms, with precious few exceptions. And I think if we get this demand uptick from China from the reopening, there’s not much of a buffer there in terms of metal inventories to cushion that period of deficit markets where demand exceeds supply, and we could see some quite spectacular price action over the course of calendar ’23.

Tim McGowen: Sam, thanks for your time. Always good to talk to you. Speak soon.

Sam Berridge: Thanks very much, and a pleasure to be back on. Thank you.