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The interdependency of energy and technical progressThe controlled shift among primary energy sourcesEnergy efficiency – the best alternative energy “source”The investment implications of five key trends

Investing in the future with energy The investment implications of shifting energy trends

UBS research focusCIO WM ResearchAugust 2012

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Investing in the future with energy – The investment implications of shifting energy trends2

UBS research focus

This report has been prepared by UBS AG.

Please see important disclaimers and disclosures at the end of the document. Past performance is no indication of future performance. The market prices provided are closing prices on the respective principal stock exchange. This applies to all performance charts and tables in this publication.

PublisherUBS AG, CIO WM Research,

P.O. Box, CH-8098 Zurich

AuthorsDirk Faltin, Economist, UBS AG

Rudolf Leemann, Analyst, UBS AG

Carsten Schlufter, Analyst, UBS AG

Alexander Stiehler, Analyst, UBS AG

ContributorJürg de Spindler, Economist, UBS AG

EditorsAndrew DeBoo, Anna Marie Focà

Editorial deadline22 August 2012

Project managementRéda Mouhid, Sita L. Chavali*

DesktopCIO Digital & Print Publishing

PicturesDreamstime

PrinterFotorotar AG, Egg, Switzerland

TranslationCLS Communication, Basel, Switzerland

LanguagesPublished in English, German, Italian,

French, Spanish and Portuguese

[email protected]

UBS homepage: www.ubs.com

*We would like to thank Sita L. Chavali,

an employee of Cognizant Group, for

her assistance in preparing this research

report. Cognizant staff provide research

support services to UBS.

SAP-Nr. 82092E-1202

Contents

Editorial ..................................................................................................... 3

Highlights .................................................................................................. 4

Chapter 1

The interdependency of energy and technical progress............................... 6

Chapter 2

The controlled shift among primary energy sources .................................. 10

Chapter 3

Energy efficiency – the best alternative energy “source” .......................... 20

Chapter 4

The investment implications of five key trends .......................................... 27

Appendix

Bibliography ............................................................................................ 32

Selection of research publications ............................................................ 33

Order or subscribeUBS clients can subscribe to the print version of UBS research focus via their client advisor or the mailbox:[email protected] subscription is also available via the CIO WM Research portal on the UBS e-banking platform.

UBS research focus August 2012 3

Dear readers,

The Kyoto protocol is the only binding treaty in international law on reduc-

ing greenhouse gas emissions. Some signatories may miss their reduction

targets at the end of 2012. The United States never ratified the treaty;

Canada walked away from it. Other international efforts to promote action

on climate change in Copenhagen and Cancun achieved few tangible

results. The question of how to meet the world’s energy needs nevertheless

remains a pressing issue. The nuclear accident at Fukushima in Japan also

placed a question mark over energy policies in various countries.

In this UBS research focus we take a look at the ongoing changes to the

energy landscape and identify the key implications for investors. In the first

chapter we look at the historical background of these changes, explain the

basic principles of energy economics and provide some essential insights

into the changing energy landscape. Chapter two deals with the drivers and

trends for various energy sources and identifies opportunities. In chapter

three we look at energy efficiency, while the final section summarizes the

most important investment recommendations.

We hope you find this report an illuminating read.

Editorial

Loris Centola

Philippe G. Müller

Loris CentolaCo-head UBS CIO WM Research

Philippe G. MüllerCo-head UBS CIO WM Research


Hardly a day goes by without the issue of energy making the headlines. Fluctuating prices, supply security, oil reserves, environmental damage, environmental disasters, waste disposal, security, renewable energy and energy efficiency have all unleashed a hefty debate and discussion. We analyze the changing energy landscape in order to identify the key implications for private investors.

The energy shift – that is, the effort to make our energy supply increasingly sustainable – has shaped the whole of human history. This includes modern renewables like wind, solar, hydro, bio and geothermic energy as alternatives to fossil fuels such as oil, natural gas or coal, as well as nuclear, where security and disposal are issues.

The changes affect not just primary energy sources. It is also a question of boosting the effi-ciency of producing and processing energy – how energy sources are converted into usable electric-ity – and the efficiency of consumption. Techno-logical advances will largely determine whether there will be bottlenecks in energy supply over the next 20 to 25 years. These technological advances can expand the range of energy sources while also improving efficiency.

Governments in many countries are promoting the use of renewable energy. But the contribution from wind, solar and other forms of sustainable energy

is not likely to be significant. They release no greenhouse gases, but their ability to produce energy is subject to major fluctuations: the wind does not always blow, nor does the sun always shine. These forms of energy are still expensive, and storing them presents particular problems.

Fossil fuels will therefore continue to dominate supply also through 2030. The market share of coal will grow until 2020, particularly as China, India and Indonesia have their own reserves. From 2020 the growth in coal will probably start to diminish, given that environmental issues should take on increasing importance. Oil is also likely to lose market share. Natural gas will become more significant, as it is environmentally friendlier, avail-able and cheap. We expect it will be the only fossil fuel whose share of the mix will be higher in 2030 than it is today. It will also become the most important primary energy source.

But energy efficiency will also play a greater role. Whenever energy prices rise, energy efficiency is taken more seriously. According to the Interna-tional Energy Agency, energy consumption today would have been more than 60% higher had energy efficiency not taken on greater signifi-cance after the first oil crisis in 1973. The greatest potential for reducing CO

2 emissions and conserv-

ing fossil resources comes from increasing energy efficiency among end consumers.

Investing in the future with energy The investment implications of shifting energy trends

Highlights


Investing in energy stocks is seen as defensive. Many companies have relatively stable revenues and pay attractive dividends. We expect the energy sector to show modest but steady growth over the long term. As energy is indispensible to the way we live, we consider an investment in the energy sector to be a long-term investment. The most interesting investments are equities and investment funds, as well as bonds and invest-ments in private equity. Equities include tradi-tional companies in the energy sector (oil and natural gas), along with electric and gas utilities and industrials (power plant builders, renewable

energy and energy effi ciency). One argument for investing in bonds in the energy sector is that they oft en have a good credit rating. Most top-tier oil and gas companies are rated AA or A, and utilities A. Companies oft en have better rat-ings than some countries and are therefore an attractive alternative. Another possibility is to gain exposure to privately held companies in the energy sector through private equity funds. There are some 400 investment funds around the world that invest in the energy sector. The return there-fore depends on making a careful choice.

15,000

12,000

9,000

6,000

3,000

01965 1975 1985 1995 2005 2011

Historical primary energy mix

Source: BP Statistical Review of World Energy June 2012, UBS

OilCoal

Natural gasAtomic energy

Hydro powerOther (including renewable energies)

In million tonnes oil equivalent

Investing in the future with energy – The investment implications of shift ing energy trends6

The interdependency of energy and technical progress

The energy shift is not a new phenomenon. It has been a characteristic driving force throughout human history, generally chang-ing society steadily but sometimes also in an abrupt and sudden manner.

Early mankind was entirely dependent on muscle power as a primary source of energy, but other important sources such as fi rewood and the strength of domestic animals were soon identi-fi ed. On the eve of the industrial revolution in the 18th century, the most important sources of primary energy were water and wind power, which drove simple mills. The invention of the steam engine in the late 18th century turned coal into the main source of energy, and the large-scale exploitation of oil fi elds got under-way in the early 20th century. Natural gas came a little later and atomic power has been an important source of energy since the 1970s. We now also have renewable energies like wind and solar power.

The shortage of resources and a stronger envi-ronmental consciousness spawned a develop-ment of trying to use energy more sustainably. These eff orts are characterized as energy shift s. This includes modern renewables like wind, solar, hydro, bio and geothermic energy as alternatives to fossil fuels, such as oil, gas and coal, as well as to nuclear energy. Great importance is also attached to energy effi ciency, which aims to slow the increase in demand by improving usage. The energy shift refers to both a switch in primary energy sources (the mix) and also the entire energy value chain. It aff ects the production of energy sources and energy processing, i.e. con-verting energy sources into usable electricity (or other products), and also how that energy is used or consumed.

Chapter 1


Energy, the master resourceThe economist Julian Simon called energy the “master resource.”1 It is a requirement and ele-ment of all human activity. If infinite usable energy were available, there would be almost no limits to economic growth. Without sufficient energy, economic activity, growth and progress are restricted. Usable energy is an economic good in short supply. The key factors are the level and change in the shortage over time. The extent of the shortage determines the price. The less usable energy there is available, the higher the price, and vice versa. Of course, the effect of the price as a signal of shortage can be switched off, at least temporarily or in part, by subsidizing commodity and energy prices. An artificially low price suggests that some commodities or energy sources are available in greater quantity than is actually the case. We will look at government intervention in the energy market in the second chapter.

The availability of commodities and energy sources is estimated by means of technical or economic forecasts. Technical assessment of com-modity sources and their availability involves extrapolating from current rates of use and deducting this from energy sources physically held, such as oil reserves or coal stocks. Factors like the growth in the global population and ris-ing urbanization are taken into effect.

As commodity deposits are physically limited, each unit used reduces the amount held. Also, easily accessible deposits are generally exploited first.2 Production therefore becomes more techni-cally challenging, and more expensive, over time. The world population is rising, as is urbanization and development, so the rate of usage is also rising constantly. Not surprisingly, therefore, this technical approach to estimation nearly always concludes that commodities and energy sources are becoming increasingly scarce and their prices will have to rise with time.

Historical data shows a surprising trend, though. Over the long term, for example, the prices of coal, oil or energy (in units of electricity) have fallen relative to income growth and the con-sumer price index. This also means that commod-ity reserves have fallen less over time, at least relative to other goods.

Contrary to the technical forecasting approach, which frequently does not identify this trend, economic models tend to be better at forecast-ing. They are generally based on historic price trends. Unless there is a reason to assume that the future will be fundamentally different from the past, price trends are projected into the future, with a few adjustments. The advantage is that these models implicitly incorporate the effects of technical progress that are (ironically) ignored in most technical forecasts.

Technical progress and the energy value chainThe availability and price of commodities, energy sources and energy in general depends on techni-cal progress. At the first step of the energy value chain, technical progress makes it possible to access entirely new energy sources. Think of oil, which had almost no practical use before 1850. It took technical innovation for it to become usable and make it into an economic good. The same may apply to other commodities that might be


What is energy?

The term energy comes from the Greek words “en” (“inside”) and “ergon” (“action”). Energy is often described as the capacity to perform work or generate heat. Energy is expressed in various units: kilocalories when talking about food, kilowatt hours when measuring electricity. Energy con-tained in naturally occurring sources – such as coal, oil, natu-ral gas, minerals, the sun, wind, water, biomass and geo-thermal energy – is referred to as primary energy. Only a small proportion of primary energy can be used directly by consumers without conversion. Most primary energy is therefore converted into secondary energy in the form of electricity, wooden pellets, heating oil or district heating by a process of transformation in power plants, natural gas and district heating plants, biofuel plants and other (sometimes combined) facilities. When this secondary energy is supplied to the final consumer it is referred to as final energy.

1 Simon, J. (1998)2 This phenomenon was described by the economist David Ricardo in the early 19th century and is partly due to rational human self-interest. It is also linked to the law of diminishing returns, which states that, above a certain level of factors of production used, the addition of further factors, such as labor, reduces the marginal return. So over time the marginal return from top-class arable land or mines declines, and land and mines of lesser quality come into use.


possible to use as energy sources in ways com-pletely unknown to us today. Technical changes such as horizontal drilling and hydraulic fracturing (known as fracking) also make it practical to exploit physical forms of energy sources that are known but have not previously been usable (such as shale natural gas and oil as well as tar sands). Technical progress adds further to reserves of known energy sources by making it possible to better exploit existing reserves or access reserves previously considered inaccessible (such as by deepwater drilling).

Technical progress is also important at the second step of the energy value chain, because there are losses in converting primary into secondary energy and transporting it to consumers.7 The energy loss in the value chain is expressed as a degree of efficiency.8 For fossil fuels, processing natural gas in combined cycle power plants is one

Chapter 1

of the most efficient types of power plants, with an efficiency level of almost 60%. In other words, there is probably still scope for raising efficiency at many types of power plants. The key point here is that the savings in secondary or final energy result in much greater savings in the amount of primary energy input.

Technical innovation, efficiency improvements and savings have an impact at all levels of the value chain. This starts with distributing the energy to end users through smart grids that are

Is there a limit to growth?

Ever since the industrial revolution people have been worry-ing that essential commodities and energy sources might soon be exhausted. In the early 19th century the theologian and economist Thomas Malthus warned that the combina-tion of population growth and limited arable land would inevitably result in starvation. Similarly gloomy forecasts were made in1865 by the economist William Stanley Jevons about a supposed looming shortage of coal. In 1914 the US Bureau of Mines forecast that US oil reserves would be totally exhausted within 10 years. In 1939 the US Department of the Interior estimated that oil reserves would last another 13 years, until 1952. Shortly before this deadline the forecast was pushed back another 13 years to 1964. In the 1970s the Club of Rome, a think tank looking at the future, turned to the issue of commodity exhaustion. The club published a much heralded book in 1972 called The Limits to Growth, in which the main author Dennis Meadows put forward calcu-lations showing world oil reserves would be exhausted by 1992 and world natural gas reserves by 1993. The study has been updated several times since then, pushing the forecasts for commodity exhaustion forward into the future.3

Why have all these predictions been so dramatically wrong? For two reasons: firstly, they ignore the technical progress that comes when new reserves are brought on stream, creat-ing enormous efficiency improvements in production,

processing and use. Secondly, they tend to be based on known reserves. The amount of reserves that is probably still in the ground is often many times larger, however. Known reserves of oil could last another 40–50 years.4 New discov-eries could extend this by another 70 years. Accessing unconventional reserves such as tar sands would add another 115 years (at current usage rates), while shale oil could extend this by centuries.5 Considerations like this led economists such as Julian Simon and Bjørn Lomberg to sug-gest that the world’s energy resources are practically inex-haustible. Simon talks about the ultimate resource, human ingenuity, which is capable of solving every shortage.6

3 Various peak oil forecasts saying when maximum production would be reached and then start to decline suffered a similar fate. The first peak oil forecast was made by geologist M. King Hubbert in 1956, who put it at around 1970. It was then shifted back to 2000.4 Bradley S. & Fulmer (2004).5 The idea that technical progress increases the amount of usable natural resources over time does not contradict the law of diminishing returns, which states that above a certain level of factors of production (labor, capital, machinery) the marginal return from a piece of arable land or a commodity deposit must fall. This is because it only applies at a particular point in time for a particular level of technical knowledge and capital investment.6 Simon, J. (1998). One essential requirement for this ultimate resource to be effective is that free trade is possible and private ownership of the factors of production is protected. In other words, the basics of a market economy have to be in place.

7 To demonstrate the importance of energy efficiency, Bhattach-aryya (2011) shows that assuming average current levels of efficiency, more than 18 liters of crude oil must be used to produce, convert and transport one liter of gasoline.8 The degree of efficiency is the ratio of fuel in (primary energy used) to (secondary) energy out. Comparing the degree of efficiency is a way of comparing different types of power plants.



able to smooth out peaks in demand by means of price transparency and flexibility. There is also great scope for saving energy by raising building efficiency, having more efficient control systems, and increasing energy recycling, such as using waste heat from power plants to warm buildings.

Challenges for the energy shiftThe energy shift tends to focus on ecological aspects such as climate protection (cutting CO

2

emissions), the pollution of the oceans and con-cerns about the safety of nuclear power plants. But there are also other important challenges. The leading energy institutes also emphasize the need to overcome inequality in energy access.9 At present, some 1.3 billion people (95% of them in Africa and Asia) have no access to affordable, reliable electricity. Apart from pollution and ine-quality, the most fundamental challenge for the energy shift is to ensure the global security of supply. The energy institutes estimate that over the next few decades global energy demand will rise 1.3–1.6% annually.

This would be a slowdown compared to the last 20 years, partly because the energy intensity of economic growth falls over time. Even so, this would put global demand in 2035 40–50% above the 2009 level. Meeting this growth is a major challenge. The leading energy institutes are assuming there will be no energy shortages in the next 20–25 years. This depends on sustained technical progress expanding primary energy sources and extending the life of existing resources by means of higher efficiency all along the value chain.

9 IEA (2011), EIA (2011).


The controlled shift among primary energy sources

Chapter 2

38%

13%8%

7%

19%

16%

Fig. 2.1: Electricity industry is largest consumer

Source: International Energy Agency – Key World Energy Statistics 2010

Electricity generation

Rest of the energy sector

Industry

Transport

Buildings

Other

Primary energy consumption by industry

A combination of market forces and energy policy is driving the energy revolution. From the investor perspective the interest lies in the trends that are emerging, the forces that will determine the mix of primary energy sources, and how this mix will change over time.

The breakdown of global primary energy sources, the primary energy mix, generally only changes very slowly. This is because capital investment in the energy sector is very long term and the infrastructure has a long life. Between 1980 and 2009 the share of coal in the primary energy mix rose only marginally, from 25% to 27%, and the share of hydro and biomass also only moved slightly. There were, however, changes in oil and natural gas. Oil fell from almost 43% to 33% and natural gas went up from 17% to 21%. In addition, there was signif-icant growth in the share of nuclear and renew-able energy, although these remained small in absolute terms.

The industry that uses the greatest amount of primary energy is electricity generation, making it particularly important (see Fig. 2.1). Global demand for electricity has tripled over the last four decades, growing at a faster rate than energy consumption overall, which “merely”


doubled. Because electricity is the result of con-version from primary energy, we refer to it as a secondary energy. The power production mix, i.e. the sources from which electricity is produced, has changed in the past (see Fig. 2.2). Coal is the most important, at 41%. Natural gas, hydro and nuclear are also all important for generating power and have been among the relative winners in recent decades. Renewables have also been growing significantly recently, but at a relatively low level overall.

Scenarios for the primary energy mixThe greatest uncertainty when making projections about the future primary energy mix is the energy policy in different countries and regions.1 Differ-ent scenarios are therefore often drawn up, depending on how strictly environmental objec-tives are implemented. The International Energy Agency (IEA), from whom we have generally taken the most recent forecasts in this chapter, assumes in its core (most likely) scenario that cur-

Breakdown of the primary energy mix

Oil currently has the largest share in the primary energy mix and will grow further in absolute terms. As a percentage, though, oil has fallen steadily over the last 40 years and will continue to do so.

Coal takes second place in the global energy mix and will grow faster than average in coming years and peak by 2020, after which it will enter a relative decline.

Natural gas is the only commodity will increase both its rela-tive and absolute share. Demand for natural gas is expected to rise twice as fast as that for coal and oil.

Renewable energies will gain in absolute importance in the next few years but only see their share expand slightly. Fossil fuels will continue to dominate.

33%

21%

27%

6%

2% 10%

1%

Fossil fuels (oil, coal and gas) dominate

Source: International Energy Agency – World Energy Outlook 2011International Energy Agency – Key World Energy Statistics 2010

Oil

Coal

Gas

Nuclear energy

Hydro

Biomass

Renewable energies

Current global primary energy mix

18,00016,00014,00012,00010,0008,0006,0004,0002,000

01980 2009 2015 2020 2030 2035

Natural gas and renewable energies will increase share

Source: International Energy Agency – World Energy Outlook 2011International Energy Agency – Key World Energy Statistics 2010

OilCoal

GasNuclear energy

Hydro Renewable energiesBiomass

Global energy mix – future trends

41%

21%

6%3%

13%

16%

Fig. 2.2: Coal and gas are indispensible for producing energyPower production mix by energy source

Source: International Energy Agency – Key World Energy Statistics 2010

Oil

Coal

Gas

Nuclear energy

Hydro

Other (incl. renewable energies)

1 Assumptions are also made regarding economic growth, demographic developments and technological progress. The major uncertainty, in the case of political assumptions in particu-lar, is that the results should not be understood as a forecast, but rather as projections that could present a picture of how developments will unfold provided that certain assumptions prove accurate.



Chapter 2

2 The IEA also describes this climate protection scenario as the 450 scenario, since it works on the assumption that there is the political will to limit the concentration of greenhouse gasses in the atmosphere to 450 parts per million of carbon dioxide equivalents.3 Other energy institutes and energy groups largely come to similar conclusions in their studies.4 Kharas, Homi, “The emerging middle class in developing countries,” OECD Development Centre, Working Paper No. 285, Jan. 2010

rent political trends, objectives and programs will be continued. The reference scenario makes the unlikely assumption that there will be no more political involvement, i.e. that current objectives will be abandoned or not implemented. The third scenario is based on implementing particularly strict environmental objectives, especially for cli-mate protection.2

The core scenario has global energy demand growing some 40% by 2035. In the reference scenario demand is up over 50%, but only 23% in the climate protection scenario. All scenarios assume demand for energy will rise. The share of fossil fuels declines only marginally, from 81% to 80%, in the reference scenario, to 75% in the core scenario and to 62% in the climate protec-tion scenario. All three scenarios still have fossil fuels as the most important source of energy in 2035.3

Oil: share in the primary energy mix to fall furtherOil will see by far the lowest growth rate of all energy sources. The transport sector is the main user of oil. Other sectors, such as electricity gen-eration and industry, will probably see substitu-tion by cheaper alternatives like natural gas.

The modest rise in demand for oil overall is driven by blistering demand growth in emerging markets (mainly China, India and the Middle East), where the OECD is projecting that in the next 20 years the number of people earning a medium income (which makes them a potential car buyer) is set to expand by around three bil-lion.4 OECD countries, by contrast, can expect oil demand to fall further. This fall in demand in industrialized countries is mainly due to improved engine efficiency. Some industrialized countries are also trying to cut dependency on oil imports by diversifying their national energy mix. China and India are having the same thoughts. So far there is no alternative in the transport sector that

can rival oil for efficiency and ease of use, so for individual mobility at least there are very few alternatives.

Trends in the oil sectorIncreasing production of shale oil and unconventional deposits such as tar sands and extra heavy oil: Oil shale is a rock that con-tains bitumen or low-viscosity oils and is primarily exploited in the US. Tar sand is a precursor of crude oil comprising a mixture of clay, silicates, water, crude oil and other materials; the largest deposits are in Canada and Venezuela. The IEA is forecasting a sharp rise in output. New technolo-gies have made it possible to exploit these reserves and the high oil price has made them financially viable. Shale oil production in North America is only profitable when the oil price is above USD 50 per barrel. The output from new shale oil reserves falls very quickly after the first drilling. In the US, the infrastructure has not been able to keep up with developments and more capital spending is needed. In terms of the global energy mix, the shale oil reserves in North Amer-ica are still insignificant. Shale oil would have to be produced all over the world for this to change. It can be found in many other places, though (such as in the Paris basin), and could be very important for security of supply. The production methods (especially fracking, which injects large amounts of water and chemicals into the ground) are still controversial, and environmental concerns are holding back many developments.

Reconstruction and development of the oil industry in Iraq: Proven reserves in Iraq were revised upwards in October 2010 to 143 billion boe (barrels of oil equivalent). This puts Iraq in possession of the world’s fifth-largest reserves. War, poor maintenance and a lack of investment have taken their toll on the Iraqi oil industry. Reconstruction has started, but will take years. The investment needed is huge and the political environment full of uncertainty even in times of peace. It will mainly be the major oil companies who get involved, because they have the money and experience needed.

Developing the deep-water oil fields in the South Atlantic off the coast of Brazil: Large oil deposits were found off the coast of Brazil in 2006. Estimates of the amount of oil that can be economically produced differ significantly. It is clear, however, that the fields have the potential to catapult the country into the league of the



world’s largest oil producers. The fields are at great depth, and in some cases lie under two kilometers of salt strata, so production will be technically very challenging and require vast amounts of investment in the years to come. The national oil company Petrobras has plans for USD 142 billion to be invested in developing these deposits between now and 2016.

Coal: emerging markets drive growthThe demand for coal will be driven largely by power generation, which accounts for some two thirds of demand. Coal is by far the most impor-tant fuel source for power generation, accounting for 41%. In China coal even has a share of 80% currently, and in India it is 70%.

Emerging market demand for coal has exploded in recent years. They will remain the largest end-markets in future. China, India and Indonesia together make up almost 90% of the future growth in non-OECD demand for coal. In a few years, China will likely make up over 50% of glo-bal coal demand.

In industrialized countries coal demand is falling as it is increasingly replaced by various gas resources and renewables. This is mainly because burning coal releases carbon into the atmosphere, with harmful climatic effects. Under a tighter cli-mate policy (the climate protection scenario), the IEA estimates the share of coal in the energy mix would fall to only 16% by 2035. From the point of view of energy policy, though, coal has major advantages. It is relatively cheap, and for many countries offers a high degree of security of sup-ply. Reserves are sufficient for another 150 years at the current rate of use. Also, unlike oil, coal reserves are geographically well diversified.

Trends in the coal sectorDeveloping technologies to allow coal to be burned cleanly: The main argument against using coal as an energy source is the emissions when it is burned and converted into electricity. Carbon dioxide capture and storage technology (CCS) makes it possible to separate out the CO

2

that damages the climate and store it under-ground so it does not reach the atmosphere. CCS technology has not been a great success to date because it is expensive and the infrastructure is lacking. Power plants generally only use CCS technology if there are government subsidies. A further factor of uncertainty is the move towards more unconventional gas resources, which is

keeping down the price of natural gas and mak-ing it more attractive. It remains to be seen if CCS can establish itself.

Converting and liquefying coal into gas: Underground coal gasification (UCG) is especially interesting for countries with coal reserves that cannot be exploited to any significant degree. The conversion of coal into gas allows coal deposits to be used that cannot be mined directly. The liquefaction of the gas produced is only economical if the oil price is relatively high. However, coal liquefication is also being encour-aged as a way of reducing dependency on oil imports. The process is successfully used in China, South Africa and the US.

Natural gas will offer outstanding opportunities over the coming decadesThe demand for natural gas is mainly driven by the power generation sector, so its share of the electricity mix will continue to rise until 2035. That is because it produces significantly less CO

2

compared with coal, has higher thermal efficiency and operational flexibility, needs less capital investment and enjoys shorter construction peri-ods. The buildings sector (heating and warm water) is the second largest consumer of natural gas, even if growth here is expected to be on the low side. There is greater growth potential from industry and the transport sector.

More than 80% of the growth in demand has come from non-OECD countries. Demand from China plays an especially important role here, as it does for oil and coal. According to our core scenario, demand from non-OECD countries will grow by around 2.4% per year, so that its share in the primary energy mix will rise to 19% from 14% by 2035. The demand for natural gas will also increase in OECD countries. The same is not true in the strict climate protection scenario, where annual growth rates and the share in the energy and electricity mix would fall over the long term.

In a report published in summer 2011, the IEA suggested that we were possibly on the verge of a “golden age of gas.” The authors also dis-cussed the demand-side advantages of natural gas, such as its flexible use, its relative technical security and its better environmental performance compared with other fossil fuels. It also has sup-ply-side benefits, namely the security of supply, which comes from, for example, the extent of the


known gas deposits and the broad geographical distribution of these reserves. Given the fact that the three basic aims of energy policy are afford-ability, security of supply and environmental pro-tection, natural gas should be given a favorable assessment in most regions.

Trends in the natural gas sectorDeveloping and producing unconventional sources of gas around the globe: Shale gas deposits in the US are particularly important. Shale gas is natural gas trapped within shale formations. The reserves of this raw material are enormous and could meet consumption needs in North America for decades. Because they could eliminate the need for imports, these gas reserves are hugely significant. In the US, shale gas accounted for 1% of the country’s overall gas production in 2000. This figure currently stands at 25%, which has led to a slump in the price of natural gas in the US. Although it is politically controversial, the US could soon even be able to export its natural gas if it steadily increases production. Unconventional gas depos-its are widely distributed worldwide. According to the IEA, all global regions have gas resources they can tap, which at today’s consumption rates could last for at least 75 years. Globally unconventional gases make up 13% of overall gas production, but this could increase to 22% by 2023. In Europe, Poland is well ahead in developing unconventional sources of gas. Major spending on infrastructure, such as extending pipelines and building liquefied natural gas (LNG) terminals, will be needed if unconven-tional sources of gas are to be further devel-oped. As with oil shale, there are major concerns over the environmental impact of the extraction process. Around 7,500 to 20,000 cubic meters of water (and chemicals) are pumped into each borehole. Most concerns relate to the high con-sumption of water and the danger of contami-nating groundwater.

Liquefied natural gas boosts the interna-tional trade of natural gas: The technology to cool natural gas to –163°C, liquefy it and there-fore significantly reduce its volume has been around for several decades. Over the past dec-ade it has become more widespread, allowing additional areas of exploration to be developed. Natural gas can also be produced in remote regions and transported to consumer markets anywhere in the world. This trend will continue and over time will lead to the globalization of

the regional markets. Increasing volumes are likely to be exchanged between regions and the still very wide variations in gas prices will level out.

An uncertain future for nuclear energyNuclear energy has enjoyed a small renaissance as it produces practically no CO

2 emissions, though

there are major problems disposing of nuclear waste. After Fukushima, the public’s perception of the safety of nuclear energy has shifted in some countries.

Currently there are 433 operational nuclear reac-tors with an overall capacity of around 372 giga-watts. Most are located in industrialized countries and in nations of the former Soviet Union. Sixty-three power plants are currently under construc-tion and 160 have been ordered or planned. Most are in emerging nations, notably China and India. This reflects the fact that the demand in growth (around 80%) is coming primarily from non-OECD countries. The IEA is forecasting annual growth here of 5.6%. Between now and 2035 nuclear energy’s share of electricity production could double from 5% to 10%. But, according to the IEA, even in industrialized nations, supply for nuclear power is likely to show a modest rise over the coming decades. The high cost of investment could hinder construction projects, however.

The benefits of nuclear energy include the high operational availability of plants, which responds to the need for secure supply and diversification. And virtually no greenhouse gases are produced. This has become an increasingly important advantage in recent years as the issue of climate change has climbed up the agenda. But there are also drawbacks. There are concerns, fueled by Fukushima, as to whether atomic plants are technically safe. There is also the issue of how to dispose of and store atomic waste securely and permanently. Moreover, the problem of how to dismantle old plants has not been satisfactorily answered.

Nuclear energy sector trendsDifferent preferences in different countries: Investment will continue to flow into nuclear energy. In the US, for example, work has begun on an atomic power plant in the state of Georgia. In Europe new plants are under construction in Finland and France. But due to more stringent safety requirements, high building costs, lower profitability and greater planning risk, we are not

Chapter 2


expecting a marked expansion of nuclear power in the US and Europe. On the contrary, in the aftermath of the disaster in Japan, Germany has announced it will close all its nuclear power plants by 2022. Switzerland and Italy have also said – in a policy U-turn – that they will not be building any new plants. But even here further investment will be needed for security, mainte-nance, disposal and dismantling. And new reac-tors will continue to be built, especially in China, Russia, India and South Korea.

Renewable energies: the energy sources of the futureRenewable energies include biomass, hydroelec-tric, solar, wind, geothermal and tidal energy. They include traditional biomass, i.e. wood, char-coal and peat, which serves as fuel for 2.7 billion people, particularly in developing nations. Tradi-tional biomass accounts for three quarters of renewable energies. Leaving away traditional biomass, renewable energies – especially wind and solar energy – are referred to as modern renewable energies. Renewable energies (exclud-ing hydro and biomass) will increase their share of the energy mix significantly from the current 3% level.

Most of the growth in demand for renewable energies will come from OECD countries. Annual growth rates of 7% are expected for solar, wind and geothermal energy, so their share of the pri-mary energy mix in these countries could increase from 1% in 2009 to 6% in 2035.

Political intervention will mainly drive the expan-sion in renewable energies in order to diversify the energy mix and thereby reduce dependency on imports, along with protecting the climate and environment. Renewable energies are theoreti-cally available in abundance. The biggest prob-lem, however, is pricing and cost. In most instances, modern renewable energies are simply not economical yet.5 Growth is therefore depend-ent on government subsidies. IEA estimates indi-cate that government support for modern renew-able energies amounted to USD 57 billion (0.08% of global GDP) in 2009. The IEA forecasts that this figure will steadily rise to USD 205 billion (0.17% of global GDP) by 2035. The biggest dan-ger for this sector is that government subsidies may not increase by the expected amount, which,

given the pressure on public finances in many developed economies, is a risk.

Among the modern renewable energies – wind, solar and geothermal energy – wind is the leader in terms of capacity. Globally there are more than 200,000 turbines with a total capacity of around 230 gigawatts. The reason for wind energy’s success is its scalability: the large wind parks operate on a similar capacity to fossil fuel power stations and are therefore an attractive source of energy for utilities. In addition, the costs of producing wind energy at the very good onshore and offshore locations are already com-parable to fossil fuels (for instance wind parks in Scotland). Looked at globally, however, wind energy is still dependent on subsidies. The com-petitiveness of wind energy has also taken a hit in the US, due in large part to slumping natural gas prices there, which has contributed to a sharp fall in demand. Photovoltaic has also enjoyed a massive boom in recent years, driven by Western Europe (Germany and Italy). By the end of 2011, nearly 70 gigawatts of solar panels were installed worldwide, with 25 gigawatts of this in Germany alone. In response to this boom, however, both countries decided to slash the generous subsidies, so new installations there are likely now to have peaked. Whereas wind turbines are in the hands of utilities, photo-voltaic energy has developed for the most part into a localized energy resource operated by private individuals on rooftops.

Despite huge subsidies in many countries, renew-able energies only have a 1.3% share of the glo-bal energy supply. But the political will to combat climate change should lead to strong growth in this form of energy going forward.

Trends in the renewable energy sectorSolar heat collectors as a link between sun-light and warm water usage: While solar thermal power plants (for example, parabolic trough collectors) are still in their infancy, the commercial use of so-called evacuated tube col-lectors has already notched up considerable suc-cess. Like photovoltaic modules, the collectors can be mounted in modular arrangements on roofs. The radiation energy generated by the sun heats up a thermal transfer medium (usually a water-glycol mix) which, with the help of pumps, transports the heat collected throughout the house. China has been making widespread use of solar thermal collectors to great success for


5 With the exception of larger hydroelectric power plants


Chapter 2

Fig. 2.3: Electricity grid today

Source: Nomura, UBS

Large power station

Single-family home Single-family home Single-family home

Energy flow

Energy flows in only one direction

several years now. As of end-2011, 57.6 million square meters of solar thermal collectors had been installed (cumulative basis), which equates to approximately 40.3 gigawatts of thermal out-put. China now installs significantly more solar thermal water systems than boilers that use gas or electricity to generate heat.6

Smart grids as the prerequisite for the energy shift: While renewable energies will play an important role, first the grids to support them need to be built. Grid expansion is thus a decisive factor for the successful expansion of solar and wind energy. The buzz word in this context is smart grids. With traditional electricity supply, end customers are supplied with electric-ity from large power plants via the transmission and distribution grids (see Fig. 2.3). Converting conventional grids into smart grids enables the use of small, decentralized resources to generate power, such as solar modules and energy stor-age systems. What is more, grid operators can analyze the power need in real time and adjust how much electricity is generated accordingly (see Fig. 2.4). Households are thus no longer end users, but also producers: the electricity they need for their own use is consumed, while the remainder from batteries and generated solar energy is sold. This benefits both utilities compa-nies and customers, since the grid operators are

able to react to the volatile nature of electricity generation (wind power, solar energy) by saving electricity in accumulators which can be fed into the network as and when needed. This new infrastructure fosters greater transparency in terms of energy consumption and electricity costs. In future, end users will be able to adjust their electricity consumption patterns using smart meter readers. In order to reduce their electricity bills, consumers will be able to take measures such as regulating their air condition-ing during peak usage times, while industrial companies will be able to use fewer machines where appropriate.

Electrical energy accumulators balance out supply and demand: Storing energy is a suitable way to balance out the sharply fluctuating avail-ability of renewable energies. In contrast to water, steel or other goods, electricity is not easy to store. Load management is thus vital in order to strike a balance between energy supply and demand. Smart grids are only part of the solution, however. Renewable energies are testing the lim-its of the technologies currently available since the volume that needs to be stored is so large. This makes sophisticated storage technology more urgent than ever – just think what happens to a solar panel as soon as the sun stops shining, or to a wind turbine when no breeze is blowing.

6 solarserver, February 2012


The power generated by renewable energies is virtually impossible to control, and until now countries like Germany have been unable to feed in the total output produced. The increasing offering of renewable energies and the unpredict-able fluctuations in supply therefore pose a real challenge, especially as far as the management of power stations is concerned (see Fig. 2.5).

The use of renewable energies requires various storage systems: short-term ones for just a few minutes, medium-term ones to counterbalance fluctuations throughout the day (see Fig. 2.6), and longer-term ones (several days) to safeguard against exceptional environmental factors (for example, lack of wind in the winter). Electricity producers thus try to bridge fluctuations in the grid by means of accumulators and different gen-eration systems (gas-fired power plants, for exam-ple, usually have shorter power-up times than coal-fired power stations) and are continually striving to improve the quality of electricity produced.7

Pumped-storage hydropower plants are used as energy storage facilities if the topological location is right. In Germany, they account for 95 percent of grid storage, with an average output of 250 megawatts. Sweden, Austria, Switzerland and Norway also use this technique in Europe, while


Fig. 2.4: Smart grid

Source: Nomura, UBS

Large power station

Single-family home with solar panels

Single-family home with solar panels

Plug-in hybrid/electric car

Energy flow

Large solar farm Wind turbines

Energy flows in various directions

Electric cars as power storage facilities

The significance of electric cars is likely to increase dramati-cally over time. With this in mind, the US, Germany, France and China are promoting their use. Electric vehicles can also solve part of the problem of energy storage (see Fig. 2.4, smart grids). The potential here is enormous. Take a normal onshore wind turbine, for example (output of 2 megawatts). According to our calculations, “all” that is needed are around 123 car batteries (assumption: battery capacity of 25 to 30 kilowatt hours) charged for one hour in order to store the electricity produced by the turbine over the same period.

Let‘s fast forward to 2050 for a moment and imagine that by then there are nothing but electric cars. For Germany (with a current car pool of 42 million vehicles), this would

yield a storage capacity for one hour’s electricity production from 34,150 wind turbines (assumption: 10 percent of the cars (= 4.2 million) are not being used and can be plugged in; at 123 car batteries per wind turbine, 4.2 million cars corresponds to 34,150 turbines). Currently there are 22,600 wind turbines in Germany with an average output of 1.3 megawatts (Germany has lots of older turbines with a lower output). Assuming that there were only electric cars, if 10 percent of these were parked they could in theory store the entire energy produced by all wind turbines in two hours and 20 minutes. If we also work on the assumption that various cars can be charged and discharged at different times throughout the day, in this scenario energy storage would no longer pose any problem at all.

7 Auer J., Keil J., January 2012


Fig. 2.6: Pumped-storage hydropower plants can smooth electricity demand

Source: Daiwa

Day Night Day

Energy stored at night is made available during the day

Dem

and

for e

lect

ricity

Peak loadProduction surplus

8 Auer J., Keil J., January 2012

Chapter 2

the largest power plant is in Bath County, in the US state of Virginia, with a total output of around 3 gigawatts. The average pumped-storage hydro-power plant can produce electricity for eight to nine hours when running at full load. The largest pumped-storage hydropower stations are also designed to effect load balancing between the seasons (pump in summer, produce in winter) (see Fig. 2.6).

Alongside pumped-storage hydropower plants, compressed air storage also harbors significant potential. Here, excess energy is stored in the form of compressed air, which when needed is used to drive a gas turbine and produce electricity. Both the US and Germany are working on pilot facili-ties. To date, only two storage power plants of this kind are in operation worldwide: in Huntorf, Ger-many, and McIntosh, in the US state of Alabama. The potential offered by this technology is sub-stantial since there are countless viable locations; airtight salt caverns are especially well suited to the task. Like pumped-storage hydropower plants, compressed air power plants can be started very quickly. However, the technology is extremely expensive due to the technically demanding nature of the power stations required and is mostly only used to cover peak load power.8

Conclusion: the primacy of natural gas and coalFossil fuels will still dominate supply in 2030. Nat-ural gas will likely gain in importance over the next two decades, with demand boosted by its environmental sustainability, high availability, improved infrastructure and attractive prices. To this end, gas-fired power generation capacities will be significantly expanded in the years ahead; natural gas produces around only one half of the CO

2 emissions generated by coal, and has the

added advantages of high efficiency, low capital costs and short construction times. We expect natural gas to be the only fossil fuel with a greater share of of the energy mix in 2030 than it has today, and in a few decades it will become the most important primary energy source. The share of natural gas in the power generation mix is already very significant in many countries (see Fig. 2.7), and in the next 10 to 20 years, this looks set to rise dramatically in almost all coun-tries with high energy consumption – especially the US, China and India.

Coal will also play a special role. Driven by their need for increasing power plant capacities for electricity generation, China and India in particu-lar will likely account for the lion’s share of the additional growth in coal consumption. They will

70,000

60,000

50,000

40,000

30,000

20,000

10,000

024 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23

Fig. 2.5: Supply of renewable energies difficult to predict24-hour profile in megawatts; electricity produced on a sunny day in Germany (19 June 2012)

Nuclear energy Hydro, oil and other Natural gas SolarLignite Hard coal Wind

Source: European Energy Exchange, UBS

Note: The day was very sunny but had little wind.


100%

80%

60%

40%

20%

0%

US2010 2030 2010 2030 2010 2030 2010 2030 2010 2030 2010 2030 2010 2030 2010 2030 2010 2030 2010 2030 2010 2030

Germany UK France Italy Spain Japan China India Russia Brazil

Fig. 2.7: The importance of natural gas should increase

Source: UBS

Coal Gas Oil Hydro Nuclear energy Renewable energies

Electricity production mix in various countries


be able to draw on their own coal reserves for this purpose, which will propel the expansion of the coal-fired power grid. Both countries will have a decisive impact on the market for coal before growth tapers off from 2020 onward. This slow-down is based on the assumption that environ-mental considerations will start to occupy a more prominent role in energy policy. Oil, by contrast, will continue to lose market share. As has become apparent and has been reflected in the higher oil prices in recent years, the work and costs involved in extracting oil will continue to increase.

While renewable energies will play a key role in the energy revolution that is underway, their con-tribution is likely to be limited in the near future. Their major advantage is that they do not pro-duce any greenhouse gases, and thus perfectly address the requirements of environmental policy. This means they are supported politically in many

countries. However, they also have the consider-able disadvantages that their ability to produce energy is subject to major fluctuations (the wind does not always blow, nor does the sun always shine) and that they are not yet competitive from a cost standpoint. Then there are the major chal-lenges in terms of storage. Investments in renew-able energies therefore often do not pay off under normal market conditions; an investor who is operating solely according to economic consid-erations would in most cases not invest in wind or photovoltaic projects. In addition, a purely artifi-cial market driven by subsidies would soon fall victim to spending cutbacks when governments are forced to tighten their budgets, as happened recently to the solar industry in Europe. Thus, even though they will see strong growth, renew-able energies will still only make up a small share of the primary energy mix in 20 years’ time.

Investing in the future with energy – The investment implications of shift ing energy trends20

Energy effi ciency allows us to save energy and reduce CO2 emissions. Higher energy prices are calling for increased investments in energy effi ciency. However, the most impor-tant driver is stricter regulation with a view to protecting the environment and securing the supply of energy.

“Less is more” could be the motto for the coming decades. Energy effi ciency is the response to many of the questions that we posed in the fi rst two sections, such as the sought-aft er reduction in the usage of fossil energy sources or the lack of storage technologies for renewable energies. Saving energy directly at the source lowers costs while also conserving resources and cutting back on emissions. The growing pace of urbanization in developing countries in particular is creating an increased demand for effi cient buildings and equipment. In 2010, the 50 percent of the world’s population living in cities accounted for a

Energy effi ciency – the best alternative energy “source”

disproportionate 75 percent of energy consump-tion and 80 percent of greenhouse gas emissions. Energy effi ciency is not a new topic. Yet whereas between 1974 and 1990 the average annual glo-bal energy effi ciency gain was approximately 1.9 percent, since 1990 lower energy prices and insuffi cient incentives promoting energy effi ciency have meant that this fi gure has fallen to about one percent a year. A countertrend has emerged once again in recent years, and the IEA predicts that by 2030–35 savings could once again reach two percent annually. According to the IEA cli-mate protection scenario, which forecasts the energy pathway to Green Growth, around half of CO

2 reductions will stem from energy effi ciency

measures by 2030–35.

From an economic perspective, the rule of thumb is that for each US dollar invested in energy effi -ciency measures, around two US dollars can be saved in investments in electricity supply and up

Chapter 3


long known that energy efficiency is the most cost-effective solution to the challenges posed by energy shortage and climate change. By 2020 the EU is striving to reduce greenhouse gas emissions by 20 percent versus their 1990 levels, and to boost energy efficiency by the same amount. The US has set similar targets, as evi-denced by the various initiatives introduced since 2003 such as the Global Climate Change Initia-tive (2002), the Energy Independence and Secu-rity Act (2005), the American Recovery and Rein-vestment Act (2009) and the National Action Plan for Energy Efficiency (NAPEE). Energy effi-ciency measures are inevitable in the US, since the average energy consumption is 60 percent higher than the OECD average and the primary energy intensity (the ratio between the gross inland consumption of energy and gross domes-tic product) is 20 percent higher. The issue affects not just developed countries, however. According to the CO

2 output figures forecast by

the IEA, both emerging and developing coun-tries will see their CO

2 emissions increase signifi-

cantly over the coming decades (see Fig. 3.1), not least due to the major impact of infrastruc-ture projects.

All four of the major emerging nations – Brazil, China, India and Russia – are making a targeted effort to reduce their CO

2 emissions and improve

their energy efficiency. In China, for example, CO2

Energy efficiency – the best alternative energy “source”

to four US dollars in electricity costs over the life-cycle of a product.4 A study commissioned by ABB revealed that 88 percent of all companies in the industrial sector regard energy efficiency as the key factor for their business’s success in the next two decades. In particular, competitiveness will play a major role for companies with high rates of energy consumption.5

Not only aging infrastructure and rising energy prices but also politics will foster investments in the energy efficiency market. Politicians have

4 Nahal S., et. al., 20125 ABB, 2011

45

35

25

15

5

02005 20072006 2015 2020 2025 2030 2035

Fig. 3.1: Global CO2 emissionsIn billion tonnes

Source: US Energy Information Administration (EIA)

OECD countriesNon-OECD countries

Estimate

Lighting and refrigerators

Around one fifth of the electricity generated worldwide is used for lighting. According to the company Osram, almost 70 percent of this electricity is consumed by lights for which there is today already a better alternative. Depending on the light technology (lamp/bulb type), new lighting methods can yield energy savings of 30 to 80 percent. The payback period when replacing a 60 watt light bulb with an LED lamp is less than one year in commercial buildings, and one to three years in residential buildings. LED lamps have currently pen-etrated less than two percent of the market.

The energy efficiency of refrigerators has improved markedly over the years. While in 1973 average consumption was more than 2,000 kilowatt hours per year,1 today’s refrigera-tors only use between 80 and 550 kilowatt hours per year

(depending on size and configuration, and whether or not it has a freezer compartment).2 However, if you put this in the context of the average electricity consumption of a three-person family in Germany (3908 kilowatt hours per year),3 on average modern refrigerators still account for around seven percent of a household’s annual electricity needs. A refrigerator from the 1970s used as much electricity in one year as a three-person household uses today in six months for all of its electronic appliances combined.

1 Nahal S., et. al., 20122 www.stromverbrauchinfo.de3 Energieagentur.NRW, 2006


Chapter 3

intensity per unit of GDP is to be reduced by 40 to 45 percent from 2005 to 2020; in India, the target for the same period is 20 to 25 percent. Brazil, meanwhile, has initiated various energy efficiency measures, including the National Cli-mate Change Plan to boost energy efficiency in several sectors, and the National Energy Efficiency Action Plan to cut energy consumption by 10 percent by 2030 (for example, by replacing 10 million old refrigerators, expanding and updating the power grid, and improving the efficiency of buildings). In 2009 Brazil also announced that it intended to reduce greenhouse gas emissions by almost 40 percent by 2020. Russia’s energy inten-sity is three times the OECD average due to its strong reliance on heavy industry. One of the country’s overriding objectives, therefore, is to improve industry’s energy efficiency by 2030, with energy intensity to be reduced by 56 percent and building efficiency to be increased by 50 per-cent versus 2005 levels.6

The energy efficiency market is extremely frag-mented in terms of products (there are millions of different devices) and has numerous different business models. Total global primary energy consumption can be broken down into three segments: buildings (around 40 percent of con-sumption), industry and transport (around 30 percent each). More energy-efficient lighting (LEDs), better building insulation, more efficient air conditioning systems, more efficient manufac-turing machinery and even tires that reduce roll-

ing friction are just a few examples of how con-sumers can make better use of energy. Megatrends such as cloud computing also signifi-cantly enhance the efficiency of computing cent-ers, which with capacity utilization levels of cur-rently only 20 to 25 percent are currently extremely inefficient.

Buildings are goldmines for energy savings potentialThe buildings segment currently accounts for 40 percent of energy demand and offers the greatest potential for reducing consumption. According to the IEA, the amount of energy consumed could be reduced by 30 to 50 percent from 2030 to 2050. On average, a building is used for at least 50 to 75 years and 60 to 85 percent of the life-cycle costs are operating costs, compared with just 5 to 10 percent spent on design and con-struction.7 This makes energy efficiency a simple means of bringing down maintenance costs. High energy prices, laws that prescribe stricter stand-ards, and tried-and-tested technologies at accept-able prices all have a role to play in promoting energy efficiency. The driving force, in our view, is more stringent regulation, not only for old build-ings, but also for new ones. As more and more countries have recognized the advantages of

6 Nahal S., et. al., 20127 Source: National Institute of Building Sciences

Fig. 3.2: Key classification instruments and assessment criteria for the sustainability of buildings in various countries

UK UK UK/EU UK/EU Hong Kong

Japan Germany Australia France Canada/US US Italy

Local standards BREEAM CFSH EPCs DECs BEAM CASBEE DGNB seal

Green Star

HQE Green Globes

LEED Protoco ITACA

Energy X X X X X X X X X X X XCO2 X X X X X X X XEcology X X X X X X X X X XEconomy X * X *Health and wellbeing X X X X X X X X *Environmental quality indoors X X X X X X X X X *Innovation X X * X * X *Land use X X X * X X X X *Management X X X X X * X * *Materials X X X X X X * X XEnvironmental impact X X X X X X X X X *Renewable technologies X X X * X * X X XTransport X X X X * X X *Waste X X X * X X XWater X X X X X X X X X X

Source: King Sturge (2009)* Data may not be complete; other criteria may be included in the assessment.



lighting products (for example, LEDs), moderniz-ing heating, ventilation and air conditioning sys-tems, improving insulation and implementing modern energy management (IT control). Fig. 3.5 shows various ways of saving energy. Cooling, heating and lighting use the most energy and offer the greatest energy saving potential.

In emerging nations, the ongoing trend of urbani-zation coupled with higher income and improved

energy-saving investments, demand for efficien-cy-boosting measures in the construction industry has risen markedly in recent years. Several coun-tries have already introduced building standards and classification instruments to improve knowl-edge about the sustainability of existing buildings. This provides countries with precise information on the respective building conditions and on the need for political intervention by means of control instruments. Figs. 3.2 and 3.3 show the most important classification instruments and stand-ards for sustainability by country, as well as the key assessment criteria.

However, these standards and classifications differ greatly and not all of them pursue the same objective, which makes a general comparison impossible. Most European countries have much stricter legal regulations than the US, for exam-ple, with the Minergie-P standard in Switzerland prescribing an energy efficiency level that in some areas is 85 percent above US standards (for exam-ple, the Minnesota Energy Code for educational institutions, see Fig. 3.4). In the case of the Min-ergie-A standard, energy consumption for heat-ing and building facilities is even reduced to zero.

The buzz word in the building sector is smart buildings, which involves using more efficient

Fig. 3.3: Legal regulations in European countries on energy efficiency for residential buildings

for new buildings for existing buildings

Country General Specifically for ventilation

Using renewable energies

Energycertificates

Energycertificates

Energy subsidies for energy-

efficient renovation

Finland Yes Yes Yes Yes Yes YesNorway Yes No No No No NoSweden Yes Yes No Yes No NoPoland Yes No No Yes No YesHungary Yes No No Yes No YesGermany Yes Yes Yes Yes Yes YesItaly Yes No Yes Yes Yes YesSwitzerland Yes Yes No Yes Yes YesUnited Kingdom Yes Yes Yes Yes Yes YesSlovakia Yes No No Yes Yes YesFrance Yes Yes No No Yes YesBelgium Yes No No Yes Yes YesAustria Yes No Yes Yes Yes YesNetherlands Yes Yes No No No YesDenmark Yes No No No Yes YesSpain Yes Yes Yes Yes Yes YesCzech Republic No No Yes No Yes YesPortugal Yes No No Yes Yes YesIreland Yes Yes Yes Yes No Yes

Source: 70th Euroconstruct Summary Book, December 2010, UBS

300

250

200

150

100

50

0US/MN energy law LEED Platin Compulsory

Swiss lawMinergie-P-Standard

Fig. 3.4: Switzerland has very strict building regulationsIn kilowatt hours per square meter per year

Source: INTEP Example, State of Minnesota, Educational Building, swisscleantech

USSwitzerland

350


Chapter 3

access to technology should stimulate demand for energy-efficient buildings. By sharp contrast, the main challenge facing industrialized nations is their high inventory of older buildings. In the US, for example, 45 percent of multifamily homes date from the 1970s, and only 14 percent of those built since 1990 were equipped with more modern building efficiency (see Fig. 3.6).

Thanks to stricter laws and higher energy prices, new buildings in France, for example, must not emit more than 10 kilograms of CO

2 per square

meter per year (as of 2012), compared with an average consumption of 60 kilograms from 1950 to 1975. And by 2020 the target figure is just two kilograms of CO

2 per square meter per year.8

Yet in spite of these trends the IEA expects energy

demand for buildings and CO2 emissions to rise

globally (increase of 60 percent by 2050), driven by population growth and increasing demand for building floor space (increase of 30 to 40 percent from 2008 to 2035). This trend is reflected in increasing demand for fossil fuels.

Industrial processes harbor multifaceted savings potentialGiven the large number of applications in the industrial sector, there are an equal number of opportunities for increasing efficiency in this area. Take the electric motor, for example. Around two thirds of the electricity used in industrial processes drives electric motors such as ventilators, pumps or compressors. It is astonishing that only around 10 percent of all motors are equipped with speed controls, meaning that nine out of 10 motors are always running at full tilt, irrespective of how much output is required. According to ABB, speed controls would reduce energy consumption by up to 50 percent. Another way of reducing energy consumption is to use production robots, which increase manufacturing quality, decrease downtime and markedly reduce energy consump-tion. The “FlexPainter” robot developed by ABB, for example, has cut the energy consumption of automotive paint shops in half worldwide. Along-side the applications already mentioned, count-less other areas are still benefiting from efficiency-boosting developments. The use of semiconductor components for IT applications, in

Fig. 3.5: Electricity consumption in US homes and businesses

Source: Energy Information Administration, Annual Energy Outlook 2011 & JMP Securities, LLC, UBS

Homes

Lighting 16%

Space heating 9%

Space cooling 20%

Refrigeration 10%

Water heating 10%

Electronics 11%

Computers 4%

Cooking 5%

Wet cleaning 7%

Other 4%

Energy adjustment 4%

Businesses

Lighting 28%

Space heating 6%

Space cooling 17%

Ventilation 12%

Refrigeration 9%

Water heating 2%

Electronics 5%

Computers 7%

Other 13%

Energy adjustment 3%

Broken down according to end use

14%

19%

15%

30%

22%

Fig. 3.6: US structures outdatedYear of construction of multifamily homes

Source: Energy Efficiency in Buildings. Transforming the Market, April 2009 (World Business Council for Sustainable Development)

1990–2000

1980–1989

1970–1979

1960–1969

Before 1960

8 Source: EURIMA, 2004



9 Source: Blair M., 2012

14,000,000

12,000,000

10,000,000

8,000,000

6,000,000

4,000,000

2,000,000

099 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15

Fig. 3.7: Trend toward gas-powered vehicles in Asia Pacific and South AmericaNumber of vehicles from 1999 to 2015

Source: Historical data by NGV Global, estimates by Macquarie Capital (US) 2012

Asia/Pacific North America AfricaEurope South America

Estimate

particular, has influenced the way in which machines are controlled and is continually reduc-ing the energy they consume.

In the transport sector, natural gas and electric vehicles offer viable alternativesWhile the transport sector is characterized by a strong capacity for innovation and the constant reduction in consumption per kilometer, the increase in energy consumption and CO

2 emis-

sions resulting from the massive rise in demand in developing countries has more than offset these efficiency gains (especially strong economic and population growth).

The big question is which direction the trend will take after “Generation Oil.” In the long term, developments seem to be moving in the direction of electric cars. However, high battery costs, low cruising ranges and a lack of infrastructure have so far hampered any serious market penetration. What is more, in many Latin American and Asian countries the trend is toward natural gas-pow-ered vehicles (see Fig. 3.7). Indeed, today around 15.3 percent of the vehicle pool in Argentina is powered by natural gas; in Bolivia this figure is 20.5 percent, in Colombia 6.9 percent, in Peru 6.6 percent and in Brazil 3.4 percent. The head of the pack by a considerable margin is Pakistan with 61.1 percent. Natural gas price trends in the US could also force a rethink in industrialized nations as well, all the more so because natural gas-powered vehicles make good economic sense. In Brazil, the additional investments made in natural gas-powered vehicles paid off after just 0.7 years, and in Argentina after 1.3 years. Throughout the lifecycle of a car (assuming 10 years) this could generate savings in these coun-tries of between 7,000 and 17,000 US dollars. Studies also show that natural gas-powered vehi-cles emit around 25 percent less CO

2 than a com-

parable gasoline or diesel-powered vehicle.9

Regardless of which resource will ultimately pre-vail in the individual regions, over the coming years there is potential to increase efficiency with all modes of driving. The major topic in the auto-mobile sector is downsizing (see Fig. 3.8), which means specifically reducing engine size through efficiency enhancements (for example, improved engine control, use of turbochargers, reduction of internal friction through the use of smoother materials, reduction of moving masses).

There are also a wide range of other possibilities, such as tires that reduce rolling friction (at low speeds, up to 10 percent, at higher speeds, 5 percent) or start-stop technology, which can cut fuel costs by up to 25 percent in city traffic, depending on how it is used, and 5 to 10 percent

Fig. 3.8: Downsizing passenger cars – better performance and more torque with a smaller engine (VW Passat)

Fourth generation 1998–2005

Fifth generation 2006–2009

Sixth generation 2011

Model Passat 2.0 Passat V5 Passat 4motion Comfortline Sportsline V6 4motion TSI Comfortline TSI Highline

Engine size ccm 2000 2400 2800 1800 2000 3200 1400 1400

Injection/turbo Injection Injection Injection Turbo Turbo Injection Turbo Turbo

Consumption l/100km 8.6 10.3 10.5 7.6 7.9 9.8 6.6 6.6

Power Bhp 116 170 193 160 200 250 122 122

Torque Nm 172 220 280 250 280 330 200 200

Source: Company data, UBS


10 Source: Guzzella L., 201111 Source: IEA Climate protection scenario

0 20 40 60 80100120140160180

1973 1980 1990 2000 2006

63%

Fig. 3.9: Consumption would be 63% higher without efficiency measures

Source: BofA Merrill Lynch, IEA

Actual energy consumptionEnergy savings through improved energy efficiency

* Based on EA 11 data, a group of 11 countries, for which there is data available for the past 40 years. These countries account for around 80% of the IEA’s energy demand.

Theoretical energy demand without energy efficiency improvements

In exajoules (1 exajoule = 278 terawatt hours), 1973–2006

for highway driving. While professors at the Swiss Federal Institute of Technology in Zurich expect an increase in hybrid vehicles in the coming years, they say this increase will be restricted to wealth-ier regions. Alternatives, such as pure electric cars, are likely to remain niche products for the fore-seeable future due to their technological and economic drawbacks, while sales of economical gasoline and diesel engines should pick up. If conditions remain favorable (among other things, low natural gas prices in high-demand areas, expansion of fueling station networks), the pro-portion of vehicles powered by natural gas should rise substantially.10

Conclusion: Energy efficiency is the answerEnergy is the lifeblood of our society. It is in the products we consume every day and it drives our economy. In a world where resources are limited, demand must adjust itself to the restricted supply. Energy efficiency – alongside renewable energies – is the answer to this problem. A look back to 1973 shows us that without energy efficiency measures in buildings, in the transport sector, in power plants and in industrial applications, energy consumption would be at least 63 percent higher today, according to the IEA (see Fig. 3.9). Thus the subject of energy efficiency will remain with us for some time to come. The greatest potential for reducing CO

2 emissions and conserv-

ing fossil resources comes from increasing energy efficiency by end consumers.11

Chapter 3


Chapter 4

Investing in energy has been rewarding in the past, in both absolute and relative terms. The current shift in the primary energy mix is also aff ecting fi nancial investments. Five dominant trends will shape the investment landscape.

The shift in energy resource development and use over the coming years and decades will diff er from region to region, not least because of diff er-ing political frameworks. The political landscape is very important because it is the key to directing long-term trends. We expect natural gas to show the highest level of global growth among fossil fuels over the next two decades. We therefore see good investment opportunities in this area across the value chain and in the oil and gas serv-ice industry. Coal will also do well over the next decade, particularly because of demand from China, India and Indonesia, but then slow notice-ably. This trend refl ects greater environmental awareness, which also makes renewables the fastest-growing energy source. Renewable ener-gies and energy effi ciency therefore complete

The investment implicationsof fi ve key trends

the picture of investment opportunities holding long-term interest.

Global trends and associated investment opportunities

Gas: growing in importance all over the worldOne of the most important energy trends over the next 20 years will be the growing importance of natural gas. The largest known gas reserves are in Russia, Iran and Qatar, followed at some dis-

Chapter 4


Chapter 4

tance by the US. Many countries also have impor-tant, economically viable deposits of unconven-tional gas resources such as shale gas and coal gas. The owners and operators of these deposits, including the traditional major oil companies which have increasingly moved into gas in recent years, will enjoy sustained growth. The large energy groups are still dominated by oil (typically some two thirds of sales), but the balance comes from natural gas and its share will rise.

The use of natural gas in industry, buildings and power production is likely to rise further. In the US, gas-fired power plants are already squeezing out coal-fired plants on purely economic grounds. As described in chapter 2, production from shale gas deposits has pushed prices down, so burning gas gives a higher return than coal. The coming years are therefore very likely to see an expansion in the number of gas-fired plants. In fact, the number of gas-fired plants looks set to rise sharply all over the world, resulting in replace-ment investments (especially in developed coun-tries) and expansion capital spending (mainly in growth regions). Builders and operators of power plants will benefit from this trend.

As new natural gas deposits come on stream, transport will be important. The traditional route to the consumer has been along a pipeline, but the rise of LNG (natural gas that has been cooled and liquefied to reduce its volume) has brought new transport options, allowing additional reserves to be exploited profitably. Transport infra-structure, gas storage and distribution are all lucrative, providing attractive opportunities for investors along the entire value chain.

Coal: growth restricted to a few countries The largest coal reserves are in the US, Russia, China, India and Australia (see Fig. 4.1). Nowa-days coal is mainly used for power generation and in the steel industry. Right now most coal power stations are being built in China and India. China is expected to add around 600 gigawatts of capacity in the next few years, roughly equal to the present total capacity in the US, EU and Japan. This promises to create a business bonanza for the builders of power plants. It is hardly sur-prising that the demand for coal is expected to grow most strongly in these countries. China con-sumes around 43% of global coal production at present and the trend is rising. Since late 2008 the country has been a net importer of coal.

Coal production and power plant construction offer promising investment opportunities, but the position is less clear in the power generation industry. The growth in the capacity of coal-fired power plants is clear and sustainable, but electric-ity tariffs and coal prices are also very important. It is not always possible to achieve a positive mar-gin and we see no clear upward trend for inves-

237

7

7

41 34 34

157

11561

76

Fig. 4.1: Global reserves of coal

Source: Survey of Energy Resources, World Energy Council 2010

In billion tonnes

29UBS research focus August 2012

Investment implications

tors. Processes like CCS (carbon capture and stor-age), which involves extracting CO

2 and storing it

in underground caves, open up an entirely new area of business, provided there are economically feasible CO

2 provisions in place.

High transport costs mean that for coal the dis-tance between producer and users is important. It is less competitive over longer distances. Produc-ers in growth regions like India or China therefore enjoy a clear competitive advantage. The same applies for manufacturers of the equipment used in production, where Chinese manufacturers enjoy a cost advantage over the US.

The oil and gas service industry: profiting from high pricesOver recent years the production of oil and gas has become steadily more difficult and cost-in-tensive, and projects have become enormously more complex. Without innovative production technologies it would not have been possible to produce anything at all. The high oil price makes it economical to exploit a large number of fields, among them tar sands in Canada, gas fields in Siberia, shale gas in the US and China, and deepwater drilling in the North Pole region, the Antarctic and Brazil (see chapter 2).

The IEA is forecasting that an average of USD 440 billion will be invested every year in oil and gas production over the next 25 years. This capital spending will be subject to cyclical swings, how-ever, and in many cases it is risky and posited on relatively high prices for oil and gas. Complex projects involving unconventional oils only add up if the oil price exceeds USD 80 per barrel. All in all, we expect companies in the oil and gas serv-ice industry to post above-average growth rates in coming years. Attractive investment opportuni-ties are therefore likely.

Renewable energies: rising volumes and falling pricesRenewable energies have been enjoying an unprecedented boom in recent years. Initially, euphoria and high growth rates were the order of the day, but the mood among producers has been much less cheerful recently. Increasing com-petition from Asia and lower subsidies are push-ing prices down, revenues are tumbling and mar-gins shrinking; stock prices are thus lower in many cases. It has been a tough time for the young industry. Photovoltaic in particular is going through a period of consolidation right now. It is still hard to see which companies will make it in the long term (see Fig. 4.2).

Fig. 4.2: Shakeout phase in the solar industry

Source: Citi Group, UBS

Size of industry Current situationEntry/exit of competitors Cost of solar modules

Falling prices and competitive pressure from Asia are leading to a consolidation

Market maturityInnovation Limited market maturity/expansion

Time

Price/watt

Shakeout


We still believe that alternative energies will see sustainable growth, because the varying technol-ogies all have one thing in common: They can be produced in a relatively environmentally friendly way in an “industrial process” and do not come from exploiting a resource built up over centuries. Theoretically, sunlight can produce sufficient power to cover the energy needs of the human race several times over (see Fig. 4.3).

The list of variables for corporate success is long, though, and the investment risk remains high. The company landscape may look radically differ-ent a few years from now, and the Solar Cham-pion of 2030 might not even exist yet. At the same time, established builders of power plants are positioning themselves and squeezing out small firms. The prospects are favorable, but even so investors face high risks and an uncertain out-come. We see only a few good investment oppor-tunities in renewables just now, but the industry will definitely grow at a rapid rate.

Energy efficiency: the simplest way to save energyGlobal demand for energy is rising, and in some regions supply is tight and environmental issues increasingly problematic. Politicians in many coun-tries have long recognized that energy efficiency is the cheapest solution to this problem.

As we explored in detail in chapter 3, we regard improved energy efficiency as an opportunity to cut demand for energy. It is becoming a key busi-ness factor for a growing number of companies. We see the biggest potential in power generation and transmission (expanding and modernizing the grid), industry (efficient motors and gears, heat capture and robots), buildings (better insulation, more efficient heating and ventilation) and trans-port (lower consumption by cars). Companies in these areas should see above-average growth in the decades to come. There are already compa-nies today that have based their business models on energy efficiency in various areas.

Chapter 4

1750x

200x20x 20x

5x 1x

Fig. 4.3: Renewable energies can provide five times current global energy consumption

Source: DLR

Global energy consumption (≈ 500 EJ/year) set to 1x

Sunlight (only continental)

3.65x 0.5x 0.2x 0.4x 0.1x 0.15x

Wind Biomas

s

Geoth

ermal

Waves

, tide

s

Water

Entire physical energy supply, equal to ≈2,000x global energy consumptionEntire theoretical usable potential with today’s technologies, equal to ≈5x global energy consumption


Investment implications

Investment recommendationsInvesting in energy stocks is often seen as defen-sive. Many companies have relatively stable rev-enues and pay attractive dividends. As already explained, we expect the energy sector to show modest but steady growth over the long term. Since energy is essential to our lives – in fact an absolute necessity – the industry is suitable for long-term investments. The most interesting investments are equities and equity funds, corpo-rate bonds and private equity.

Equities and equity funds: a stake in long-term growth trendsInvestors in a company can participate directly in industry growth. In addition to company-specific risk – which the BP oil spill in the Gulf of Mexico demonstrated vividly in spring 2010 – there is also political risk, so it makes sense to diversify across both projects and regions. It is important to remember that companies do not directly own the actual commodity in the ground; they hold a license to prospect and produce in a particular region, they make the necessary investments and they hand over part of their profit to the host country. Investment candidates include traditional companies in the oil and gas sectors, along with electric and gas utilities and industrials (power plant builders, renewable energies, energy effi-ciency). Investments can be made directly in a company or via a diversified equity fund. Passive instruments (exchange-traded funds or ETFs) are a possibility, but actively managed vehicles are gen-erally preferable because investments can be focused on particular companies with better growth opportunities.

Corporate bonds: an attractive alternative to government bondsCompanies producing fossil fuels and those in the utility sector both have long investment horizons and project planning schedules. The amounts invested in individual projects can also sometimes be very large, whether they involve bringing a large oil field on the sea bed into production, a gas liquefaction plant, a pipeline, a coal-fired power plant, a dam, or a nuclear facility. Large investments with long depreciation periods have to be financed up front. Bonds in the energy sec-tor therefore tend to have longer terms than in other industries.

They also often have a good rating. Most top-tier oil and gas companies are rated from A to (rarely) AAA, and utilities A. Many companies are higher rated than some governments, making them an interesting alternative.

Private equity: direct participation for qualified investorsPrivate equity funds are a way for investors to gain exposure to privately held companies in the energy sector. There are some 400 firms around the world that invest in the energy sector. The return therefore depends on making a careful choice. Private equity funds also invest all along the value chain in both traditional and renewable energies. Direct investments in private equity funds are normally only open to qualified inves-tors prepared to commit a minimum sum for 10 years. Products have been launched in recent years with lower minimum amounts.


Bibliography

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Sarmah, P. K., So, C., “Energy Storage Toolkit: Making the Right Connections”, Daiwa Capital Markets, February 2012

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Selection of research publications

OnlinePublications with content available to the general public can be found at www.ubs.com/research.Clients can access our online CIO WM Research portal via e-banking. The portal contains electronic versions of all of our publications and much more.

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UBS research focusUBS research focus examines how major global trends affect personal wealth planning decisions. Each issue is devoted to a specific subject spanning the fields of economics, financial markets and investment.Available in: English, German, French, Italian, Spanish and Portuguese.June 2011 Inflation – The return of a

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