252. Lazard, LCOE and the real cost of power - Oct26

0:07 With Laurent Seguelin from London and Gerard Reid from Berlin, this is Redefining Energy.

0:13 Today on Redefining Energy, Gerard, we're going to talk about the real cost of power production.

0:20 Laurent, I'm really looking forward to this conversation. We're going to talk about LCOE, Levelized Cost of Energy. And actually, Lazards really have made this LCOE their term over the last, I don't know how long it's been. It's been 15, 20 years of this report coming out every year. It's amazing. And I'm going to say as an analyst, crikers to have a report that has that impact over that period of time. I have real great respect for them. And as I said, I'm looking forward to having a conversation about it.

0:52 That Lazar LCO report is comparing the economics of solar, wind, coal, gas, and nuclear. And it has really helped change minds. change minds. Because there were always people who said, oh, renewables are too expensive. And they demonstrated that the price was going down last decade. And so they helped channel a vast amount of capital into the energy transition. That's why those reports were so important.

1:19 Yeah, I like the way the reports are changing and learning from the times. And what I mean by that is they're now looking at the value of power to the system. Because we all know that if you have too much solar in the system, prices go zero. There's less value from putting an extra unit of solar onto the system. And so respect also for the way that they continue to develop the product.

1:46 For our listeners who probably don't understand, Lazar is one of the world's most prestigious investment banks. was founded in 1848. And they are advising every great corporate, every government. And we have the privilege of welcoming George Belichich, who is the global head of power, energy, and infrastructure at Lazare.

2:13 And George had a fantastic career, and he worked alongside legends such as Felix Roatin, Bruce Wasserstein. So we We really have an energy titan coming on the show.

2:26 Well, let's bring him on.

2:28 George, welcome to the show.

2:30 It's great to be here. Thank you for having me.

2:32 George, I'd love to just kick off by giving your, just I'd love to get a sense of what you see going on in global power markets. What's the big things that the clients are asking you every day?

2:44 The biggest thing right now is just what is the true medium-term to long-term power demand need? in view of data centers, general economic growth, and things of that nature, plus depending on the region of the world, the commodity price sensitivity of the relevant input. So in Europe, LNG's costs are a much more important consideration than the cost of natural gas in the United States, which has remained flat even in the wake of the war. So I'd say it's about power demand and then how that demand is going to be satisfied and the risks of overbuilding in respect of anticipated power demand.

3:22 Yes, because the last big cycle was 25 years ago, and clearly they overbuilt, and the aftermath was kind of painful. Has it already reached that point? The fact that G.Vernova is booked until 2031 or something, and the speed to power, they're going to put anything they can, fuel cells, Boeing engines.

3:44 So it seems like people are super exuberant, but they start to be a bit frightened at the same time.

3:51 This trend cycle is very different than the late 90s and early 2000s because everything is being done with a structure that produces infrastructure cash flows. So the cash flows are contracted where the risk is really a terminal value risk as opposed to what you saw in the late 90s and very early 2000s where if someone saw an open field, they built a power plant and they just remained exposed to the market because there was this belief that markets were going to grow. to match the construction of new powers. It's a very different environment right now, very different risks.

4:27 If you look at it from a regional perspective, I mean, what's obvious is that, I take it from a European perspective, there's certain countries where power demand is definitely going up and there's some that there's.

4:36 Not, and you have the same in the US.

4:38 How do you think about that?

4:40 The power industry is very different in many ways than the elements of the oil and gas industry because you need to understand how the regional system functions and you have transmission constraints and different regulatory regimes and things of that nature. So someone who is a global power company is going to be screening for where there is power demand, where you can build things in a reliable manner and have regulatory and legal certainty on a going forward basis.

5:10 In the United States, there is a power demand growing essentially across the country. But when you actually deconstruct the United States, there are different regions where the power demand is very different, such as the Southeast, such as Texas, such as the Upper Midwest. And these are also places where you can build things. In the Northeast, California, Pacific Northwest, there's power demand, but it's very difficult to build anything in those areas.

5:41 Lazar is known for a lot of things, but in particular, when it comes to energy, you put together, and I guess that's the 18th year, your LCOE report. Well, first, can you explain a bit what it is and how it's calculated?

5:56 So we will next year publish our 20th editions. And what it does is that it takes different generation types and puts them on as much as possible, taking into account reasonable capacity factors, construction costs and operating costs and tries to put those generation types on an apples to apples basis to illustrate how resource planning should take place.

6:19 And we've been doing this for a long time. And it originally started because we were trying to understand better different solar technologies, solar thermal versus different kinds of PV. And we extended it into wind and natural gas and coal, new coal, new nuclear, and then operating assets. And we continue to evolve the study.

6:39 Can you maybe sort of talk a little bit about the highlights this year? What's the big trends that we should be thinking about?

6:45 We have added over the last few years a proxy for the cost of intermittency with renewables. It's a pretty good proxy for intermittency costs, but it's also a little bit imperfect. But in any event, what the study shows is that in the United States, renewables remain the cheapest resource. But because of the capacity factor that's available for renewables, how renewables function, you have to use other generation resources.

7:14 And that includes natural gas, existing nuclear assets, existing coal assets to give a full 24 by 7 reliable resource. But without question, renewables remain cheap. It was actually interesting this year because I thought natural gas new build costs would be higher We had great data depth for the last 12 months. By the way, the data is last 12 months and it's all US data. It's not a global study, although you can extrapolate the model to global markets.

7:43 And the natural gas new construction costs were a bit lower than I thought. We know based on the data we've been collecting and market feedback that those costs will be much higher next year.

7:54 Everybody's following those trends. So the past decade, solar wind went down pretty fast, but Although solar remains not cheap, and of course we can discuss tariffs and the fact that getting access to Chinese panels is much more difficult now. But if I take wind and gas, it looks like they bottomed about three, four years ago, and now they've been going up and faster than inflation. How can you analyze that?

8:21 That's a function of the cost. We're picking up in the study inflation in Europe. physical assets, equipment, the inputs to wind and gas that is running through other elements of the economy. Plus, labor costs are much higher. And for wind, there hasn't been any great advancement in technology. During the course of our study, wind blades have gotten much bigger. Capacity factors are able to be much higher.

8:48 We just haven't seen that technology evolution. That's part of the dynamic. And I think on natural gas, It is the equipment costs plus labor are really driving the costs up. We'd expect something of a flattening of wind and solar costs. Batteries are going to be intermittently moving higher or lower depending on import considerations. And then we think over the next few years, because this power demand largely has to be satisfied by natural gas plus renewables and storage, we're going to see a lot of pressure on natural gas, new construction costs, including because a lot of the big construction that needs to take place hasn't started yet because they haven't been able to get the big CCGT turbines.

9:34 What we've seen in Europe is that batteries are eating into the load factors of fossil fuel. And now that they are reaching four hours, six hours, I mean, it's already the case in California. But if I look at Texas, I see the number of hours going bigger and bigger. Is that something that the people who are developing gas have in mind or they just do their things?

9:56 It definitely is in the mind of the developers of gas and it would orient someone to more peaking gas assets, CTs as opposed to CCGTs. But because of the nature of the power demand growth, which requires 24 by 7 power, we need more baseload power, which is the CCGT asset. which is a lower cost, a levelized cost of energy basis than CTs. But there's definitely an effort to blend a mix of, you know, if you did a 24-hour crosscut in a region of the United States or anywhere, some portion of a county somewhere, and you say, what's being dispatched over a 24-hour period? It's some gas, it's some nuclear, it's some wind, it's demand management or energy efficiencies.

10:40 So as batteries continue to extend, I think it has an impact on baseload gas versus CTs. Do you have any view?

10:48 I mean, one of the things that sort of from outside looking at the U.S. is that what you've got is because you've got a whole pile of tariffs, particularly on Chinese products coming in, what you've got is inflation there, equipment that maybe in Europe we're not seeing. Do you have any view on that and where that ends up?

11:05 I think the supply chain, I mean, to the extent this Chinese-U.S. trade tension continues and it's reasonable to think it's going to continue for any reasonable business planning period. It has to be the case that the supply chain will move to regions of the world where it's simpler to import batteries without the geopolitical tension. And in theory, if a European country is not imposing the same tariffs on a Chinese entity, then they should have a lower cost.

11:36 But it's just higher cost to do everything in Europe so that the relative cost position, not that it's relevant because it's not a global business, it's a regional business. is offset by the cost of doing business in Europe.

11:49 Talking about Europe from an American view, what do you think Europe does right and what do you think it does wrong?

11:57 Europe does right. It has not forgotten the importance of stakeholder interests around climate. And there is still support for the energy transition or whatever you want to call it. And as you can see from what Exxon says in their communication materials, Many recognize that there's still a need to try to decarbonize, as hard as that may be.

12:19 So I think Europe gets that right. In the current environment in the United States, there's been a de-emphasis on that. And in some governmental levels, a complete rejection of that as being important. That's an overreaction to what was happening in the United States in the late teens, very early 20s.

12:38 What Europe doesn't get right is it's just too hard to do business and build things. They are relative to the United States, even though it's very difficult to build things in the United States where there's a need for permitting reform. Those are the two areas I would focus on. We do think, just to extend the answer a little bit, there will be, using the political framework references, the United States moved very left on ESG. It's now moved very right.

13:07 It's going to move back to the middle, in our view, where ESG and environmental considerations becomes more of a focus. There's going to be support for broad diversity of generation resource, but also focus on decarbonization, the environment, in a way that we haven't seen for the last few years in the United States.

13:26 At the end of the day, it's all connected together, in particular the water issue. It's all great. Data centers need to cool, so do power stations. And then if you just take pollution as well, forget about climate change, just in terms of making people in a particular area feel good, it is sort of important to take care of these issues.

13:45 Completely. Just again, from a U.S. perspective, if you look at what's going to happen in generation over the next 10 years, when we look at it, again, as I said earlier, natural gas, renewables, and storage, nuclear will not come in that timeframe. So emissions are going to increase. And what has been lost a little bit, except in some niche areas, is a recognition of the need to innovate and help mankind do something different. That will become more of an emphasis. I think the venture capital community is not super engaged in power in a way that is likely to be impactful. That could change. The government has always supported research in energy, and perhaps you see more activity in that area. And then as these energy

14:30 companies consolidate, which will continue, there should be more room for research and development to find new ways of doing things. So this could be better carbon sequestration. This could be more efficient gas combustion turbines, efficiency breakthroughs in solar and wind and things of that nature, or some new technology and something in the data center space where less energy is consumed.

14:56 For me, things are very simple. In the U.S., gas at $ 3 per mbtu, that's equivalent of burning a barrel of oil at less than $ 20. In Europe, we have it at above $ 20. dollar per mbtu so it's a barrel of oil at 130 gas in europe we're trying just to get rid of gas and and it's tough because there are a lot of sector where you you simply cannot replace it but anything that can be replaced in term of gas will be replaced because the strategic vulnerability the geopolitics and the costs are unbearable unbearable in the u.s your energy balance is slightly positive but in europe we just send away half a trillion dollar every every 1st of Jan to a lot of people who don't even like us. So I can tell you that

15:41 the clarification in Europe, people are following what China is doing much more than the U.S., not because we decide that one is good or bad or an ally or an opponent, but because there's no choice. In the U.S., you have the choice. So it's a very different mindset.

15:58 There is so much gas in the United States and in Western Canada that Europe with focus could massively minimize this gas price issue, which it's done. There's a lot of offtake from LNG at very reasonable prices, where the liquefaction owners in the United States are barely earning their cost of capital. So the offtake price is super attractive.

16:24 If you look at the onboarding, onshoring cost of gas at, let's say, $ 7 or $ 8, which is what you can accomplish into Europe with good negotiations, That has a huge impact on what you just said. But now, you know, in this era where we're affected by the war, you're at $ 25, $ 27 LNG prices. It makes gas a real problem, but creates this huge economic margin to be able to innovate and use different technologies.

16:53 No, but that margin is taken by the traders. Shell, Total Energy, the Vitol, the Glencore. These are the guys cashing in the difference.

17:03 The utilities in Europe could be contracting. Those who need gas in Europe could contract directly for LNG at much lower prices than where LNG has been. They then just have to not take advantage of high LNG prices, naively.

17:21 I think all the CEOs go to church every Sunday and pray to God that the war with Russia ends and they get cheap gas back again.

17:28 Simple as that. That's really what's going on, right?

17:31 Just one of the things myself and Iran have been talking about really is the nature of the market. And what we sort of see is that, you know, generation has to get closer to the customer. And it seems like we're going to have a move back to vertical integration. I'd love to hear your views on that and how you see that.

17:48 There was in the 90s into the next decade, this movement to deregulation globally. And it maybe started even earlier than the 90s, very late 80s, where there was this emphasis on separating transmission from elements of distribution, including the meter and also generation. Definitely from a U.S. perspective, it is easier to plan if you are in a jurisdiction where there hasn't been deregulation because the relevant utility controls distribution, transmission, and generation and is then able also to build new generation through rate base, spread the costs across the rate base, and have a stable cash flow profile and is able to build these big complicated assets more efficiently. In the deregulated markets in the United States, with the exception of Texas,

18:36 it's very, very difficult to build anything except with long-term contracts. And those long-term contracts are by definition not going to help with resource need because you have a contracting counterparty taking the power. In Texas, it's a bit of a free-for-all. It's an open market. Generation can be built, but it's more volatile. So I think the stakeholders in deregulated markets, with the exception of Texas, we think increasingly will look at inserting some return of a regulated model across generation.

19:11 And it's something to watch because you have a lot of capital allocated into a market assumption that is a deregulated market assumption. So there'll be tension between what these policymakers should be looking at, what the deregulated utilities should be thinking about, and the owners of the generation should be thinking about. Super important topic.

19:30 Another topic when I look at your LCOE report is the cost of new nuclear. So I see your LCOE around 180 to 200-ish, which is probably something that the hyperscaler can pay. I trust your numbers. Last month, there was an announcement by Darlington, so it's... it's the Canadians who are buying those Jitashi. They say, we're going to reach an LCOE of $ 100 per megawatt hour, US dollar.

19:59 Do you buy this? Do they know something you don't know?

20:01 I'm not familiar with this recent statement. We looked at the Darlington data and we thought the costs were much higher than what would be implied by a $ 100 LCOE. But what we think about nuclear is the following. First, there may be some SMR technology that emerges that can be scaled with multiple SMR facilities, but we think that it's going to be large-scale nuclear. That's what will happen.

20:29 It'll be the AP1000 technology and this GE Hitachi technology, even though that's called SMR, we put it in a bucket of large-scale nuclear. And from a US perspective, At some point, we will figure out how to build these plants. The supply chain and business know-how will scale, and you'll see a cost decline. And you can see this in our study when you look at Vogel III, the southern company, the first unit they built, to Vogel IV. There was a 20% or so cost decline. And we think this nuclear new build will happen in the southeastern United States.

21:03 You could think about doing part of it through the TVA, build out the supply chain in the Tennessee Valley region. and start to see some efficiencies, but it is a high cost product. It's a high cost generation resource, but we think it's going to need to be built. Also, it is likely that for the utilities to build this generation and rate base, they're going to need some sort of special governmental support to protect against cost overruns and you have strong contract protection with the EPC where the entity building the power plant, the construction company, We'll need to provide a little bit more certainty on costs, but that's very difficult for one of those companies.

21:41 And once we're in that zone, there's been a lot of money invested in fusion. We are skeptical to tell you the truth. Will we see any fusion in this decade or the next one?

21:53 I don't think we know at Lazard. What we do is we call sophisticated academics who know fusion and ask them if they think fusion is coming. and typically get an answer that fusion is 20 years away. But I think there's a lot of smart people working on this where they feel like they're getting closer to the crossover point where the energy necessary to produce the fusion energy is less than the fusion energy that's produced. And there are a lot of folks with passion about it. There's capital chasing it. So we would not count it out, but we do not think it is relevant at all for any reasonable long-term forecasting period.

22:33 And while we're there, geothermal, there have been some really breakthrough with companies like Furvo. But the question we always ask is, is it site-specific? Can it scale up?

22:44 We think it's great to see innovation in geothermal. We like that the DOE is supporting geothermal, but it's a niche technology. We don't think it can scale to anything that resembles what we need.

22:57 My sort of final question really is, is how you see the electrification in the United States going forward?

23:03 Electrification is out of two things. One is just growth in the economy, where you have more electric consumption and use and need for power, and then displacing other forms of energy. I think our view is that you'll see slow and steady electrification of the vehicle fleet. The batteries will get better. The duration will get better. It's been massively slowed down over the last few years, but that pace will recover And so we would expect to see more electric usage on a percentage basis over time than we currently have right now, but then ongoing other forms of energy. We do not think, for example, that the natural gas distribution system, which is used for heat and other resources, is going anywhere. So you cannot replace natural

23:54 gas heat in the cold regions of the United States with electric heat in any way that is remotely economic. That trend that folks were talking about in the teens and sort of stopped talking about, we just don't think makes any sense and is likely to produce anything that's economic for anyone.

24:13 Well, George, it was great to have you on the show and great to have an informed view of what's going on, the cost level and the future. Thank you very much.

24:22 Well, it's great to be here. Could not be a more interesting time in the industry, and I appreciate being with you on the time.

24:28 Thanks a lot, and I agree with you. It is such an exciting and interesting time in this energy space. Well, Laurent, I mean, the thing that's interesting for me in the power market is that the energy markets have always been interesting, but I don't think they've ever been as interesting as they are now because what we're seeing is global demand for electricity going up, where if you really look at the last 10, 15 years, it's gone down, really, in most countries. And the second thing that we're seeing is a massive shortage on the supply side for key components.

25:01 You know, whether it's a transformer or you want to get a CCG turbine, you can't get your hands on it. And then we also have this volatility. And then you have this technology in between, which should bring the volatility down, which is called batteries. So it's a really interesting place to be. And again, each country is different. Europe's different than the U.S. Within Europe, there's differences. Within the U.S., there's differences. So I really thought the conversation was great.

25:30 Well, John, I've got one word, which in fact is two. It's world-class. George and Lazar, this is world-class. You will not hear on this show or elsewhere somebody as knowledgeable as Lazar. This is phenomenal. So I really encourage our listeners to go and read the report. Over time, because those guys, there's no ideology, they're very mindful and thoughtful.

25:59 So really, I was extremely impressed.

26:02 Yeah, I think, Laurent, the reality of being in the finance world, if it doesn't make economic sense, you don't do it. And you're trying to advise your clients. So you have to understand, do the economics make sense?

26:14 Yes or no.

26:15 And that's the first question you have. So I find it really great to have chats with George because There's no ideology there. It's, does it make economic sense? Yes or no? And that's what you're advising your clients. You might take a view in the future and say, look, the economics of solar are going to get better. You should invest in that. That's a view you're taking, but it's all based on economics and finance.

26:39 Now, when you come to Lazard, Gerard, I'm going to share with you an anecdote, an old one, because we're talking 40 plus years ago and I was finishing my studies and everybody Everybody in our business school was looking for an internship at Lazare. It was the most prestigious bank. So there was the word processing. We used to type our CVs on the typing machine and then send them through the post. So we would send our CVs to BNP or Société Générale and, of course, to Lazare. It was a nice CV. It took like all day to make it without typo. And then, of course, we had to call the switchboard company You know, if they receive our CV and did we get an interview or not.

27:23 So you would call BNP and you would have, BNP. And you could say, but when you call Lazar, you could hear that masculine voice who would just say, Lazar. Oh my God, that was so sexy. That was so like, oh wow. So after a while, we just called just to hear the famous Lazar. At the end of the day, they just took one guy. Who was obviously better than everyone else. So, you know, they knew how to pick their interns. And this guy ended up his career CFO of LVMH. So they know how to find the best of the best.

28:04 Yeah. And then they make sure they get jobs in the big companies so they can make sure they're a client going forward.

28:10 I like that.

28:11 Yeah, that's good.

28:11 That's good. Well, Gérard, first we'd like to thank George for coming on the show.

28:16 It was really great. Yeah, thank you, George.

28:18 It was a really good conversation. And I actually look forward to having you again actually come out at some point in time. It's great.

28:24 And I talk to you next week.

28:26 Look forward to it. Thank you for listening to Redefining Energy. Don't forget to rate the show and subscribe on Apple Podcasts, Spotify, or the platform of your choice.