J.P. Morgan’s Michael Cembalest Details The Elephants In The Energy Room

Every year for the last 12 years, Michael Cembalest, the Chief Investment Officer at J.P. Morgan asset management, has published a report on the state of the global energy space. It is a comprehensive assessment of the state of play in the world of energy, chock full of charts and data related to every industry segment.

Cembalest titled this year’s edition of the report – which is a service to customers but is also publicly available – “The Elephants in the Room.” As readers here at Forbes Energy know, such elephants exist in great abundance across the globe as the world slouches ever more deeply into what promises to become the most severe energy crisis in history.

I reached out to Cembalest recently for an interview, and fortunately, he accepted the invitation. The full video of the interview can be found here.

Below is a synopsis of his comments.

Question: What, in your view is the current state of the Energy Transition? Do you think the world is keeping pace with all of these various “net zero by 2050” goals?

Cembalest: I don’t. That 2050 is such an abstract thing. And with any transition, sometimes the easiest stuff happens first. Think about this: The world is currently using the optimal places in terms of onshore wind speeds and solar irradiance. As you get deeper into the renewable transition, you’re going to be choosing the places people passed on first time around.

The world’s making good progress on one thing and one thing only, which is the gradual decarbonization of electricity, of electricity consumption used for HVAC. That’s basically it.

Separately, very little progress has been made on decarbonization of transportation.

And then, the biggest elephant in the room is there’s been almost zero progress on decarbonization of industrial energy consumption, which is how you make plastic, rubber, cement, steel, ammonia fertilizer or glass and plastics.

Question: That last element, the lack of decarbonization in industrial energy consumption, is one of the central issues in Europe, isn’t it?

Cembalest: We have a chart that looks at the pace of industrial output in gas-intensive energy sector in Germany. We have data going back 40 years and it’s at its lowest level on record.

They’ve got two problems hitting them at once: First, you can’t build wind and solar fast enough. In most countries, with the possible exception of China, which basically doesn’t have private property rules, developers can’t build wind or solar fast enough to displace gas on the grid.

Then the second thing hitting them is you can’t easily electrify the production of a lot of the things the German industry makes. That’s one of the biggest misnomers in all of the green energy plans. A lot of stuff that gets made does not conduct electricity. So it’s a lot harder to use electricity to make it. And that’s what a lot of natural gas and coal are used for, for process heat at very high temperatures for a lot of those industrial goods. Consider the US: the share of electricity in industrial energy use is unchanged since the 1980’s.

Question: Do you think we are having more of an ‘energy addition’ than an ‘energy transition’ right now? We’re adding more energy generation capacity to our grids with all the wind and solar that’s being built, but is that really lessening the need for what we have always called baseload capacity?

Cembalest: I would say that those in the community of energy people have always known that intermittent energy is not a substitute for baseload. But outside the energy community, there are these oversimplified things like ‘levelized cost of energy’ which can’t handle the concept of intermittent versus baseload.

So, you end up with a bunch of EIA reports and media articles saying that solar and wind are cheaper than gas. For the marginal kilowatt hour, maybe. But from a system perspective, you’ve got to load onto your estimate for your cost of wind and solar, things like how much backup thermal power am I going to need? How much utility scale energy storage am I going to need?

I don’t need that for gas, but I need that for wind and solar. And, how much extra transmission investment am I going to need?

Question: That was my next question – your report contains a great deal of focus on the challenges integral to the building-out of adequate transmission to bring electricity generated by wind and solar to market.

Cembalest: You know, thermal power tends to get built very close to load centers. You can build thermal power where you want to build it. But, wind and solar tends to be built really far away from those load centers. And transmission is both costly and politically extremely difficult to build.

Question: Isn’t this an especially big challenge for wind, as opposed to solar? Solar is so much more versatile in where it can be sited – you can do so many different things with it, like wrapping these new flexible panels around light and power poles, covering the roofs of big box stores and home rooftops with them, etc. With wind, it seems limited to making the towers taller and the blades longer.

Cembalest: Certainly, if you look at the projections, solar is going to be overtaking wind in the near future. The capacity factors of wind cap out at about 40% or so, even in the best places in the country.

But then the costs and the transmission and maintenance challenges are equally difficult. So yeah, solar is going to get a lot more attention. And, a lot of solar is being built along with co-located storage.

But again, that begs the question of how much is this transition going to cost if every megawatt hour of solar is going to have to be accompanied by some pretty expensive utility scale lithium-ion storage?

Question: But promising alternatives to lithium-ion are being developed, correct?

Cembalest: There are some, yes. There’s a lot of research taking place with larger, cheaper stationary storage such as vanadium redox batteries. And I think eventually some progress will be made, but it’s not going to be free.

So, the cost issues here are going to take a while to really unbundle if storage becomes an inseparable component of solar power and you need all sorts of ramping and extra protections for the grid because of the concentration of solar irradiance in the middle of the day.

Question: Speaking of the cost of all of this, Congress just passed a bill that contains $369 billion in new subsidies for renewable energy and carbon capture and all these alternatives. Do you think people really understand the reality that all that amounts to is a down payment on what the ultimate cost of all this is really going to be?

Cembalest: Yeah. I don’t know what they’re going to get in terms of bang for the buck. One thing it’s certainly going to make complicated is you will no longer be able to look at household and commercial and industrial electricity prices to understand the cost of your energy eco-system. Because there are so many unrelated subsidies that won’t be showing up in your electricity price, but they’ll show up eventually in your tax bill.

I mean, the cost of an energy eco-system is the tax on the public debt used to build it, plus the direct payment to electricity prices. So a lot of people are going to under-quote the cost of this transition because they’re going to look at how much we’re paying in electricity rates for this new stuff. But they’ll be ignoring the cost to all taxpayers of an extra $370 billion of debt at the federal level.

Question: On a scale of 1 to 10, what would you say this bill rates in terms of providing the necessary economic incentives?

Cembalest: It’s a three in terms of creating the pathways for people to execute. Because, look, Manchin’s siting bill wasn’t a part of it and that has apparently been shelved, at least temporarily, if not permanently.

And here’s a perfect example: The bill calls for $7,500 subsidies for EVs and at least half of that $7,500 you only qualify for if you buy a North American assembled car whose battery gets its critical minerals or battery composition in the United States or from its close allies.

Question: Right, and no EVs currently made in the U.S. qualify for that, correct?

Cembalest: As far as we can tell, almost no EVs would qualify for that right now. Perhaps someday in the future, as there are a lot of battery assembly plants on the drawing board.

But, let’s see what happens when people start trying to apply for permits in Nevada or Utah for a lithium mining and refining and processing operation. I can anticipate that kind of thing would take 15 years.

One of the exercises that we did…we laid out all of the assumptions that were made by Manchin and Schumer when they talk about a 40% decline in GHG emissions by 2030. They didn’t run those numbers. Obviously, they got them from an energy consulting firm. So, I went to the consulting firm and got all their assumptions.

They’re assuming a seven fold increase in the pace of solar power capacity additions compared to the last three years. That’s a moon landing war effort, a kind of pace of building that would be unprecedented in the history of the United States. And I think, practically speaking, highly improbable given all of the siting and transmission challenges that we know exist.

So, there’s certainly a lot of economic incentives for people to want to build that solar power. Their ability to execute and deliver is an entirely different question.

Question: Do you think policymakers in Washington understand the reality that if we’re actually going to make this transition work the way they think it’s going to work, that our country and Canada and Europe and really everybody in the world is going to have to get back into the strip mining business in a very big way?

Cembalest: In principle, I think they’re aware that they’ve created a bill that is supposed to incentivize the repatriation and onshoring of certain mining activities. What I think they’re missing is those activities have gravitated to parts of the world that have minimal to no controls, or domestic judicial remedies for environmental pollution.

For its level of GDP, China is the most polluted country in the world, and we’re all aware of the air pollution. But, the water pollution is worse than the air pollution, and the soil pollution is worse than both.

So, a lot of these activities have gravitated to China, sub-Saharan Africa and places like that. You know, it’s kind of like the CHIPs bill, the semiconductor bill that was just passed. We can certainly make those small chips in the United States, and we can mine and refine lithium and cobalt and manganese.

But, let’s see how much it will cost and how long it would take. If it’s done in a way that complies with Western standards. I think that the thing they’re missing is the time and the cost associated to re-shore and repatriate those activities.

[End]

Summing Up

There is much more in the full version of this interview, but in the half-hour we had allotted for it, Cembalest and I were only able to just scratch the surface of the wealth of information contained in his report. I urge everyone to give it a read.

In an interesting twist, just a few days after our interview, J.P. Morgan CEO Jamie Dimon, in an interview on CNBC, told the host that “I think we’re getting energy completely wrong.” Cembalest’s report isn’t quite so blunt, but all the elephants in the room he details in it lead inexorably to a similar conclusion.