Solar power: transformative to EM and FM countries?

Recently the media reported on the US withdrawing from the Paris climate pact with focus on the downside to the planet if this accord fails. The bigger story in my mind though is the global rise of solar power and the potential structural change on our environment and economies.

Adam Kutas | Portfolio Manager

JUNE 2017

Recently the media reported on the US withdrawing from the Paris climate pact with focus on the downside to the planet if this accord fails. The bigger story in my mind though is the global rise of solar power and the potential structural change on our environment and economies. Two recent items captured this trend: one was a BBC article highlighting how all coal plants were recently idled in the UK given the strong level of sunshine (the solar power stations filled the gap). The other data point was my recent meeting with a Philippine conglomerate where management stated solar power plant construction costs were now similar to coal-fired plants (as seen in chart 1). Hence they will shift from building a mix of 80% coal / 20% solar power generation plants in the Philippines over the past 5 years to the opposite mix over the next 5 years.

Chart 1: Cost of production – coal vs. solar
Chart 1: Cost of production – coal vs. solar
source: FMR

This power cost change is structural in nature but which group of countries will experience the larger impact – developed, emerging or frontier?  In my view, EM and FM countries should experience a bigger benefit from solar given three key factors: geography, energy import reliance and cost of capital. Key winners in this trend include South Asia (India, Bangladesh and Pakistan) and Africa (primarily Kenya, South Africa) while conversely this is negative for the oil exporting nations in the Middle East (hence part of the reason the government of Saudi Arabia would like to sell down its exposure to Aramco through an IPO).

Firstly on geography, the core reason EM and FM markets benefit more than developed markets is their location relative to the equator. As seen in chart 2, on average EM and FM countries receive more hours of sunlight per year (though as seen in chart 3 it’s hotter which makes the panels less efficient - though this could be mitigated in future through better technology).

Chart 2: Average sunlight hours per annum 

DM median 1832
EM median 2294
FM median 2394

source: Credit Suisse

 

Chart 3: Average Yearly Temperature

DM median 9.3
EM median 19.6
FM median 19.2

source: Credit Suisse

The second factor is energy import reliance. Most EM and FM countries are well aware of the abundant sun but historically didn’t use solar to meet their energy needs given its high implementation cost - hence they rely on energy imports (see chart 4). This is the case for many South Asia and African countries (though even energy abundant countries like Nigeria can’t supply their own power needs given the heavy bureaucracy to build power plants and distribution).  

Chart 4: Net Energy Imports as % of GDP
Chart 4: Net Energy Imports as % of GDP
source: FMR

Hence with falling implementation costs and reliance on energy imports, we are seeing a surge in solar power plants build out over next few years (see chart 5). This is especially true in larger EM countries (specifically China and India) as the emerged middle classes are more focused on their air quality than say 20 years ago. This drives the data in chart 6: the supply of solar power in EM and FM countries is growing faster vs developed markets.

Chart 5: Solar Supply
Chart 5: Solar Supply
Source: FMR

Chart 6: YoY Change in Solar Power Capacity
Chart 6: YoY Change in Solar Power Capacity
Source: FMR

Overall, in my view, this backdrop is similar to the steep change effect from the introduction of mobile phones in EM / FM countries 10 years ago. These countries had minimal fixed line connectivity so mobile phones became the de facto phone network and the population had their first phone in their lifetimes.

For energy, solar has the potential to become the de facto power supply in countries with limited power connectivity especially in South Asia and Africa (Economist - view of Africa from space). For places like Africa, most global corporates hold back from more investment given the lack of basic infrastructure (especially power) so a more reliable power supply base could spur further investment.

The final factor is the cost of capital in EM and FM countries which is historically higher than developed markets partially driven by historically higher levels of inflation (CPI). As seen in chart 7, frontier and emerging markets have the highest exposure to energy in their inflation calculations. This partially drives a higher absolute level of inflation but also high level of CPI volatility. This can push up the bond yields in a market as investors ask for higher rates to compensate them for inflation risk if a country relies heavily on energy imports to meet its power needs. If many countries in EM and FM move to solar, the cost and price volatility of power should fall and hence reduce the volatility of inflation rates. 

Chart 7: Energy as % of Inflation
Chart 7: Energy as % of Inflation
Source: FMR

Overall, it’s still early days in the modern solar revolution (as solar panels were invented in the 1950s), but the effects should be profound in our perceptions of sourcing and cost of energy. These effects should be far more significant in emerging and frontier markets given the higher levels of sun supply, higher levels of power needs and higher impact on inflation calculations. Key winners should be energy importers in regions like South Asia (India, Bangladesh, Pakistan) and Africa (Kenya and South Africa).

Thanks for reading,

Adam Kutas



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