The great transition is 40% done. The other 60% is an investment lying in wait

David Thornton

Livewire Markets

For many, green energy still sits on the margins of our national energy sector.  And therefore on the margins of mainstream investment. 

And they'd be wrong. 

Coal fire power plants are shutting down at a rate of knots and corporates have their eyes on near-term net-zero targets (BHP, Telstra and Woolies, among others). Add in the global adoption of electric vehicles and it's easy to see why renewable power is the indispensable trend of our times. 

Octopus Investments Australia find themselves at the epicentre of these tectonics. They're a real assets manager that deploys capital to directly develop and oversee green energy projects. 

Exhibit 1 - they've recently teamed up with Hostplus and Australia's green bank to develop the Gippsland Renewable Energy Park (GREP).  So they've become a bit of an investment conduit between institutional and government investment in green energy. 

In this roundtable, Sonia Teitel and Darren Brown, Co-Heads of Investment and Development at Octopus Investments, take us through what Australia's energy system looks like today and the changes we can expect to see over the next decade. They then dive deep into the investment piece. Retail money usually follows institutional money, and Hostplus are all in. So it's an opportunity nor worth missing. 

 Key takeaways

  • 40% of Australia's energy output is from clean energy sources;
  • Transmission network needs to reorient away from coal pits and towards 'renewable energy zones'
  • Big corporates have set net-zero targets;
  • Institutions money is pouring in;
  • The sector will house a mix of new companies and legacy energy names.

Edited transcript

David Thornton: Today, we're joined by Sonia Teitel and Darren Brown, two investment directors at Octopus Investments. And Octopus Investments are really focused on the physical side of the DeCarb play, all in the name of helping Australia reach its clean energy targets. Sonia and Darren, welcome.

Sonia Teitel: Thank you.

Darren Brown: Thanks for having us.

Thornton: So Sonia, give us a current state of play. What does Australia's electricity market look like in terms of generation, the transmission network, and just generally, how the market operates?

Teitel: Sure. I guess to start with, I'll just explain a little bit that there are actual three markets in Australia. One, funnily enough called the National Electricity Market, is actually only on the east coast. So Queensland, New South Wales, [Ricoh 00:00:50], and South Australia. There's another little market in WA, and then Northern Australia tends to look after itself a little bit, with each mine or community basically having its own generation.

So when we think about the Australian market, we mostly focus on the National Electricity Market. And the interesting thing about that is it's a traded market, similar to oil or gas, with one interesting feature is that we're constrained by the transmission network. 

So there's supply generation and demand, everyone who's using the power in each state, and they tend to then determine what the price is for electricity in each of those states bound by this transmission network within each state.

There are interconnectors between the states, and that will swing the price a little bit, but primarily, it's state by state. So, the other interesting thing about the Australian market compared with other global markets is that our transmission network is what we call quite "stringy". So, we have quite a spread out population compared with the US or Europe where all the transmission is kind of interconnected like this. And so, that also influences how the market has operated historically.

Brown: So if you think about what Sonia was saying really with the transmission network and the size of it and how stringy it is, it wouldn't be surprising for people to realise that we've got some 850,000 kilometres of what we call "distribution network", which is really the poles and wires that you see in the street that we walk past all the time, and 45,000 kilometres of transmission network, which is the really big stuff that you see more out in the regional areas and bringing in large amounts of generation back into where people are using it.

And so, what we've had over the last 20 years is probably really a pretty steady state demand in terms of how much energy we've been using in Australia. 

There's been little ups and downs and different things obviously with COVID, which has caused some dip in demand, but what we're seeing over the next 20 years is almost a doubling of demand is required as we transition more to a 100% renewables and decarbonize, whether it's the end users, whether it's transportation or manufacturing. 

And that's really exciting. So it's going to play a massive role in terms of how we're going to see that electricity market landscape change over the next 10, 15 years. And we're right in the middle of it now.

Teitel: So when we think about generation at the moment, 40% of our current generation is already in renewables. And so, I often find when you hear in the news at the moment about politicians talking about net zero out in 2050, it's a little bit of a disillusioning, but actually, the transition is with us right now. There's three key drivers for it happening at the moment. One, our coal-fired power stations are actually closing down right now. There are a swathe of corporates looking at near-term net zero targets, and electrification of transportation and industry is happening.

So if we think about it, in New South Wales, coal-fired power stations closing in the next five years mean that 40% of the existing generation has to be replaced. 

Big names, household names that we're all aware of, BHP, Telstra, Woollies have made near-term commitments in terms of net zero, which means they're out there in the market already buying green energy. 

Woollies, having done that, is turning to their suppliers, for example, their transport companies and saying, "What are you doing with your fleet to meet net zero?" And encourage them to look at electrification or hydrogen. And then, electric vehicles. Australia is just going to actually be swept up with the world with electric vehicles, and that is all going to happen really soon. So, the transition is with us right now.

Thornton: So, what you're saying is you think we're 40% there already. I think most people still view renewables as this technology sort of on the margins, that is the future, but it's not really here yet. And then you say, in aggregate, 40% of our output is already from renewable sources. Is that right?

Teitel: Including 10% from rooftop solar.

Thornton: On residential rooftops?

Teitel: Yeah.

Thornton: That's incredible. Okay. What does a completely net zero energy economy look like in Australia? What do we have to do to get from that 40% to that 100% point?

Brown: We're going to continue to see a dramatic change. So some 50 gigawatts of variable renewable energy generation will be built out over the next period of time. And I think when you look at sort of a net zero landscape of where we're heading, there's four probably key things that I'd talk about. 

The state of play of the existing transmission network and how that's going to change and move how we, as energy users and consumers on an individual level, think about energy and use that at home, how companies really think about energy and use it and drive a change in behaviour, and then finally, probably the technology mix.
Brown: So you talk about wind and solar, and they're really well known and people understand those technologies, but you've got storage really coming in to a play in terms of how we store energy that's coming off the grid and use it at different times of the day. And we understand lithium ion storage at the moment, but there's more coming in that technology place. So from a technology point of view, what will come out through storage over time in the next five, 10 years will also be big.

So if you think back to the first point around transmission, as we build out more what they call "renewable energy zones", which is really where we're trying to get the existing transmission network to go somewhere else within Australia to pick up these resources, we're going to build some 10,000 kilometres of new transmission lines in Australia to really support that renewable energy generation. When you think what we did right now, we've got these large coal-fired plants in New South Wales, like Eraring, that have 2.7 gigawatts of energy they're producing at one point in time. When that comes off, we're going to need sort of up to three times that amount to replace that base load energy.

So, some seven and a half gigawatts of renewable energy. That won't be at one location anymore. We're not going to put that at Eraring. We're going to put that all over New South Wales. You're going to be building transmission to support that. So, that's going to create a real dynamic and change. And then, if you think about what consumers will be doing at home, as they're putting more solar on the roof, batteries, electric cars, they're going to be thinking about the time of day that they're using their energy, how they're sharing it with their neighbours, what they're doing. Do they store it? Do they use it now? Do they put it back into the grid?

And then you've got companies really saying, "We want to hit our net zero targets," and really coming out and driving that. So they're looking to also contract for renewables, or think about different ways they can change their energy usage to really play into it. 

And then you overlay that with storage and the role that, that will play in amongst be whether it's at people's houses, whether it's at manufacturing plants, whether it's connected to this renewable energy generation out in the network. That will play a dynamic role. And so, you really need all of those four pieces to come together. And that's what we're in the middle of and seeing, and that's really exciting. It's been built out right now as we speak.

Thornton: You mentioned selling back onto the grid, from the rooftop back onto the grid. Do we have the infrastructure for that? Recently, I know people have been charged for putting power back on the grid, which seems crazy, but the explanation as I'm familiar with it is that it's a matter of capacity. The system isn't set up to accept that energy back onto the grid. Is that right?

Brown: Yeah. It's the same issue. So, what you're talking about there really is the distribution network and the poles and wires that are in the street. And they were never designed and built, when they were put together, to have people sending energy from their house back in them. They were really designed no different to the transmission network in Australia, you have these large single generators generating all this energy and pushing it from where they are back into the communities and into their houses. The system wasn't designed for that reverse flow. And so then, when you have not just one house, but lots of houses within the community getting together and going, "We're all going to push this same energy at the same time," because the sun shines at the same time for everyone, push it all back into the grid, the pipe isn't big enough to take it all.

So that's where the technology play really comes in around sophistication, around understanding how you use that energy in the house smartly, so that you don't waste it. That's a big part of what net zero is, and you often hear that being spoken about in terms of a DER, demand energy response, sometimes as an acronym, or also behind the metre play, in terms of how that really plays into the market. 

And if you look at what AEMO, the Australian Energy Market Operator, is predicting almost 50% of what we generate right now will almost be coming from behind the metre over the next 30 years. 

So that just shows you what a large role us, as individual energy users, will play in the future of the energy mix as we make our own personal decisions about what we put in our houses, what type of cars we buy, what type of electrical infrastructure, washing machine, and how we use that as well over the next 20 years.

Thornton: Sonia, take us through the economics of these new renewable technologies, solar, wind, and also the storage that goes along with it. Are they cheaper per megawatt or per gigawatt than a coal-fired plant today?

Teitel: Yes, new built solar and wind is cheaper than new built coal. The next thing that you need to then think about, we talked a little bit earlier about the supply and demand of the market in Australia and each state. The way the market actually works is on a five minute basis. So every five minutes, there's a new price depending on supply and demand. Now, Darren's talked about the fact that we've got all of this rooftop solar alongside the utility scale solar that already exists, and that not surprisingly puts supply into the market in particular in the middle of the day, which pushes down price in the middle of the day.

What is great about the wind in Australia is that it primarily blows in the late afternoon and evening. So you have a nice balance, but we are ending up in a situation where peak prices, for example, in the evening, will then be captured by the wind farms. 

So when you think about the cost of solar and wind, whilst the actual cost of the equipment is probably lower for solar because the prices for solar are also lower, then you actually get a nice balance of being able to build both solar and wind, where they capture these different price premiums.

Thornton: Darren, there's a lot of talk, when we're talking about the energy market, not just about total output, but also about the stability of the grid and stability of the system. What's the interplay between traditional, legacy power sources and renewables when we're talking about that stability piece?

Brown: It's an interesting point. It's one that gets spoken about a lot. And I think probably, if you look at states like South Australia right now, South Australia's proven that you can operate on a 100% renewables. And I think it was only last year, they had a stretch of seven days where they operated at greater than a 100% output of renewable supplying all of the energy needs for that state. So, what we're talking about is really that transition over the next 20 years is those coal-fired plants come out and they do provide a level of stability. I mean the Energy Market Operator really has got a role, and a really complex role, to make sure the grid is stabilised and balanced. And it's kind of like a see-saw really. You can't sort of stay stationary on a see-saw and keep balance. There's always that continual movement.

And so, that's really what the Energy Market Operator is doing. 

But I think what renewables has proven over the last few years is that it's capable of coming in and providing that stability, whether it's through batteries, whether it's through wind or solar, as this more base load generation comes out. 

And it's really the beauty of where storage is going to come in, whether it's more lithium ion battery storage, or whether it's pump to hydros, or things like Snowy 2.0 that are being built, that really fill those gaps to create that base load of generation that enables that variable renewable energy to support the energy needs to keep the lights on as base load coal comes out. So it's definitely something that will continue to evolve over the next 10, 15 years.

Teitel: The other thing that has become more dynamic is what we call "demand response" as well. So rather than just relying on the supply equation, the actual loads like businesses and individuals will change their demand and get paid for it to help the balance as well.

Brown: That's really the technology play that'll come in. As you see smart technology platforms come in that support consumers and businesses, really is about how they can play into that space. And you'll see retailers come in over time to support that as well, in terms of what platforms they can provide that really help create that balance between what supply and demand is.

Thornton: Darren, how's renewable energy priced through the supply chain to the end user?

Brown: Yeah, it's a really good question. And I think you got to come back to the point that not all renewable energy is the same. So when you look at solar farms, you look at wind farms, you look at storage, they're all a bit unique and different. From a macro sense, we've got really good data these days around when solar farms will produce, when wind farms will produce, and how much they'll produce seasonally. And we've got a growing understanding about the role that storage will play and how it fills those gaps.

Energy is priced in megawatt hours. It's traded in megawatt hours in the National Energy Market that Sonia were speaking about earlier. So in terms of how it comes to the end user, really, it's pulling an understanding together of if you're a retailer, how much energy you are generating really, and what is needed for that end user from a megawatt hour's perspective. There's an understanding about what it costs to produce one megawatt of solar or one megawatt of wind. And then really, it's filled with other types of generation right now to create that base load, whether that's gas or coal at the moment and storage as coming in.

But the cost of that generation is one part of the equation to the end user obviously. 

The transmission network itself plays a large role in terms of the percentage of any consumer's bill, and as renewable energy generation is built out and more transmission is built out, that is also going to play a role in what end users pay to get access to their energy over time. 

As we build out more generation and more transmission, it becomes something that builds together.

Thornton: So you're staying on that transmission network, unless we're building solar farms and wind farms in coal pits of abandoned coal mines, I don't imagine there's going to be much need for the power lines to come from the coal mines to the population centres. What has to change in terms of that distribution network physically?

Teitel: Basically, the way that we're thinking about it at the moment is in quite a coordinated way. So Darren mentioned earlier the Australian Energy Market Operator, they actually look at keeping the lights on for the Australian electricity and gas system. And so, what they're looking at is the forecast for new renewables through Australia and planning effectively what the transmission network needs to look like across each state. They've provided that plan to the state governments, and each state government is really currently, they can see where this is going, on the forward foot to try and look at how to roll out that investment. And New South Wales is a great example. They've created basically a roadmap which says, "These are the areas we want to build the transmission network," and they've created a framework on how that's going to get paid for. And they're running a tender process for looking at those who are going to build it, and also for those who're going to connect to it. And Victoria and Queensland are not far behind.

Thornton: And we're really talking about, correct me if I'm wrong, renewable energy zones is the term, and which I guess is analogous to what coal country was previously. Is that right?

Brown: They're aiming to create these hubs where we know the resources from a wind or solar point of view are good, and we know that we want to have more generation coming from those points in Australia back in to support the demand requirement. And so, David, we touched on earlier about transmission lines in terms of what happens to these transmission lines as you've got the coal plant at the end of them aren't used anymore. A classic example of that will be you look at Latrobe Valley. We've got two really large transmission lines coming out of Latrobe Valley back into Victoria that can support some 10 gigawatts of generation.

There is a renewable zone in Victoria being planned down around that Gippsland region right now that will support both onshore wind and solar and offshore wind. That is exactly the perfect way to ensure the existing infrastructure that's already there and purpose built is being used to support renewable generation coming in as the coal leaves, to get that generation back into Melbourne to support demand. 

And that's just one example. There's many others really, I think, across the Eastern Seaboard where making sure that those points are being used to pull back in that renewable energy generation as it gets built out over the next 10 years.

Thornton: So, Darren, what are the complexities around developing these renewable energy assets?

Brown: Look, I think that they really are complex. And what we've got to remember is that these are really big infrastructure assets. These are investments of 500 million to a billion dollars plus in each individual right that are being developed over time. You go right back to engaging with land owners and securing land and talking to communities about building a brand new infrastructure project within their region, and the people and the skills you need to really bring into those communities to talk to them about what it means and how it will work and how it will integrate with their lifestyles. You then move from having to go through planning approvals with state and federal government bodies, and really considering all the environmental aspects of an approval, whether it's around specific species that are in that area or indigenous lands owners.

Brown: That's just really the start of it. And then, you've really got to think about how you're going to design that plant, what the engineering bit looks like, how it's going to operate. Then you think about the grid and how the grid really feeds into where that plant is located. Because no two locations are the same, and depending on where you put that plant or that generation asset and the grid will really have a lot of complexity. So, it's about pulling a team together of people that can actually understand each of those complexities and put together. And that's really what Octopus has been building over the last two or three years is really a specialised team of 28 people now that can help pick up each of those elements and put together as a jigsaw puzzle. Because if you pull one element away, you're missing a really important ingredient to bring these really complex projects to life and operating for the future.

Thornton: You touched there on the engagement with local communities. How important is the ESG element to the development of these renewable assets?

Brown: It's incredibly important. I mean, I don't know, Sonia, if you want to sort of touch on that bit yourself or...

Teitel: Basically, we see community engagement as part of the fundamental process that we go through for any of our projects. It's in fact even an evaluation point. When we're acquiring a project, we have to make sure that the community has been well engaged. And we take pride in that. A couple of the projects that we have, the land owners are actually part of the development team and it just makes the biggest difference, because we're in rural areas and they know the community and they can talk to them. So, you're getting all of the inside information about how people are feeling. You can go out and have a cup of tea with them over the coffee table and explain what's going on. So that's local community, but then we've also got state government, regulatory bodies, the broader renewables industry. So, we think about all of those aspects for all of our projects.

Brown: What's really important to remember is these are assets that we're building for the next 30 plus years. They're going to be in these communities for the next 30 years. These generation plants create an opportunity to be part of that community for the next 30 years, whether it's about job growth or creating a vibrance in that community. It's a really important part of what we think about is how these generation assets will integrate into that community and how we can be part of that community and help it grow over the next 30 years.

Thornton: Sonia, tell us about the Gippsland Energy Park. Hostplus, one of the biggest super funds is on board, and funding is coming through Octopus, but then also through the green bank. What does it mean to have that kind of institutional interest now in renewables?

Teitel: It's really very exciting. I mean, what I think we are seeing is that companies are setting targets. 

Hostplus has set a net zero target and they're using investments like this to actually deliver on their promises. So, I mean, we spoke before about Latrobe Valley is in Gippsland. It's the perfect area where we're looking to see an energy transition, and Hostplus wants to be a part of that.
Thornton: Sonia, what benefits do renewable energy assets provide to portfolios?

Teitel: We start thinking about it with fuel source. So when you consider energy, typically, people think about oil and gas. And oil and gas is incredibly volatile. Current events like... Everyone can know about that. So when we think about wind and sun, they're free and they're available. No one is going to take that away from us. We have energy security. So when you think about it, we have a non-correlated fuel source with broader economic activity that gives us energy security. When we think about the next piece, how do we monetize that?

Well, typically, most of the revenues come from a power purchase agreement, which is a fixed price contract. And then sitting on top of that, you have some merchant revenue. We've just been talking about the story of how compelling it is for investors as demand increases and supply is coming off. So, there's a great investment opportunity there. And finally, when you think about these assets, they're relatively simple assets to operate. 

So we have long-term, cheap ONM agreements, very low operating risk, and in the end of all of that, you have these assets that have extremely high EBITDA, 70 to 80%. So, you get a strong yield. It's a great portfolio.
Thornton: Well, that's a great springboard to my next question. Could you see a world in which these renewable energy companies have the same status in the market as the traditional resource companies have today and have had in the past?

Brown: I mean, no one's got a crystal ball that says, "This is exactly what's going to happen in the next 15, 20 years." But if you think about where renewable energy and renewable companies that are building these portfolios and building these assets have come in the last five years, and if you think about the changing landscape for some of our largest mining resource and oil companies, which have really branded to energy companies these days, there's a massive change going on. And so, when you think through that decarbonization of whether it's through the electricity market and generation, whether it's through transportation, or whether it's through manufacturing, and then you overlay technology, there's going to be a large number of small renewable companies now that will continue to accelerate through, much like Octopus, and grow inside rapidly.

And then at the other side, you've got large mining and resource companies who're really looking to try and pivot out of their existing portfolios and what they're doing right now, and adapt to that changing landscape. So I think it's an exciting time for the next 10, 15 years to be able to watch those smaller companies going to really grow into that renewal space, whether it's through technology or physical assets, and the changing dynamics of these much larger companies that are in more traditional plays right now and they're looking to move themselves across and can they be successful in that move as well.

Thornton: How much appetite is there in those big, traditional resource companies to make that transition?

Brown: I think there's a large amount of appetite. When you look at how they're trying to talk about it, they're really trying to balance up what their shareholders are seeking right now and what they're trying to keep from a free cash flow generation perspective, and how they invest in the future at the same time and bring through new opportunities that they're trying to scale. And so, probably the best example of that is really hydrogen, which is an exciting place for the many of these really large companies to try and play in. Hydrogen hasn't scaled yet, but it will over the next sort of five to 10 years. So they're grappling with how they can really scale in those type of areas, maintain what they're doing to generate that cash flow, but also meet their emissions standards' needs. That's a really intricate balance that these large companies are trying to work through, but they're obviously going to play a large role in the future as well.

Thornton: Sonia, Darren, this has been great. It's been awesome to hear about how these renewable energy assets are developed and how important they're going to be in the future if we're to have any hope of meeting net zero. Thanks for joining us.

Brown: Thanks for having us.

Teitel: Thanks.

Leading Australia's drive towards a cleaner future

Octopus invests directly into the Australian renewable energy sector, helping to provide the innovative solutions it needs during its transition to a clean energy future. Visit their website for more information, or visit the OREO fund profile below. 

Managed Fund
Octopus Renewable Energy Opportunities Fund (OREO)
Alternative Assets

David Thornton
Content Editor
Livewire Markets

David is a content editor at Livewire Markets. He currently hosts The Rules of Investing, a half hour podcast where he sits down with leading experts across equities, fixed income and macro.

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