The Impending Recovery in the Market for Power Generation Equipment: A Global Perspective

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Eric Selmon Hugh Wynne

Office: +1-646-843-7200 Office: +1-917-999-8556

Email: eselmon@ssrllc.com Email: hwynne@ssrllc.com

SEE LAST PAGE OF THIS REPORT FOR IMPORTANT DISCLOSURES

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May 10, 2018

The Impending Recovery in the Market for Power Generation Equipment:

A Global Perspective

In this note we estimate the global demand for new power generation capacity, and fossil fueled power generation capacity in particular, over the next two decades. We conclude that demand for fossil generation capacity could rise rapidly in the 2020s, driven by the need (i) to supply the growth of power demand in the rapidly developing economies of China, India and the Middle East, and (ii) to replace aging coal, nuclear and gas fired power plants in the mature economies of North America, Europe, and Japan (Exhibit 5). In the world outside of China, we expect the combination of retirements and demand growth to drive growth in gross fossil fuel capacity additions of ~8% p.a. over 2020-2025, ~5% p.a. over 2025-2030, and ~4.5% p.a. over 2030-2035 (Exhibit 4). Gross fossil fuel capacity additions will grow most rapidly in markets that currently face slow power demand growth, but will see rapidly rising capacity retirements in the coming years; over 2020-2035, we expect gross additions of fossil fuel capacity to grow at ~13% p.a. in Europe, 12% p.a. in North America, and 11% p.a. in Japan (Exhibits 6 and 7).

Gas fired capacity additions are expected to outstrip coal, with gas additions in the world outside of China growing by ~9% p.a. over 2020-2025 vs. ~5% for coal, by ~5.5% p.a. over 2025-2030 vs. ~3.5% for coal, and by 5% p.a. over 2030-2035 vs. 3% for coal. This shift of capacity additions away from coal towards gas will reduce the average cost per GW of new capacity over time, reflecting the much lower capital cost of gas fired capacity. This will limit the growth in real expenditures for new fossil fueled generation capacity, which we estimate will grow at ~7% p.a. over 2020-2025, ~4.5% p.a. over 2025-2030, and ~4% p.a. over 2030-2035, with potentially higher growth in nominal outlays depending on the level of inflation (Exhibit 4).

Portfolio Manager’s Summary

  • In this note, we estimate the trajectory of global demand for new power generation equipment, both in gigawatts (GW) of capacity and in constant 2018 dollars, over the next two decades. We present the results of our analysis on a global basis and, because the market for power generation equipment in China is dominated by domestic suppliers, for the world outside of China as well. As planned additions of generation capacity are usually reflected in equipment orders at least two or three years in advance, our discussion begins with the year 2020. We explain our estimates in the “Methodology” section below.
  • To forecast required additions of new generation capacity to meet the growth in power demand (“net capacity additions”) we assume that firm generation capacity grows with power demand. Over 2020-2040 we estimate the growth in global power demand at 2.4% p.a. and at 1.8% p.a. excluding China, requiring global firm generation capacity to expand from ~6,000 GW in 2020 to ~9,600 GW by 2040.
  • Critically, the pace of growth in global power demand is forecast to decelerate, from 2.7% p.a. over 2020-2025 to 2.1% p.a. over 2035-2040. Growth in GW of net firm capacity added annually therefore slows from 2.5% over 2020-2025 to 0.3% over 2035-2040 (see Exhibits 13 and 20).
  • However, due to rapidly rising retirements of aging fossil fuel capacity over 2020-2035, the annual additions of fossil fuel generation capacity required to meet demand growth and offset capacity retirements (“gross capacity additions”) will grow much faster than power demand (Exhibits 6 and 7).
  • Outside of China, the capacity required to replace retiring power plants will constitute the largest component of gross capacity additions by 2025 (see Exhibit 5). We estimate that retirements will grow from 51 GW in 2020 to 94 GW in 2030 and 123 GW in 2035. Globally, we expect annual capacity retirements to rise rapidly through the mid-2030s and to exceed net capacity additions in 2035 (see Exhibit 5), when power plants recently built in China, India, the Middle East and other Asia Pacific countries begin to retire and retirements in North America, Europe and Japan are still near their peak.
  • Based on the capacity required to meet demand growth and offset capacity retirements, we expect gross fossil fuel capacity additions to rise by 3.8% p.a. over 2020-2025, 4.8% p.a. over 2025-2030 and 4.0% over 2030-2035 (see the left side of Exhibit 4).
    • Outside of China, which has the world’s newest generation fleet, capacity retirements will rise more rapidly, driving growth in gross fossil fuel capacity additions of 7.9% p.a. over 2020-2025, 4.9% p.a. over 2025-2030 and 4.6% over 2030-2035 (see the left side of Exhibit 4).
    • So significant is the expected wave of retirements in the mature economies that these regions are expected to have the fastest growth in gross fossil fuel capacity additions over 2020-2035: ~13% annually in Europe, ~12% annually in North America and ~11% annually in Japan (Exhibit 7).
  • We expect global gross additions of fossil fuel generating capacity to rise from an estimated 143 GW in 2020 to 218 GW in 2030 and 266 GW in 2035, implying an increase of over 50% in annual additions of fossil generation capacity from 2020 through 2030 and an increase of 85% from 2020 through 2035.
  • Outside of China, the growth in fossil fuel capacity additions is even more impressive, with annual gross additions of fossil generating capacity estimated to rise from 80 GW in 2020 to 149 GW in 2030 and 187 GW in 2035, implying an increase of 85% over 2020-2030 and 132% over 2020-2035.
  • We have forecast the breakdown by fuel of gross additions of fossil capacity based on the historical mix of capacity additions by region. We conclude that gas fired capacity additions should far outpace coal even with no additional efforts to reduce greenhouse gas emissions. Outside of China, we estimate that gas fired capacity additions will grow by 9.3% p.a. over 2020-2025 vs. 4.8% for coal; by 5.4% p.a. over 2025-2030 vs. 3.5% for coal; and by 5.2% p.a. over 2030-2035 vs. 3.2% for coal (see Exhibit 4).
  • This shift of capacity additions away from coal towards gas will reduce the average cost per GW of new capacity over time, reflecting the much lower capital cost of gas fired capacity. Outside of China, we estimate that capital expenditures on gross fossil fuel capacity additions will grow by 7.0% p.a. over 2020-2025 in real terms, at 4.6% in real terms over 2025-2030, and at 4.3% real over 2030-2035 (Exhibit 4).
  • Outside of China, we expect annual expenditures on fossil fuel generation equipment to double in real terms over 2020-2035, rising from an estimated $45 billion in 2020 to $62 billion in 2025, $78 billion in 2030 and $96 billion by 2035. Nominal outlays on fossil generating equipment will likely be materially higher, depending on the level of global inflation (see the right hand charts of Exhibit 3).
  • An important finding of our analysis is the extent to which the rapid growth of renewables will suppress the need for new fossil fuel generation capacity, despite the limited firm capacity value of renewable technologies. Outside of China, we expect the firm capacity value of new renewable resources to supply ~40%-45% of required net capacity additions from 2020 through 2040 (see Exhibits 8 and 9).
    • In addition, the growth of renewable generation will displace the power output of fossil fueled plants, causing their capacity factor to fall from an estimated ~42% outside of China today to ~36% in 2040 (see Exhibit 11).
  • A risk to our forecast of fossil fuel capacity additions lies in the potential for electricity storage to become cost competitive with conventional gas fired peakers, which we anticipate could occur by 2025 (see our note of February 5, Can Grid Scale Energy Storage Compete with Gas Fired Peakers? Not Yet, But Coming Soon).

We estimate that, on a global basis over 2025-2040, required gross additions of fossil fuel generating capacity would be reduced by ~3% if 10% of planned additions of peaking capacity were substituted by grid scale electric energy storage; by ~10%, if 30% of planned additions of peaking capacity were replaced; and by ~16% if 50% were replaced (see Exhibit 10).

Exhibit 1: Heat Map: Preferences Among Utilities, IPP and Clean Technology

Source: SSR analysis

Details

Overview

In this note, we estimate the trajectory of global demand for new power generation equipment, both in gigawatts (GW) of capacity and in constant 2018 dollars, over the next two decades. We do so by examining the two key drivers of demand for generation capacity: (i) the need for new generation capacity to meet the growth in global power demand, which is the key driver of demand for generation equipment in the rapidly developing economies of China, India and the Middle East, and (ii) the need to replace aging coal, nuclear and gas fired power plants as they retire, which tends to be the most important driver of demand in the mature economies of Europe, North America, and Japan (see Exhibit 5). While growth in global power demand is forecast to decelerate over the years from 2020 through 2040, rapidly rising retirements of aging fossil fuel generation capacity over this period will cause gross annual additions of firm generation capacity to grow robustly.

Before proceeding to the results of our analysis, it is useful to clarify here our use of two terms, “net capacity additions” and “gross capacity additions”. By gross capacity additions we mean the additions of generating capacity required to offset the retirement of existing capacity and add the capacity needed to meet the growth in power demand. When referring solely to the capacity required to meet the growth in power demand, we use the term net capacity additions.

We present the results of our analysis on a global basis and, because the market for power generation equipment in China is dominated by domestic suppliers, for the world outside of China as well. As planned additions of generation capacity are usually reflected in equipment orders at least two or three years in advance, our discussion begins with the year 2020. Our analysis suggests that global gross additions of fossil fuel generating capacity will rise from an estimated 143 GW in 2020 to 218 GW in 2030 and 266 GW in 2035, implying an increase of over 50% in annual additions of fossil generation capacity over the decade of the 2020s and an increase of 85% from 2020 through 2035. Outside of China, the growth in gross fossil fuel capacity additions is even more impressive, with annual additions estimated to rise from 80 GW in 2020 to 149 GW in 2030 and 187 GW in 2035, implying an increase of 85% over 2020-2030 and 132% over 2020-2035.

We expect the combination of capacity retirements and power demand growth to a drive robust expansion in the demand for fossil fuel generation equipment, particularly in markets outside of China, through 2035 (see Exhibits 3 and 4). Outside of China, we estimate that gross additions of fossil fuel generation capacity will grow at 7.9% p.a. over 2020-2025; at 4.9% p.a. over 2025-2030; and at 4.6% p.a. over 2030-2035 (see the left hand chart of Exhibit 4). Thereafter, slower forecast growth in global power demand and a decline in expected capacity retirements are reflected in a modest contraction of the market for new power generation equipment over 2035-2040, although it will remain at historically high levels.

We have forecast the breakdown by fuel of gross additions of fossil capacity based on the historical mix of capacity additions by region. We conclude that gas fired capacity additions should far outpace coal, even with no additional efforts to reduce greenhouse gas emissions. Outside of China, we see additions of gas fired capacity growing by an estimated 9.3% p.a. over 2020-2025 vs. 4.8% for coal, and by 5.4% p.a. over 2025-2030 vs. 3.5% for coal, and by 5.2% p.a. over 2030-2035 vs. 3.2% for coal (see the left hand chart of Exhibit 4). This shift of capacity additions away from coal towards gas will reduce the average cost per GW of new capacity over time, reflecting the much lower capital cost of gas fired capacity.

Exhibit 2: Estimated Gross Annual Additions of Fossil Fuel Generation Capacity (GW)

World World Excluding China

 

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Source: Energy Information Administration, International Energy Agency, Organization for Economic Co-operation and Development, SSR analysis and estimates

Exhibit 3: Gross Annual Additions of Fossil Fuel Generation Capacity[1]

Average Annual Gross Capacity Additions (GW) Average Annual Capex (Billions of Constant 2018 US$)

 

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Source: Brattle Group, Energy Information Administration, International Energy Agency, Organization for Economic Co-operation and Development, SSR analysis and estimates

Exhibit 4: Growth in Gross Annual Additions of Fossil Fuel Generation Capacity1

5-Year CAGR in GW of Capacity Added 5-Year CAGR in Capex (Billions of Constant 2018 US$)

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Source: Brattle Group, Energy Information Administration, International Energy Agency, Organization for Economic Co-operation and Development, SSR analysis and estimates

Outside of China, therefore, we estimate that capital expenditures on gross fossil fuel capacity additions will grow by 7.0% p.a. over 2020-2025 in real terms, at 4.6% in real terms over 2025-2030, and at 4.3% real over 2030-2035. In real terms, we expect annual capital expenditures on gross fossil fuel capacity to double over 2020-2035, rising from an estimated $45 billion in 2020 to $62 billion in 2025, $78 billion in 2030 and $96 billion by 2035. As these estimates are expressed in constant 2018 dollars, nominal outlays on fossil generating equipment will likely be materially higher, depending on the level of global inflation (see the right hand charts of Exhibits 3 and 4).

Our analysis suggests that the two principal drivers of gross capacity additions — the need for new firm generation capacity to meet the growth in power demand (i.e. net capacity additions), and the need to replace retiring generation capacity – vary materially in importance by region. Net capacity additions to meet the growth in demand are the principal driver of demand in the rapidly developing economies of China, India and the Middle East, while the retirement of existing plants is the most important component of demand in the mature economies of North America, Europe and Japan. As the rate of growth of the most rapidly developing economies slows gradually over time, the relative contribution to gross global capacity additions of net capacity additions and the replacement of retiring capacity will shift markedly over time, with replacement of retiring capacity coming to displace net capacity additions as the largest component of global demand.

Globally, the net capacity additions required to meet the growth of power demand are expected to exceed the capacity required to replace retirements until 2035 (see the left hand chart of Exhibit 5). In the world outside of China, however, our analysis suggests that by 2025 the capacity required to replace retirements will exceed the net capacity additions required to meet demand growth (see the right hand chart of Exhibit 5). Both globally and in the world outside of China, the capacity required to replace retirements is expected to grow much more rapidly than net capacity additions, so that growth in gross capacity additions is expected to outpace the growth in power demand.

Exhibit 5: Drivers of Gross Additions of Fossil Fuel Generation Capacity (GW)

World World Excluding China

 

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Source: Energy Information Administration, International Energy Agency, Organization for Economic Co-operation and Development, SSR analysis and estimates

The rapid growth of capacity retirements (particularly outside of China, which has the world’s youngest generation fleet) has interesting implications for the rate of growth of gross annual capacity additions across the different regions of the globe. The mature economies of North America, Europe and Japan currently face extremely low power demand growth (see Exhibit 6) and thus have limited need for net capacity additions to supply the growth in load. By contrast, it is these regions that the face the most rapid increase in capacity retirements. So significant is the expected wave of retirements in the mature economies that these regions are expected to have the fastest growth in gross capacity additions over 2020-2035: ~13% annually in Europe, ~12% annually in North America and ~11% annually in Japan (see Exhibit 7). By contrast, in the rapidly developing economies of India and China, which currently face very high power demand growth and a commensurately large need for net capacity additions, the combination of slowing GDP and power demand growth over time, and a smaller and more gradual increase in retirements, imply a much lower rate of growth in gross capacity additions (Exhibit 7).

Exhibit 6: Near-Term Growth in Electricity Exhibit 7: CAGR in Gross Additions of

Demand Given GDP Forecast, 2017-2020 Fossil Fuel Capacity by Region, 2020-2035

 

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Source: Organization for Economic Co-operation and Development, Energy Information Administration, International Energy Agency, SSR analysis and estimates

Another important finding of our analysis is the extent to which the growth of renewables will suppress the need for net additions of fossil fuel generation capacity (see Exhibits and 9). In estimating the need for new fossil fueled generation capacity, we have taken into account the additions of renewable generation capacity forecast by the International Energy Agency (IEA). While their growth forecast for total renewable capacity does appear very rapid, at 3.4% p.a. globally from 2020-2040 (see Exhibit 23), it is significantly faster than demand growth of 2.4% over the same period. Moreover, the total growth rate understates the more rapid growth rates of solar and wind of 6.7% and 4.8% p.a., respectively, over the same period. We adjusted these forecast additions of renewable capacity to reflect the intermittency of renewable generation and consequently the limited availability of renewable resources during periods of peak demand. We attributed a firm capacity value of just 10% to wind, 40% to solar and 55% to other renewable technologies (e.g., geothermal, biomass and hydro). Nonetheless, our analysis suggests that the growth of renewable resources will meet over 30% of the world’s need for net additions of firm capacity over 2020-2040, and over 40% for the world outside of China (see Exhibits 8 and 9).

Exhibit 8: Estimated Composition of Net Additions of Firm Generation Capacity (GW)

World World Excluding China

 

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Source: Energy Information Administration, International Energy Agency, Organization for Economic Co-operation and Development, SSR analysis and estimates

Exhibit 9: Estimated Composition of Net Additions of Firm Generation Capacity (%)

World World Excluding China

 

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Source: Energy Information Administration, International Energy Agency, Organization for Economic Co-operation and Development, SSR analysis and estimates

In sensitivity analyses, we have modeled the potential for the firm capacity value of renewable energy to be materially increased through the addition of electricity storage, further eroding the need for new fossil fuel generation capacity. (As explained in our note from February 5, Can Grid Scale Energy Storage Compete with Gas Fired Peakers? Not Yet, But Coming Soon, we believe that grid-scale energy storage could be cost competitive with conventional gas-fired peakers by 2025.) In Exhibit 10 below, we present the average reduction in required gross additions of fossil fuel generating capacity at different levels of substitution of energy storage for conventional peakers. On a global basis over 2025-2040, we estimate the reduction in required gross additions of fossil fuel generating capacity would be ~3%, if 10% of planned additions of peaking capacity were substituted by storage; ~10%, if 30% of planned additions of peaking capacity were replaced; and ~16% if 50% were replaced.

Exhibit 10: Average Reduction in Required Gross Additions of Fossil Fuel Generating Capacity at Different Levels of Substitution of Energy Storage for Conventional Peakers (1)

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1. Reflecting the ratio of peaking capacity to total U.S. firm generation capacity (~25%), we have assumed that peakers make up 25% of each year’s required additions of firm generation capacity (including both fossil and firm renewable capacity).

Source: Energy Information Administration, International Energy Agency, Organization for Economic Co-operation and Development, SSR analysis and estimates

Finally, we expect the continued expansion of renewable generation to erode the power output and thus the capacity factors of fossil fueled plants. The growth of the renewable generation fleet will add significant amounts of zero marginal cost energy to regional power markets, displacing the high marginal cost output of coal and gas fired generating units. Given that the generation of renewable resources such as wind and solar cannot be scheduled in advance, however, net additions of firm fossil fuel capacity will continue to be required to meet the growth in peak demand. With the growth in fossil generation capacity linked to the growth in power demand, but the output of the fossil fleet suppressed by the expansion of lower cost renewable generation, we expect the growth in fossil capacity to exceed the growth in fossil generation, driving capacity factors down.

Our estimates suggest that global fossil fuel generating capacity will grow by ~2.1% p.a. over 2020-2040, but fossil fuel generation will only grow by 1.7% p.a. over this period. Outside of China, we estimate the growth in fossil fuel generation capacity at 1.5% p.a. over 2020-2040, and the growth in fossil fuel generation at just 0.8% p.a. As a result, we expect the capacity factor of the global fossil fuel generating fleet to decline from ~44% in 2020 to ~40% in 2040. Outside of China, we see the capacity factor of the fossil generating fleet declining from ~41% in 2020 to ~36% in 2040. (See Exhibit 11)

Exhibit 11: Fossil Fuel Capacity (GW) and Fossil Fuel Generation (GWh) (2020 = 100), versus Fossil Fuel Capacity Factor (%)

World World Excluding China

 

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Source: Energy Information Administration, International Energy Agency, Organization for Economic Co-operation and Development, SSR analysis and estimates

Methodology

In this note, we estimate the trajectory of global demand for new power generation equipment, both in gigawatts (GW) of capacity and in constant 2018 dollars, over the next two decades. We do so by examining the two key drivers of demand for generation capacity: (i) the need for new generation capacity to meet the growth in global power demand, which is the key driver of demand for generation equipment in the rapidly developing economies of China, India and the Middle East, and (ii) the need to replace aging coal, nuclear and gas fired power plants, which tends to be the most important driver of demand in the mature economies of Europe, North America, and Japan (see Exhibit 5).

To estimate global growth in peak power demand we first estimated the growth in electricity consumption by region. Based on data from the U.S. Energy Information Administration, the International Energy Agency and the Organization for Economic Co-operation and Development (OECD), we have calculated for each principal region of the globe the ratio of (i) the 10-year CAGR in electricity consumption to (ii) the 10-year CAGR in real GDP (see Exhibit 16). Capitalizing on the OECD’s long term forecasts of GDP growth by region, we have used these historical ratios to estimate the likely growth of regional electricity consumption for each year out to 2040 (see Exhibits 12 and 13).

Exhibit 12: OECD GDP Growth Forecast Exhibit 13: Estimated Power Demand Growth

 

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Source: Organization for Economic Co-operation and Development, Energy Information Administration, International Energy Agency, SSR analysis and estimates

To estimate the required growth in firm generation capacity, we have assumed that load shapes and loss ratios by region are unchanging over time, so that the system requirement for firm generation capacity grows at the same rate as regional electricity consumption. More specifically, we have assumed (i) that peak power demand grows at the same rate as overall electricity consumption, and (ii) that the current excess of generation over electricity consumption by region – primarily attributable to power losses on the transmission and distribution grid – will persist in future, and that the capacity of the generation fleet must remain sufficient to offset these losses. Given these assumptions, our forecast rate of growth in firm generation capacity is identical to that of electricity consumption.

To estimate the growth in required fossil fueled generation capacity, we have adjusted our estimate of the required growth in firm generation capacity to account for (i) net changes in nuclear generation capacity over time as well as (ii) an estimate of firm capacity value of expected additions of renewable generation capacity. The International Energy Agency (IEA) provides long term forecasts by region of expected growth in renewable generation capacity, broken down into wind, solar and other renewables, as well forecasts of the expected construction or retirement of nuclear generation capacity.[2]

To estimate the fossil fueled generation capacity required in each region, we have added to our estimates of the firm generation capacity required to meet future power demand in the region the IEA’s estimates of future nuclear retirements, and have subtracted the IEA’s estimates of new nuclear generation capacity expected to be added. Next, we subtracted the firm capacity value of the renewable generation resources forecast by the IEA to be built in the region over the coming decades. The output of certain renewable generation technologies, including hydroelectric, geothermal and biomass fired power plants, can be reliably scheduled in advance and thus can be treated as firm capacity. Moreover, while the output of individual solar and wind power plants is impossible to predict, the output of large, geographically diverse fleets of wind and solar power plants rarely falls below a certain minimum percentage of their nameplate capacity; this minimum percentage of nameplate capacity can also be treated as firm capacity to meet demand during the highest demand hours of the year. We have therefore classified as firm capacity a minimum percentage, depending on the generation technology, of the IEA’s forecast renewable capacity additions, attributing a firm capacity value of 10% to wind, 40% to solar and 55% to other renewable resources, which is most regions of the world are expected by the IEA to be hydroelectric.[3]

The remaining need for firm generation capacity we have assumed is met by through the construction of new coal or gas fired power plants. To estimate the share of each, we have assumed that the choice of technology in each region will replicate the proportions of coal and gas fired capacity in the region’s historical additions of fossil fuel capacity over the last ten years. In the case of China, however, the government has stated that it intends to limit total coal generation capacity to 1,100 GW, and we have respected this cap in our forecasts.

Estimating the annual retirements of existing firm generation capacity is more complex than estimating power demand growth or the need for new firm generation capacity. In the United States, utilities and independent power generators face regulatory reporting requirements that provide a trove of information on the existing generating fleet. Specifically, the Energy Information Administration (EIA) of the Department of Energy maintains data on the capacity, primary fuel, prime mover, and commercial operation date of the ~16,000 operating and retired fossil fuel generating units in the United States. Based on the ages at retirement of already retired units, we estimated the average useful life of different types of power plants. Our estimates assume an average useful life of (i) 60 years for nuclear, coal, gas and oil fired steam turbine generators and (ii) 35 years for gas and oil fired combustion turbines and combined cycle gas turbine generators. Knowing the type and the commercial operation dates of the generating units currently in operation, we have estimated their likely retirement date. Finally, where the owners of a unit have announced its planned retirement date, and this date has been accepted by regional reliability coordinators, we have incorporated this data into our model. (See our note of April 19, 2018 The Next Wave of Rate Base Growth Half of U.S. Generating Capacity Will Retire by 2040: Who Wins and Who Loses?.) [4]

Outside the United States, similarly granular information on the existing generating fleet was not readily available to us. However, IEA data on the growth in power generation capacity by region is available from 1980 on. For the years from 1980 to 1990, we assumed that these capacity additions comprised steam turbine generators, whether powered by coal, oil, gas or nuclear fuel; as in the United States, we assumed that these steam turbine generators have a useful life of 60 years. After 1990, we assumed the required capacity additions comprised a mix of steam turbines, combustion turbines and combined cycle gas turbine generators (CCGTs); as in the U.S. we assumed that the combustion turbine and CCGTs have a useful life of 35 years. We modeled the mix of steam turbines, combustion turbines and CCGTs added each year so as to arrive at a mix of these generation technologies in 2015 that reflected the actual mix of generation technologies reported in the IEA data for that year. Finally, to estimate the retirement dates of plants brought on line prior to 1980, we assumed that the age profile of each region’s generating fleet in 1980 paralleled that of the U.S. generating fleet in 1980. We then estimated the retirement dates of these units by assuming that the units will retire 60 years after their estimated date of commercial operation.

Principal Conclusion No. 1: Net Growth in Global Capacity Additions Will Likely Peak in the 2020s

As noted above, the demand for new power generation equipment has two principal drivers: first, the need for net additions of generation capacity to meet the growth in power demand, particularly evident in those regions of the world where GDP growth is highest, and second, the need to replace retiring firm generation capacity, a more important contributor to demand in the more mature economies. Our projections suggest that the first of these drivers, the need for net capacity additions to meet the growth in demand, is likely to peak in the decade of the 2020s.

As Exhibit 14 illustrates, we estimate that in 2020 the advanced economies of North America, Europe and Japan will account for ~40% of the world’s installed generation capacity. As can be seen in Exhibit 15, by contrast, the contribution of these economies to the aggregate demand for net new generation capacity in 2020 is so small as not even to be visible. This disparity reflects a combination of (i) slow expected GDP growth in the advanced economies (ranging, in the OECD’s forecast for 2017-2020, from 0.4% p.a. in Japan to 1.5% p.a. in Europe and 2.1% p.a. in North America; see Exhibit 17) and (ii) extremely low ratios of power demand growth to GDP growth in these regions, such that power demand is growing at a small fraction of the rate of growth in GDP (ranging, over the last ten years, from 16% in Europe to 19% in Japan to 21% in North America; see Exhibit 16). By contrast, India, the Middle East and China together account for 80% of the forecast demand for new firm generation capacity in 2020 (see Exhibit 15). This reflects a combination of (i) very rapid expected GDP growth (ranging, in the OECD’s forecast for 2017-2020, from 4.3% p.a. in the Middle East to 5.3% p.a. in China and 6.8% p.a. in India; see Exhibit 17) and (ii) extremely high ratios of power demand growth to GDP growth in these regions (ranging, over the last ten years, from 95% in China to 98% in India and 135% in the Middle East; see Exhibit 16).

Importantly, high ratios of power demand growth to GDP growth tend to correlate with high rates of GDP growth; developing economies tend to see more rapid growth in electricity use than mature ones, reflecting phenomena such as rural electrification, the adoption of electrical appliances and air conditioning in homes, as well as the more rapid development of industrial capacity and transportation systems. This tendency for rapidly developing economies also to have high ratios of power demand growth to GDP growth results in regional rates of power demand growth being even more polarized than the underlying rates of GDP growth would suggest. As can be seen in Exhibit 17, forecast rates of power demand growth over 2017-2020 range from a mere 0.1% p.a. in Japan to 6.7% p.a. in India.

Exhibit 14: Breakdown of Firm Generation Exhibit 15: Breakdown of Net Additions of

Capacity by Region in 2020 Firm Generation Capacity by Region in 2020

 

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Source: Energy Information Administration, International Energy Agency, Organization for Economic Co-operation and Development, SSR analysis and estimates

Exhibit 16: Trailing 10-Year Ratio of Exhibit 17: Near-Term Growth in Power

Power Demand Growth to GDP Growth Demand Given GDP Forecast, 2017-2020

 

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Source: Energy Information Administration, International Energy Agency, Organization for Economic Co-operation and Development, SSR analysis and estimates

A graphic illustration of how these factors will shift the global distribution of installed generation capacity over time is presented in the right hand chart of Exhibit 18. As can be seen there, the large but slowly growing generation fleets of North America and Europe will soon be dwarfed by the already larger and very rapidly growing generation fleet of China.[5] Currently small but rapidly growing generation fleets in the Middle East, India and other developing regions of the world will over time come to rival or surpass the generating fleet of Europe.

Exhibit 18: Estimated Requirement for Total Firm Generation Capacity by Region (GW)

 

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Source: Energy Information Administration, International Energy Agency, Organization for Economic Co-operation and Development, SSR analysis and estimates

While the installed base of generation capacity will continue to expand, the GW of net new generation capacity that must be added annually to meet the growth in power demand – currently the primary driver of power generation equipment sales (see Exhibit 5)– are expected to grow at a declining rate over time. This reflects not only the deceleration in global GDP growth forecast by the OECD, but also a mix shift in the pattern of global GDP growth, with the rate of economic growth in the developing regions of the world expected to decelerate much more markedly than that of the mature economies. The latter factor is important for the growth of annual capacity additions because the ratio of power demand growth to GDP growth is so much higher in the developing than in the mature economies. In summary, not only is the rate of global GDP growth expected to fall, but the composition of global economic growth is expected to shift in favor of those regions where power demand growth is least responsive to the growth of GDP.

As can be seen in the left hand chart of Exhibit 19, the OECD forecasts broadly flat to slightly declining growth in the mature economies of the world. This reflects continued slow growth of the labor force in North America, slowing labor force growth in Europe, and an expected absolute decline of the labor force in Japan. In the developing regions of the world, which make up the bulk of the demand for net additions of new generation capacity, GDP growth is expected to decelerate more rapidly (see the right hand chart of Exhibit 19). In these regions, the OECD’s GDP growth forecast reflects (i) the expectation of slowing labor force growth, as urbanization and rising family incomes are reflected in falling birth rates over time, and (ii) the difficulty of sustaining the current very high rates of productivity growth, as the work force gradually completes the shift from low productivity sectors such as subsistence agriculture to high productivity sectors such as manufacturing or urban services.

Exhibit 19: OECD Forecast of Real GDP Growth by Region

North America, Europe & Japan China, India, Middle East & Other Asia Pacific

 

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Source: Energy Information Administration, International Energy Agency, Organization for Economic Co-operation and Development, SSR analysis and estimates

The ratio of power demand growth to GDP growth in the rapidly developing regions, ranging from 95% in China to 98% in India and 135% in the Middle East, is 4 to 5x the ratios of power demand to GDP growth that characterize the mature economies of North America, Europe and Japan, which range from 16% to 21% (see Exhibit 16). As we have seen, the very high ratios of power demand growth to GDP in China, India and the Middle East, combined with the very high rate of GDP growth in these regions currently, imply that fully 80% of global net additions of new firm generation capacity stem from power demand growth in these three regions (see Exhibit 15). As the mix of global GDP growth shifts in favor of regions where power demand growth is less responsive to GDP growth, our analysis suggests that the growth in net additions of firm generation capacity will slow dramatically. We estimate that the five year CAGR in net additions of firm generation capacity globally will slow from 2.5% p.a. over 2020-2025 to only 0.3% p.a. over 2035-2040. If we exclude China, the five year CAGR in required additions of firm generation capacity is expected to fall from 3.1% p.a. over 2020-2025 to 0.5% p.a. over 2035-2040 (see Exhibit 20, 21 and 22).

Exhibit 20: 5-Year CAGRs in Growth of Required Annual

Net Additions of Firm Generation Capacity

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Source: Energy Information Administration, International Energy Agency, Organization for Economic Co-operation and Development, SSR analysis and estimates

Exhibit 21: Required Annual Net Additions of Firm Generation Capacity by Region (GW)

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Source: Energy Information Administration, International Energy Agency, Organization for Economic Co-operation and Development, SSR analysis and estimates

Exhibit 22: Required Annual Net Additions of Firm Generation Capacity (GW),

Excluding China

 

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Source: Energy Information Administration, International Energy Agency, Organization for Economic Co-operation and Development, SSR analysis and estimates

Principal Conclusion No. 2: Required Net Additions of New Firm Generation Capacity Will Be Met in Large Part by the Growth of Renewables, Diminishing the Need for Fossil Capacity Additions

A surprisingly large share of the global requirement for new firm capacity to meet the growth of power demand is likely to be met with renewable resources. The impact will be to suppress additions of new fossil generation capacity, which traditionally has served as the primary source of firm generation capacity on the grid.

The International Energy Agency (IEA) provides long term forecasts by region of expected growth in renewable generation capacity, broken down into wind, solar and other renewables, as well forecasts of the expected net construction or retirement of nuclear generation capacity.[6] The IEA’s forecast calls for broadly linear growth in total renewable generation capacity, implying slowing rates of growth in renewable generation over time (see Exhibits 23 and 24). While their growth forecast for total renewable capacity does appear very rapid, at 3.4% p.a. globally from 2020-2040, it is significantly faster than demand growth of 2.4% over the same period. Moreover, the total growth rate understates the more rapid growth rates of solar and wind of 6.7% and 4.8% p.a., respectively, over the same period. We note that more aggressive assumptions as to the pace of growth in renewable resources would further erode the requirement for fossil fuel capacity additions estimated here.

Exhibit 23: IEA Forecast of Global Renewable Exhibit 24: IEA Forecast of Growth in

Capacity by Region, 2020-2040 Renewable Capacity by Region, 2020-2040

 

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Source: Energy Information Administration,

As explained in the Methodology section above, our forecasts assume that firm generation capacity by region must keep pace with the growth of power demand. To estimate the net additions of firm fossil fueled generation capacity required in each region, we have subtracted from our estimates of required firm generation capacity by region the IEA’s estimates of new nuclear generation capacity, and added the IEA’s estimate of nuclear retirements. Next, we have taken into account the IEA’s forecast of additions to renewable generation capacity by region. We adjusted these forecast additions of renewable capacity to reflect the intermittency of renewable generation and consequently the limited availability of renewable resources during periods of peak demand. We attributed a firm capacity value of just 10% to wind, 40% to solar and 55% to other renewable technologies (e.g., geothermal, biomass and hydro). Nonetheless, our analysis suggests that the growth of renewable resources will meet over 30% of the world’s need for net additions of firm capacity over 2020-2040, and over 40% for the world outside of China (see Exhibits 25 and 26).

Exhibit 25: Estimated Composition of Net Additions of Firm Generation Capacity (GW)

World World Excluding China

 

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Source: Energy Information Administration, International Energy Agency, SSR analysis and estimates

Exhibit 26: Estimated Composition of Net Additions of Firm Generation Capacity (%)

World World Excluding China

 

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Source: Energy Information Administration, International Energy Agency, Organization for Economic Co-operation and Development, SSR analysis and estimates

In sensitivity analyses, we have modeled the potential for the firm capacity value of renewable energy to be materially increased through the addition of electricity storage, further eroding the need for new fossil fuel generation capacity. (As explained in our note from February 5, Can Grid Scale Energy Storage Compete with Gas Fired Peakers? Not Yet, But Coming Soon, we believe that grid-scale energy storage could be cost competitive with conventional gas-fired peakers by 2025.) In Exhibit 27 below, we present the average reduction in required gross additions of fossil fuel generating capacity at different levels of substitution of energy storage for conventional peakers. On a global basis over 2025-2040, we estimate the reduction in required gross additions of fossil fuel generating capacity would be ~3%, if 10% of planned additions of peaking capacity were substituted by storage; ~10%, if 30% of planned additions of peaking capacity were replaced; and ~16% if 50% were replaced.

Exhibit 27: Average Reduction in Required Gross Additions of Fossil Fuel Generating Capacity at Different Levels of Substitution of Energy Storage for Conventional Peakers (1)

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1. Reflecting the ratio of peaking capacity to total U.S. firm generation capacity (~25%), we have assumed that peakers make up 25% of each year’s required additions of firm generation capacity (including both fossil and firm renewable capacity).

Source: Energy Information Administration, International Energy Agency, Organization for Economic Co-operation and Development, SSR analysis and estimates

Finally, we expect the continued expansion of renewable generation to erode the power output and thus the capacity factors of fossil fueled plants. The rapid growth of the renewable generation fleet will add significant amounts of zero marginal cost energy to regional power markets, displacing the high marginal cost output of coal and gas fired generating units. Given that the generation of renewable resources such as wind and solar cannot be scheduled in advance, however, net additions of firm fossil fuel capacity will continue to be required to meet the growth in peak demand. With the growth in fossil generation capacity linked to the growth in power demand, but the output of the fossil fleet suppressed by the expansion of lower cost renewable generation, we expect the growth in fossil capacity to exceed the growth in fossil generation.

Our estimates suggest that global fossil fuel generating capacity will grow by ~2.1% p.a. over 2020-2040, but fossil fuel generation will only grow by 1.67% p.a. over this period. Outside of China, we estimate the growth in fossil fuel generation capacity at 1.5% p.a. over 2020-2040, and the growth in fossil fuel generation at just 0.8% p.a. As a result, we expect the capacity factor of the global fossil fuel generating fleet to decline from ~44% in 2020 to ~40% in 2040. Outside of China, we see the capacity factor of the fossil generating fleet declining from ~41% in 2020 to ~36% in 2040. (See Exhibit 28)

Exhibit 28: Fossil Fuel Capacity (GW) and Fossil Fuel Generation (GWh) (2020 = 100), versus Fossil Fuel Capacity Factor (%)

World World Excluding China

 

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Source: Energy Information Administration, International Energy Agency, Organization for Economic Co-operation and Development, SSR analysis and estimates

Principal Conclusion No. 3: The Need to Replace Retiring Generation Capacity Will Become the Biggest Driver of Demand for Fossil Fueled Generation Plant, Sustaining Robust Growth in Gross Capacity Additions to 2035

The two principal conclusions we have presented so far are:

(i) The rate of growth in net global additions of new firm capacity will likely peak in the 2020s, reflecting the expected deceleration in economic growth in the rapidly developing regions of the world, such as China, India and the Middle East, where the ratio of power demand growth to GDP growth is five to six times that of the developed but slower growing economies of North America, Europe and Japan. Required net additions of new firm capacity are estimated to grow at ~2.5% p.a. over 2020-2025, gradually declining to 0.3% p.a. by 2035-2040 (see Exhibit 20).

(ii) Given the modest and declining rate of growth in required net additions of new firm generation capacity, the continued growth in renewable generation will limit the need for net additions of fossil generation capacity despite the limited firm capacity value of renewables. We see fossil generation contributing only 66% of the required net additions of firm generation capacity through 2040 on a global basis, and only ~59% if China is excluded.

It should not be surprising, therefore, that our third principal conclusion is that the need to replace existing generation capacity may prove to the biggest driver of gross additions of fossil fuel capacity over time, particularly in the world excluding China (see Exhibits 30 and 32). When the capacity required to replace retiring plants is added to the net additions of firm capacity required to meet the growth in demand, we see the potential for robust growth in gross additions of fossil fueled generation capacity through 2035 (see Exhibits 38 and 42).

Importantly for the major North American, European and Japanese manufacturers of fossil fuel generation equipment (such as General Electric, Siemens and Mitsubishi), the regional breakdown of power plant retirements is a far more attractive one for the than the regional breakdown of new capacity additions required to serve growth in load. While the need for net new capacity additions is heavily skewed toward markets like China, where these manufacturers find it difficult to compete, the need to replace retiring capacity is greatest in their home markets of North America, Europe and Japan (compare Exhibits 33 and 34).

As explained in the Methodology section above, we have estimated the retirement dates of the world’s operating fossil fueled power plants based upon (i) the plethora of data available on the U.S. generating units, and (ii) the implications of our analysis of the U.S. fleet for the likely retirement dates of similar power plants abroad. Based on the experience of the U.S. fleet, we have assumed average useful lives of (i) 60 years for nuclear, coal, gas and oil fired steam turbine generators and (ii) 35 years for gas and oil fired combustion turbines and combined cycle gas turbine generators. Knowing the commercial operation date of each of the ~16,000 generating units retired and currently operating in the United States, we have been able to estimate how much of this existing capacity is likely to be retired each year. Outside the United States, we estimated the age of regional generating fleets by using IEA data on the annual growth in power generation capacity by region from 1980 on. From 1980 to 1990, we assumed that these capacity additions comprised steam turbine generators, whether powered by coal, oil, gas or nuclear fuel, with an average useful life of 60 years. After 1990, we assumed the required capacity additions comprised a mix of steam turbines, combustion turbines and combined cycle gas turbine generators (CCGTs), with an average useful life of 35 years. We modeled the mix of steam turbines, combustion turbines and CCGTs added each year based so as to arrive at a mix of these generation technologies in 2015 that reflected the actual mix of generation technologies reported in the IEA data for that year. Finally, to estimate the retirement dates of plants brought on line prior to 1980, we assumed that the age profile of each region’s generating fleet in 1980 paralleled that of the U.S. generating fleet in 1980. We then estimated the retirement dates of these units by assuming that the units will retire 60 years after their estimated date of commercial operation.

The resulting estimates of the fossil fuel capacity likely to be retired each year in the various regions of the world are presented in Exhibits 29 through 32. In contrast to the required net additions of firm generation capacity by region (see Exhibits 21 and 22), which are dominated by the rapidly developing economies of China, India and the Middle East, retirements of existing generating capacity are concentrated in the mature economies of North America, Europe and Japan.

Globally, we expect annual capacity retirements to rise rapidly through the mid-2030s and to exceed net capacity additions in 2035 (see Exhibit 30), when power plants recently built in China, India, the Middle East and other Asia Pacific countries begin to retire and retirements in North America, Europe and Japan are still near their peak. Outside of China, the capacity required to replace retiring power plants will constitute the largest component of gross capacity additions from 2025 on (see Exhibit 32). We estimate that retirements will grow from 51 GW in 2020 to 94 GW in 2030 and 123 GW in 2035.

Exhibit 29: Global Retirements of Fossil Exhibit 30: Gross Fossil Capacity Additions

Generation Capacity, by Region (GW) (Retirements Plus New Capacity Need)

 

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Source: Energy Information Administration, International Energy Agency, Organization for Economic Co-operation and Development, SSR analysis and estimates

Exhibit 31: Fossil Capacity Retirements Exhibit 32: Gross Fossil Capacity Additions,

by Region, Excluding China (GW) Excluding China (GW)

 

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Source: Energy Information Administration, International Energy Agency, Organization for Economic Co-operation and Development, SSR analysis and estimates

The regional breakdown of power plant retirements is a far more attractive one for the major North American, European and Japanese manufacturers of fossil fuel generation equipment (such as General Electric, Siemens and Mitsubishi) than the regional breakdown of new capacity additions required to serve growth in load, which is much more heavily skewed toward markets like China where these manufacturers find it difficult to compete. As can be seen in Exhibit 33, the rapidly developing economies of China, India, the Middle East, and the remainder of the Asia Pacific region are expected to account for over 90% of net additions of generation capacity in 2020. By contrast, in 2020 we expect over 70% of the fossil generation capacity retired to be located in North America (40%), Europe (26%) and Japan (5%) (see Exhibit 34).

Exhibit 33: Breakdown of 2020 Net Capacity Exhibit 34: Breakdown of 2020 Capacity

Additions by Region (GW) Retirements by Region (GW)

 

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Source: Energy Information Administration, International Energy Agency, Organization for Economic Co-operation and Development, SSR analysis and estimates

So significant is the expected wave of retirements in the mature economies that these regions are expected to have the fastest growth in gross capacity additions over 2020-2035: ~13% annually in Europe, ~12% annually in North America and ~11% annually in Japan (see Exhibit 36). By contrast, in the rapidly developing economies of India and China, which currently face very high power demand growth and a commensurately large need for net capacity additions (Exhibit 35), the combination of slowing GDP and power demand growth over time, and a smaller and more gradual increase in retirements, imply a much lower rate of growth in gross capacity additions (Exhibit 36).

Exhibit 35: Estimated Growth in Electricity Exhibit 36: CAGR in Gross Additions of

Demand Given OECD GDP Forecast, 2017-20 Fossil Fuel Capacity by Region, 2020-2035

 

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Source: Organization for Economic Co-operation and Development, Energy Information Administration, International Energy Agency, SSR analysis and estimates

With rapid power demand growth in the developing countries and accelerating retirements in the mature economies, the fifteen year period from 2020 through 2035 is likely to be one of consistent robust growth in demand for generation capacity. Over this period, we expect compound annual growth in gross global additions of fossil fuel generation capacity of 4.2%; in the world outside of China, gross global additions of fossil fuel capacity are expected to grow a 5.2% p.a.

Globally, growth in gross annual additions of fossil fuel capacity is expected to accelerate over the decade of the 2020s, rising from a compound annual rate of 3.8% over 2020-2025 to 4.8% p.a. over 2025-2030. Growth slows in the decade of the 2030s, first modestly, to 4.0% p.a. over 2030-2035 and then more markedly, to 0.4% p.a. over 2035-2040. (See Exhibit 38.)

In the world outside of China, the most rapid growth in gross additions of fossil fueled generation capacity is likely to occur over 2020-2025, when by our estimates annual growth will reach 7.9% p.a. (see Exhibit 38). Growth remains robust over the next ten years, with gross additions of fossil fuel generation capacity rising at a compound annual rate of 4.9% over 2025-2030 and by 4.6% p.a. over 2030-2035. From 2035 to 2040, we expect gross additions of fossil fuel capacity to decline by 0.7% p.a.

Exhibit 37: Required Growth in Net Exhibit 38: Required Growth in Gross Fossil

Additions of Fossil Capacity to Meet Capacity Additions to Meet Demand and

Demand (Trailing 5-Year CAGRs) Offset Retirements (Trailing 5-Year CAGRs)

 

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Source: Energy Information Administration, International Energy Agency, SSR analysis and estimates

In absolute terms, we expect global gross additions of fossil fuel generating capacity to rise from an estimated 143 GW in 2020 to 218 GW in 2030 and 266 GW in 2035, implying an increase of over 50% in annual additions of fossil generation capacity from 2020 through 2030 and an increase of 85% from 2020 through 2035 (see Exhibit 39). Outside of China, the growth in fossil fuel capacity additions is even more impressive, with annual gross additions of fossil generating capacity estimated to rise from 80 GW in 2020 to 149 GW in 2030 and 187 GW in 2035, implying an increase of 85% over 2020-2030 and 132% over 2020-2035 (see Exhibit 40).

Exhibit 39: Estimated Gross Annual Additions of Fossil Fuel Capacity (GW)