The Value of Energy: A 1st Principles Approach

Value ≠ Price

Happy Monday and a Happy Memorial Day to those celebrating in the United States. I hope everyone is enjoying the long weekend and paying reverence to those who have served our country with pride and made the ultimate sacrifice.

While he always reminds me “I’m not dead”, a shout-out nonetheless to my uncle John Mauk and a BIG thank you for his ~25 years of service to the US Army. Perhaps one of the staunchest critics of my Musings — I hope this one passes his bar! Enjoy…

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What is energy? ☀️

Well I’m glad you asked Gary Johnson.

Energy is… ubiquitous

From the electrons flowing through my computer battery to the gas in my car to the sun shining through my windows — energy is all around us.

Energy is… overlooked (Value vs. Mindshare)

Due to its ubiquitous nature, energy is often overlooked and underappreciated.

While I don’t have to sell you on the importance of energy in our day-to-day lives, the ratio of [Value ÷ Mindshare] for energy, as opposed to say… your favorite social media platform… is lacking.

With that said, let’s take a different type of Musing for a spin this week.

Rather than taking a topic, sharing a bit of education on it, then offering a (hopefully) unique perspective… let’s take a first-principles, investigative approach and see what sort of education we can arrive at by the end of it.

The goal? Gain a deeper understanding and appreciation for energy. (woo!)

Let’s hit the following…

• What makes energy valuable in the first place?

• How is that value rewarded by the marketplace?

• What can we learn from this value-backed lens on energy?

What makes energy valuable? 📊

A seemingly innocuous question — let’s start with a first-principles approach to what makes energy valuable. Said differently — what characteristics can we use to compare the value of vastly different energy sources like uranium, oil, hydrogen, and sunlight?

Energy derives its value from its…

• Versatility: the ability to be used in a wide-variety of sectors, applications, and conditions. Perhaps the most versatile form of energy, and becoming more versatile by the minute, electrons (electricity). From car motors to heating to steel making to computer electronics — pretty versatile!

• Flexibility: said differently, where you want it, when you want it. Can the energy be transported long distances and can it be stored for a long time? Oil is a high-performer here. From oil platforms in the Middle East to the shores of the USA, stored in tanks for years and years — A++!

• Availability: is the energy source abundantly available across the globe? And will it stay available for long periods of time? A fun example here is ultra-deep geothermal. At 10-20km below the surface¹, conditions exist for high-energy density geothermal energy. Folks like Quaise are trying to unlock this potential.

• Sustainability: perhaps a factor that would not have been listed 20 years ago, does the energy have a low environmental footprint. Both from a global warming perspective, and a broader land-use / ecosystem lens. Energy forms on the struggle bus here are coal (CO2) and hydropower dams (altering ecosystems).

And the ability to deliver that value is based on…

• Energy density: is the energy dense both volumetrically and gravimetrically (weight)? Is it easily transported and stored compactly? (think: gas tank)

• Existing infrastructure: does the existing infrastructure exist for the energy to be utilized? For the deep geothermal example, without the deep wells, power plants, and electrical lines to get that energy where we need it — not as useful…

• Carbon+²: is the energy source fundamentally reliant on carbon molecules? (cough, cough… hydrocarbons) Hard to get around a reaction that involves some combination of C’s and H’s alongside oxygen… reacting to form CO2 + H2O.

• Laws of physics: the master of all — physics sets the foundation for all of the value. Hydrogen is a gas, CH4 (methane) at atmospheric pressure and temperature… also a gas, oil a liquid, and so on so forth.

Is energy rewarded for its value? 🏆

So… how do we take all of those fancy, first-principles ideas and say something useful?

Recognizing value

The good news — or bad news for a McKinsey framework — is that my categories aren’t mutually exclusive. Moreover, the ability of energy sources to deliver this value is a mix of intrinsic and extrinsic factors. Optimizing the exploration, refinement, delivery, and use of fossil fuels over 100 years offers some inseparable advantages.

For example: flexible liquid fossil fuels, have lots of infrastructure built for them, and have been widely explored… thus being widely available as well.

Nonetheless — let’s highlight a few examples and test out this framework:

• ☀️Sunlight: global availability, but for only ~20% of the day. Not energy dense and requires the addition of a battery or energy carrier to store.

• ☢️Uranium: crazy energy dense (~1 million times fossil fuels) and available, but a lot required to unlock that energy safely, limiting use-cases

• 🏭Coal: dirty, but cheap — and existing infrastructure exists to use it in steelmaking and electricity

• 💧 Natural gas: since the advent of fracking in the US, practically unlimited; easily transported in pipelines, and potential for use in almost every single sector

• 🛢️ Oil: similar to natural gas but even more energy dense from a volumetric perspective — only catch is the carbon footprint

• ⚛️Hydrogen: remove the carbon and keep the energy content? Cool! Potential across every single sector, but not naturally abundant and available

Barring sustainability considerations, oil and natural gas are pretty ideal options (the reason why we have trouble kicking the habit!) Uranium and sunlight are ideal from individual perspectives, but have their own respective limits. Hydrogen has tons of potential but a long road ahead of it, and coal — meh.

Rewarding value: Value ≠ Price

Now… if we believe that high-value energy sources are the gold standard, you might expect them to garner the highest prices in the market.

Not necessarily the case. Check out the $ / MMBtu³ (energy unit) chart below:

This chart highlights the price per MMBtu of energy for different carriers.

BIG DISCLAIMER: This chart is imperfect and incomplete.

The above focuses primarily on the fuel cost, and doesn’t account for all of the additional OPEX, CAPEX, and efficiencies to fully utilize an MMBtu of energy — along with a long list of subsidies and pricing mechanisms that exist.

The point however is clear — there’s a broad range of prices paid for an MMBtu based on the format it arrives in, and that price isn’t directly correlated with value drivers.

Why is this the case?

Without going down a pricing rabbit-hole, products or services of any kind are generally priced through one of four different approaches — where energy is closest to a version of demand & cost-plus blended together:

• Demand-based: the market (supply, demand) determines what they are willing to pay for a product or service

• Cost-plus: the seller largely dictates the price they charge based on the cost to make or provide the service, plus some margin (e.g., capital recovery or IRR)

• Value-based: the product is priced based on its intrinsic values — for example, a product that makes your home more efficient and saves you money may be priced at ~50% of the “value” or savings it provides you

• Competition & alternatives: a product is priced according to competition or alternative product choices — this can lead to both underpricing to stay competitive and margin-padding for superior products.

The takeaway? Energy is not priced based on the ‘intrinsic’ or first-principle values it offers — for better or for worse.

What can we learn from all of this? 💡

Alright… I’ll admit, that was sure a long-winded way to arrive at energy not being priced through a values based approach. (I told you this was an experimental Musing!)

Let’s zoom out and arrive at a few core takeaways, with climate in-mind…

High-value, low-cost energy is hard to quit

The fracking boom was a perfect example of this and the interplay between value and price. When all of a sudden we had abundant, exportable, $2.50/MMBtu natural gas, it makes a lot more sense to build more natural gas plants and export terminals.

Fossil fuels — flat out — are hard to quit.

Add together the intrinsic benefits (e.g., energy density) with 100 years of optimization and infrastructure scaling… and the incumbents have a significant advantage.. They provide a lot of value for their price — this means it’s up-hill sledding for a low-carbon transition.

The case for a green-premium isn’t straight-forward

A lot of the up-and-coming low carbon products are hoping for a green premium. Said simply, people pay more for the ‘value’ of sustainability. While evidence of green premiums can be seen in the market today (ranging from 30-200%), the direct case between value and price as illustrated above is not always crystal clear.

To mitigate that green-premium, cost again becomes king — especially in cost-plus driven markets like solar PPAs⁴ that are more immune to market demand forces.

Bring on the scale!

Ultimately… a prioritization exercise

A winning mindset for a relatively painless, low-carbon transition is ultimately one of prioritization. Of the four value drivers laid out, sustainability is only one.

The energy transition presents the world with a number of non-ideal choices to mitigate climate risk. Swallowing these non-ideal choices for the greater good means prioritizing the sustainability value of energy sources first-and-foremost, with the other three factors (versatility, flexibility, availability) after that.

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Deep breath 😮‍💨

Well… that was an experiment, eh? 😅

If you hate my ‘matter-of-fact’ assertion style… maybe you liked it! If you already thought my Musings were long-winded… you probably hated it!

C'est la vie

Regardless, I hope this Musing gave you a deeper and more well-founded appreciation and understanding of the energy ecosystem that props up our daily lives.

This energy ecosystem will be changing rapidly over the next 20-30 years — so hang on for a wild ride and lets see how this first-principles approach evolves!

Until next time…

1. 10-20km below the surface is ~3x deeper than the deepest oil wells drilled today.

2. For the “+”, this includes the physical footprint of the energy source and utilization mechanism (e.g., solar fields, uranium mining, etc.) and the surrounding environmental impact of that footprint.

3. MMBtu = Million British Thermal Unit. Some units of measure have very quirky back stories… but the Btu is rather straight-forward.

1 Btu = the amount of heat required to raise the temperature of one pound of water by one degree Fahrenheit

4. Power Purchase Agreement: the ~15-20 year fixed price agreements that a large number of renewable generating facilities lock in before they are built