Shifting the US supply chain back home for cheaper, cleaner energy
A new source of national comparative advantage
COVID-19 has provided vivid examples of the vulnerabilities associated with complex global supply chains. The repatriation of "critical" industries will be an important topic in the coming policy debate around economic re-development post COVID-19. Politics – international and national - combined with the increasing convergence of labor cost are reducing the attractiveness of relying on far-flung supply chains. We believe that a relatively novel factor - the availability of low-cost decarbonized energy – could play an important role in determining which sectors actually (re)locate to North America, and where they choose to site their facilities in order to create the greatest comparative advantage. The US energy sector, especially its utilities, can play an important role in creating opportunities for local communities to welcome back manufacturers with low priced, low carbon energy, while creating hundreds of thousands of jobs for Americans.
The revenge of distance
Among its many impacts on our lives, the COVID-19 pandemic is redefining the modern world's experience of space. On the one hand, we're finding that on-line communication can effectively replace what, a few weeks ago, seemed like essential in-person meetings and working sessions. On the other hand, the physical distances that the fossil-fueled transportation revolution erased last century have resurfaced as meaningful limits on modern life, in the form of shortages of essential goods. Policy makers, pundits, and business leaders have been outraged to learn that essential medical supplies or critical supply chain components for a host of industrial and consumer goods are simply not physically available where they're needed. And many are demanding that these "essential" industries – with very elastic definitions of "essential" - return onshore to the US.
In many ways, this resilience-inflected demand for onshoring merely reinforces the political and economic reaction against globalization following the Great Recession. The current US administration's willingness to actively employ tariffs and trade sanctions has exposed the risks of dependence on Chinese supply sources. Geopolitics aside, the convergence of labor costs - together with increasing use of automation, reduces the value of offshoring to arbitrage labor costs. China, the largest exporter globally, has seen significant erosion in its cost advantage. The gap between US and Chinese wages is narrowing rapidly. Chinese wages are rising, doubling in the past decade and outpacing labor productivity growth, while the labor cost in the US only increased by 15% in the same period. In addition, the value of yuan has strengthened significantly since its admission to the GATT/WTO in 2001, making China's exports more expensive.
An increasingly important set of considerations involves the growing importance of environmental and energy-related issues impacting manufacturing (see Figure 1 below). Consumer and investor sensitivity to ESG-related issues, including GHG footprint, has risen substantially over the past decade. ESG-related disclosures, including information on companies' GHG intensity or "footprint" are increasingly de rigueur for PE firm's portfolios as well as for publicly list firms, and ESG-themed ETFs and mutual funds continue to gain in popularity.
The US energy sector has become one of the least carbon-intensive economies in the industrial world, especially with respect to its electricity sector. The GHG-intensity of US energy started to decline at the start of this century, overall and in the electricity sector. This trend accelerated dramatically with the combined advent of domestic unconventional gas production and the take-off of renewable generation. The combination of these phenomena resulted in a dramatic reduction in the share of electricity generation provided by (more GHG intensive) coal, with a 27% decline in carbon intensity and total GHG emissions over the past decade. We anticipate this trend to continue or even accelerate over the coming decade with another ~ 100 GWh in renewable generation required to meet existing state-level decarbonization and RPS (renewable portfolio standard) commitments by 2030.
Beyond greenery, energy costs also matter for many industries. By the 1980s, energy cost increases from the '73 an '79 oil crises drove numerous energy intensive industries offshore. Between 1980 and 2018, the energy intensity of US GDP declined by over 80%, reflecting both moderate improvements in energy efficiency of US businesses, but even more a dramatic shift in the mix of businesses located in the US, as many more energy intensive industries (from primary materials like chemical to industrial manufacturing) shifted production offshore or exited.
Clean, cheap energy as a sustainable national competitive advantage
As Covid has illustrated, location does matter for things that can't be digitized, and as mentioned previously, the price of other key inputs like labor and capital have converged to a large degree. That leaves inputs which are difficult to transport economically – like electricity – as remaining, durable sources of competitive advantage for many industries. US energy, and electricity in particular, has become one of the least expensive and cleanest in the world, and is primed to play a critical role in determining the country's overall competitive advantage.
This "new" source of competitive advantage – cheap, clean energy – naturally is most significant for energy intensive industries. Data centers and indoor agriculture are more contemporary, well-publicized examples. But energy represents a significant input cost for a broad array of primary material businesses such as glass, metals, and cement, as well as numerous light and heavy manufacturing sectors. For example, in organic chemicals production, energy cost represents over 50% of total production cost. Energy cost savings can directly improve companies’ bottom lines.
It's important to note that the abundance of low and even negatively priced electricity (during a growing number of hours when renewable generation is curtailed due to excess supply or transmission constraints) also holds the promise of enabling economically produced "green" hydrogen. This in turn can provide an effectively zero-carbon input for numerous families of chemicals (hydrogen-derived methanol is a critical input for coatings, plastics, and many pharmaceuticals), synthetic natural gas, and a high-density energy source for the electrification of medium and heavy transportation. As electrolyzer (the device for converting water into hydrogen) costs are expected to decline over the coming decade, hydrogen production via electrolysis is poised to become cost competitive to diesel and hydrogen produced via steam methane reformation (SMR), given low electricity prices (see Figure 3 below)
How significant could a clean-energy based renaissance of manufacturing be for the US? Setting aside the indirect jobs and fiscal benefits, the repatriation of the equivalent of just 20% of current imports in several energy-intensive, "critical" manufacturing industries, could result in ~ $350 billion of incremental GDP and create ~800,000 of jobs in the US (see Figure 4 below).
We believe electric and gas utilities have a unique role to play in capitalizing on this opportunity, in concert with regional policy leaders, and other large – and probably energy intensive and/or "green" – corporations. Creating hubs or industrial clusters anchored around advantaged renewable resources requires solving complex collective action problems in building, financing, and originating customers for the requisite infrastructure (generation, grid, possibly storage or H2 conversion). And it requires engaging multiple affected constituencies to enable the necessary permitting and planning, development of a regional supplier base and skilled labor, and so on.
Fortunately, there are multiple examples to learn from globally. In Europe for example, 89 regions and cities from 22 countries are taking part in the initiative to shape their green energy transitions with hydrogen and fuel cells. Globally, the hydrogen council has ambitious GHG savings target and underlines the key future role of coalitions. They serve as a showcase for the versatility of H2 as energy carrier and the variety of its use cases.
We urge US utilities and their corporate partners to expand their vital role in helping their communities re-emerge from the COVID-19 crisis by realizing the potential of our country's clean energy abundance through strategic supply chain relocation.