Speaker 1If the last few years have taught us anything, it's to be humble when predicting what comes next for our economies, our elections, our geopolitical stability, even our culture. Our energy industry is no exception. The title of the 2024 S&P Global Commodity Insights Report on Energy and Climate Scenarios is "A New Pragmatism." It admits that any definitive view of the future of this industry should be taken with a grain of salt. Greenhouse gases continue to rise, and fossil fuel demand is back to pre-COVID levels. However, the popularity of electric vehicles and innovation around renewable energy and capacity point to some promising developments. But the S&P report decided to focus on, as they put it, "the practical steps necessary to translate ambitious policies and strategies into reality." And today, we hope to offer an equally grounded view of that future. Welcome to the Infrastructure Investor Podcast. I'm Rob Kuteki, and in this episode, sponsored by Qwik, Winbrook Infrastructure Partners and Nuveen, we'll be discussing the state of distributed energy, which means any electricity generation system that incorporates multiple small-scale devices rather than a centralized power plant and distribution network. We'll also discuss behind-the-meter power generation, which refers to generation and storage systems connected to a distribution system on the customer's side of the meter, such as on-site solar or EV charging stations. This, of course, brings up questions around battery and storage, and all these issues have a regulatory element that affects the energy industry. So let's take a look at the issues we're sitting down with two veteran investors in the energy and renewable space. Don Dimitrovich, the Senior Managing Director and Portfolio Manager for Energy Infrastructure Credit at Nuveen, and David Skaysbrook, the co-founder and managing partner of Qwik, Winbrook Infrastructure Partners. Let's start with the state of distributed energy and behind-the-meter systems, a corner of the market that's evolving with cheaper solar panels but still battling for sufficient grid connections. Here's Don with his take.
Speaker 2Don Dimitrovich: On the issue in terms of behind-the-meter solutions, clearly this is at the forefront of a lot of the discussions around the convergence of power generation in data centers. And this is an evolving landscape, and we just have to look to the FERC decision that was made in early November, wherein we saw that Talon had requested FERC approval to ostensibly shift one of its nuclear facilities to provide power to an Amazon data center.
Speaker 1FERC stands for the Federal Energy Regulation Commission.
Speaker 2Don Dimitrovich: And the FERC denied the request, partially on the basis that there was a view that that shifting of power generation capacity to support a data center was coming at the expense of grid stabilization and stability. And I think you take a step back here, and data centers are as we know, a huge consumer of power. And as a result, you're starting to see the tension between the need for grid stabilization, grid support from various power capacity generation facilities, and this demand by data centers. So one solution is for those data centers to co-locate power generation units directly on site that are discrete and separate to address this tension. I think you're going to see more and more of those types of commercial agreements. One example
Speaker 1already hit the headlines a short time ago.
Speaker 2Don Dimitrovich: We saw it with Microsoft making an announcement of reaching a commercial agreement with Constellation Energy to bring back one of the Three Mile Island units. And of course, that's carbon-free nuclear power generation. And I think you're going to see this trend play out more and more because of that. And I think you're going to see this trend play out more and more, because of that. And I think you're going to see this trend play out more and more, because there will be this competing tension. If data centers continue to really consume and demand a significant amount of power from the grid, that's going to create issues for the broader grid infrastructure, and it has both political and capital investment consequences.
Speaker 1David has his own story from the trenches on the intersection of demands here.
Speaker 3I can give you an example from a project that we did recently, or doing in Maryland, where the rules historically have conspired against the proliferation of distributed solutions, because many of the utilities and co-ops actually don't want that to happen. And so the rules are written in such a way to actually restrict or prevent a customer hosting distributed solution behind the meter, because it reduced the amount of megawatts they're able to sell from their existing utility fleet or from their grid transmission lines. And that was the case, let's say, in Maryland until recently, where in order to build a data center there, they had to have a grid transmission line. And that was the case, where the backup generation had to go through the entire PUC generation approval as if it was a new power station in the grid. But that's not where the story ended. We had to work for months with the governor to get the rule changed to be a little bit more pragmatic to enable what will become probably one of the largest data center campuses in America, right across the river from Virginia, which is currently very congested. But you're going to have something like 800 megawatts of backup generation that's sitting there on standby that can now be constructed. So if we can work to a rulemaking that enables backup generation solutions like that, which are by their nature distributed, to also be able to participate in the capacity solution for the grid, that's a win-win. It's a better result for the data center operators. It's a better result for the local grid stability. But the rules really have to evolve to let that happen.
Speaker 1John points out that there may be a compelling rationale for some of that regulatory reform.
Speaker 2For the last two decades, certainly in the U.S., power has largely grown at a pretty muted level. As we look forward here, you're going to see power demand growth with a significant step up. And so there's going to be a focus around power capacity. And we saw it with the latest PJM capacity market auction.
Speaker 1PJM is a competitive wholesale electricity market for 13 states, including D.C.
Speaker 2I think you're going to have a renewed focus on what are those sources of power generation? How are they being developed? The capital investment opportunity around that. And so distributed generation can serve as a solution to some of that in the context of grid stability and the need for incremental power generation and load growth. So this notion that you can have behind-the-meter solutions that, one, allow power demand consumers to not really put stresses onto the grid is one part of it. Two, where you do have essentially backup power capacity that can then be provided to the grid in times of peak demand, that's an added benefit. So I think we're going to see an evolution in the way people think about that capacity resource.
Speaker 1If capacity is a core issue, it's only one part of it. But if you look into the potential of microgrids, which are self-sufficient energy systems that act as a single controllable entity, can they be scaled up to address the increasing need? Here's David.
Speaker 3You're never going to get the theoretical proliferation that you think you're going to get. If you look at the energy economist forecast for microgrid growth, just like a lot of others, in their sort of theoretical sense, it ought to happen, right? Because the economic drivers are being behind the meter. In some markets, not all, because there isn't a uniform way to price access to the grid. In some markets, it's not all, because there isn't a uniform way to price access to the grid. Even if you need it 1% of the year, for example, and you want to generate behind the meter. So there is a patchwork of regulation, some of it which is helpful and some which is actually prohibitive. But putting that aside, the issue that you've got is really scale and the development cost, right? So you look at the cost to develop a microgrid project. In some cases, the number of stakeholders that you have to corral to get everybody on board with it. Then you've usually got to navigate, you know, planning rules. And development permits in counties which have never done it before and don't really know how to assess it. And time kills you in development, right? So the longer it takes you to navigate these things, the economies of scale usually kill you in the end.
Speaker 1But again, the actual story is more complicated than bleak, since microgrids have bloomed in certain places.
Speaker 3It's only really proliferated in those states which have created very clear and strong incentives to do it, because you get a booster in your tax credits or whatever it might be. But just navigating the development process is not easy. So it's like the more micro, the tougher it is to do. And I think you'll see more, you know, larger scale industrial campuses host onsite solutions that just need a little bit of extra scale to make sense. However, David identifies another wrinkle here, one that has to do with the new occupant of the White House. I think if you see, you know, the cost of equipment, which we've already seen increase, and it's one of the more inflationary sectors of the economy right now, as Don was saying, the cost of transformers, switchgear, you know, they can't make this stuff fast enough. So no one's getting a discount. So the cost of everything is increasing. If we layer on another level of tariffs for that, you know, then it becomes, you start to erode that economic benefit of being behind the meter in the first place. You know, I don't want to be a downer on it, but we just can't really get excited about that proposition. And maybe you're talking to the wrong person. We've just sold out. We've got a distributed energy business in Australia. We did very well out of it, but I don't think we'd go in and do it again because it of that scale question. But David's not alone. Here's Don. Yeah,
Speaker 2I would agree with David. I think there are clearly situations where behind the meter distributed generation makes a lot of sense, especially as we've talked about in terms of the data center space. There's an obvious synergy there. I think in other areas, I mean, we're active investors in community scale solar. We think that's an area that is economic. You have to deploy it at scale. You've got to have the right development team to do it, the right approach. It's obviously location-specific, state and region-specific. So it takes a certain sophistication and ability by the developer to really execute. And if they do it well, it can be an attractive risk-adjusted return, both I think from an equity and frankly, from a credit perspective. But I think the notion that behind the meter and microgrids in particular, that that's sort of a full-stop solution, I think, is a very good idea. I think it's a good idea. I think it's probably a little too optimistic.
Speaker 1Capacity is a big question going forward, but so is storage, which is crucial to supply for the grid and any distributed energy solution. David weighs in on the state of storage.
Speaker 3It's a big topic, this one. I mean, we were early into storage, probably 2015. So we've been in it probably nearly nine years now. And the market's just starting to realize that energy storage is not a plug-and-play technology at all. And there is a significant disparity, not just in the use case, but in the use case as well. And so I think it's a good idea. And therefore the investment business models for storage, but also a significant difference in the performance of the battery storage, depending on what manufacturer and the equipment that you've chosen. And that's certainly not the case in most other technologies, whether they be gas turbines or solar modules or wind turbines. But what does this mean for his actual approach to the market? There are at least six, probably eight different ways to play storage in various markets, depending on duration. And I think that's a good question. I think that's a good question. We do have some of that. It's pretty constrained. It's not really up the middle of the fairway for our mandate. ERCOT is the Electric Reliability
Speaker 1Council of Texas, which operates the state's grid. But David's approach is surprisingly high-tech, even for renewables.
Speaker 3The way we've decided to play the arbitrage battery is really through our artificial intelligence optimization platform called Habitat Energy. And this is a service model that uses machine learning and optimization of dispatch and charging of batteries. And that is actually, we think, you're going to have to have an optimizer, an algorithm that's optimizing your merchant battery in real time in modern power markets. We're seeing that right now where optimized batteries are generating anywhere between 15 and 25 percent more revenue, pound for pound, compared to batteries which are managed by human traders.
Speaker 1But that's hardly his only approach to storage plays. Here's his example of a hybrid where solar or wind is coupled with battery storage.
Speaker 3We've just commissioned the largest, coupled system in the United States in Nevada called Gemini, which is using excess solar during the day to charge a huge battery, which then when the sun goes down, it's releasing that power in the early evening, which is when the most expensive energy is going to be, we think, in the shoulder period in the early evening peak. Now that is a great example of time shifting, but the combination of the solar and the battery from an investment perspective is underwritten for 25 years in a way that we have with NV Energy. That's what we call an infrastructure battery because we're able to really optimize the solar and the battery, but get a fixed revenue stream from the utility partner because we're not trying to arbitrage price intervals during the day. The second piece is tolling arrangements. So we've just closed out the largest battery in Australia here, about $1.4 billion installation, which is underwritten by local utility partners for 15 years. But we give the company the toggles. We own and operate the battery complex. And he's bullish on how battery tech will evolve in the near term. We uniquely have access to technology roadmaps through to 2030 for some of the world's leading manufacturers. And I can tell you what we see is nothing short of extraordinary. And I think it would be imprudent to assume that you're not going to see very, very significant leaps in the capacity and the ability and the performance, if you will, of lithium batteries over the next five to six years. The insights we have inform our investment decisions. And one of the reasons why we like contracted revenues in the battery storage space is I think the technological obsolescence risk that we see in batteries is unprecedented. Like I've been in this business 35 years. I never had to worry about waking up one morning and GE having a gas turbine that was 30% more efficient than the Siemens one. But that was genuinely what you're seeing at the moment in battery storage. And that's probably one of the biggest risks as an investor you need to be aware of if you're doing a merchant battery proposition. So it's a shifting landscape. It's terribly exciting. I think battery storage is single handedly going to shift power markets more than any other technology. But there's a number of different ways to play it. And they each have different risk return propositions. And Don is just as bullish on batteries.
Speaker 2I've been investing in the renewable space for almost a quarter of a century. And as I look at the developments back in the 2000s, we really saw the proliferation of onshore wind. And then over the last, call it decade, 15 years, we've seen solar really gain prominence in different markets. The key aspect to energy storage is it sort of solves the puzzle of you, if you will, in terms of intermittency as renewables increasingly play a part of the grid resource in market share. You need to couple that intermittent solar and wind capacity with energy storage to be able to take that excess capacity during the day when the sun is shining and the wind is blowing and then dispatch it when it's required.
Speaker 1However, Don, like David, pursues multiple angles to battery storage plays.
Speaker 2I think David's point in terms of the different ways you can effectively model the revenues, whether it's through a tolling arrangement, or a hedge fund model where they're really trying to optimize the pricing arbitrage. From a credit perspective, we try to provide flexible capital solutions where typically the offtake will have some component of a tolling arrangement, giving us a certain amount of cash flow visibility, and then allowing the infra project equity owner to participate in the market arbitrage as well, allows us to have some cash flow protection and yet make the money. So I think that's one of the things that David's point in terms of how we're trying to make those projects economic. And I think there is clearly over this next decade, energy storage is going to be a key, key part of the solution set. What I think is interesting as well is, you know, in contrast to some other areas of the supply chain, we've actually seen costs come down over the last, call it six months in terms of the price of the batteries. We've also invested in projects like the solar project to provide that two-hour, four-hour duration to make the project holistically more economic and viable.
Speaker 1He also noted that tariffs may play a role in those prices. But what do firms like Nuveen and Quinbrook expect from the Trump administration with regard to the energy industry as a whole?
Speaker 3Well, it is the number one conversation. It's occupying a lot of bandwidth right now. Certainly not just at our shop, but everywhere. I think that the most significant elements to it from a point of view are really the impact it has on both incentivization of domestic manufacturing of the equipment that we need, particularly solar and battery storage, and then how supply chains are going to shift, the impact of tariffs on the cost of equipment imported into America. I don't see it as a wholesale rewrite. You know, we have been under a Trump administration previously. In fact, we were able to progress and start construction on the largest solar and battery project in U.S. history with the help of some of the Trump regulations they introduced around government efficiency, ironically. So this to us isn't a fundamental rewrite. I'd say we can anticipate the areas where there will be shifts. I think it'll move to an all of the above energy policy. They've already signaled that. We will have certainly more incentivization of fossil fuel generation, particularly gas. It won't be anti-renewables in our view. But this doesn't mean he expects things won't change at all. I think where you'll find the impacts will be felt mostly in active trade and tariff discrimination around the sourcing of equipment and the impact of what will certainly be inflationary cost increases on imported equipment, particularly from China. That's where we are very much focused on that outcome, which will certainly in our minds create a two-tiered market of those that can access equipment, particularly solar and batteries that qualify for domestic content. However, That is going to be redefined and imported equipment is going to be subject to quite punitive tariffs. Now, they have already been introduced by the Biden administration, significant tariff increases from next year on particularly Chinese-sourced equipment. Question is, how much further does the Trump administration go? They've signaled more punitive impacts. That'll simply widen the spread between the procurement costs of those that can access in a mitigated way and those that can't. Overall, though, I think sentiment will dampen, but investment really won't. Don agrees, but stresses the broader
Speaker 1trends in the industry as well when he thinks about this new era.
Speaker 2The reality is an all-energy solution, I think, is frankly mandatory. We're in a period where, for reasons with generative data, artificial intelligence, there's a need for significant capital investment to satisfy power demand. As we look forward here, there are secular trends, whether it's a combination. The generative data, power demand, some of the factors that David cited just in terms of the tariff environment, the geopolitical environment, there's clearly a focus on the need to ensure energy security. That means being able to procure a lot of the equipment for the infrastructure supply chain domestically. That onshoring of the supply chain is a huge driver of energy and power demand. I mean, just to level set, there's a semiconductor facility that is planned for here upstate in New York, which once it's reaching its full capacity, will consume as much power as the states of Vermont and New Hampshire combined. So the fundamental drivers on power demand and energy demand growth are there. And the question is, how do we effectively supply that demand? And renewables are certainly, of course, a part of the solution.
Speaker 1That said, Don doesn't ignore what a new administration means, which includes a substantial role for natural gas in that overall solution.
Speaker 2And in many ways, it's complementary, because as we've seen over the past year or two years, some of the renewable projects here in North America have been delayed just as a result of some of the permitting issues. It's taking longer to get projects permitted. We have interconnection issues and then we have supply chain issues. I mean, there's still a delay on transformers, inverters, you know, where we're seeing it takes five to seven years from really inception to see these renewable projects come online. And so natural gas, power generation or thermal power generation can be part of the solution. And so natural gas, power generation or thermal power generation can be part of the solution.
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