What’s the future of energy?

Back in 2007, McKinsey did two ground-breaking pieces of research that still inform how I think about energy—the resource-productivity framework and the greenhouse gas (GHG) cost curve.  And then, with metaphorical holding of breath, my colleagues made forecasts  based on this work.  My colleague Matt Rogers and I thought it would be interesting to look back at these predictions—which were broadly on target, with a few clunkers—and then look at what might come next.

Win some, lose some
The 2007 research looked at a number of potentially disruptive technologies and assessed their prospects. Here’s how we did:

Solar: Photovoltaic (PV) solar installations have taken off much faster than we expected. Costs fell steeply, driving adoption. The compression of costs happened throughout the solar system, from sourcing of raw materials to manufacturing to installation and service.  We expected costs to fall to $2.40 per watt by 2030, but were not bullish enough; in fact, they are on course to hit $1.60 per watt by 2020.

Wind: We projected that the installed base of 94 gigawatts in 2007 would expand to 800 gigawatts by 2030. Again, growth has been faster than expected, with 370 gigawatts of installed capacity by 2014. That’s a 22 percent growth rate. The key, again, was lower costs. Also, manufacturers improved their maintenance protocols and turbine efficiency. Cautionary note: new onshore wind installations dropped more than 20 percent in 2013.

Batteries: When we published the greenhouse-gas cost curve in 2007, electric vehicles were not even included; we expected the big improvements would come in internal combustion engines. But innovation in consumer devices (smartphones, tablets, and laptops) is changing the game for large-format batteries. In 2007, large-format lithium-ion storage cost about $900 per kilowatt hour; today it is about $380, and it is on track to drop below $200 in 5 years.

Unconventional oil and gas:  Like everyone else, we didn’t see this coming.  As gas prices peaked in 2008, a massive wave of innovation was unleashed. Result: US unconventional oil production rose from almost nothing in 2007 to 3.7 million barrels per day in 2014.

Energy efficiency: Innovation has come faster than we expected; the forces we thought would hold us back such as high adoption costs and slow innovation proved surmountable. Today we are at a tipping point for consumers to change behaviors; cheap mobile communications, for example, are enabling the connected home. And hardware costs have come down. For example, an LED bulb now costs about $12, down 80 percent from 2010.

In all these areas, innovation and ingenuity drove costs down much faster than we expected, expanding production; we got the direction right, but not the speed. In other cases, unforeseen events or pressure from competing technologies have had the opposite effect. Specifically, we saw a bigger future for nuclear, but cost overruns, cheap natural gas, and the disaster at Fukushima in 2011 derailed these expectations.  Biofuels have also stalled. In 2007 we projected annual consumption of 14 billion gallons of biofuels by 2030; we are nowhere near on pace for that. Lack of innovation and low oil prices have hurt demand; it is also the case that doubts about many forms of biofuels are building. Finally, we were too bullish on carbon capture and storage (CCS), which is a way to make burning coal much cleaner. High costs and technical difficulties have slowed adoption. Today there are only 13 CCS projects in operation and others have been cancelled or delayed—four in 2013 alone.

As a whole, then, we were too optimistic on most conventional energy and not optimistic enough on most renewables, natural gas, and efficiency. If these trends continue—and of course, they might not—what are the implications?

Without venturing too deep into the geopolitical weeds, consider what happens to countries like Iran, Saudi Arabia, or Venezuela, whose economies rely heavily on fossil fuels, if demand for shrinks or dries up. In the US, the shale revolution has meant that the country is now the largest producer of petroleum and natural gas hydrocarbons—an idea that would have seemed ludicrous just a decade ago. The United States now sends diesel fuel to Europe, gasoline to Latin America, and natural gas to a growing number of markets.  Almost no crude oil now moves across the Atlantic to the United States; instead, almost all of it moves to Asia. These shifts are changing dynamics of regional markets worldwide and shifting the center of trading and pricing to Asia.

On an industry level, low prices and uncertainty are making more urgent the pressure on oil-and-gas companies to improve performance. Disappointing conventional exploration results, declining production efficiency, and rising capital intensity have harmed investor confidence. Utilities are already having difficulty dealing with the new energy environment; their business models are not adapted to competition from on-site generation, and valuations have tumbled in many markets.

For consumers, the biggest change is likely to be on the road. Electric vehicles are still rare—they accounted for less than 1% of US sales in 2014, and even less globally—but the pace is picking up.  McKinsey’s Global Energy Perspective  projects that about 10 percent of all cars in the 34 countries in the Organization for Economic Cooperation and Development will be at least partially electric in 2030. China has set an ambitious target of five million electric vehicles on its roads by 2020. Autonomous trucks in mining and farming are showing big savings in labor and CO2 emissions. Other kinds of innovation are also rocking this sector. Car-sharing services are taking off in Europe and the United States, while Uber, Lyft, and others have upended the taxi business, and begun to change patterns of personal vehicle ownership and public-transport choices.

More predictions
All in all, our 2007 research held up reasonably well. So let’s try again. Here’s how we see a few important trends over the next 20 years.

Gas will be king: In China and the United States, the future is bright for gas, because demand is expanding–for example by shifting to gas for heavy road transport. Cities in California, Illinois, New York, and elsewhere are equipping their fleets with gas-powered vehicles. In Asia, gas is not used as much because of monopolization of resources. In Europe, where energy demand is declining, many markets are looking to coal rather than gas.

Solar will grow really fast, but still be fairly small: Crashing prices in solar may be the key to bringing power to the 1.3 billion people who currently do without. A future of distributed generation would allow countries to leapfrog the cost and complexity of building a reliable grid. PV solar is set to capture by far the largest slice of the renewables pie.

Coal will grow more slowly, but still be huge: The king of fossil fuels is still top of the heap in Asia and is likely to remain the fuel of choice. While China is making ambitious moves toward cleaner energy, a true shift away from coal is not imminent. In the United States and Europe, however, coal is under pressure, due to political pressure and low natural gas prices.  While coal still accounts for 39 percent of US generation today, that figure will likely decline as no new coal-fired capacity is expected to come online. As much of Europe shifts away from nuclear and experiments with both renewables and shale gas, coal is proving irresistible. Over time, the attraction will fade due to environmental concerns.

Value will continue to migrate from generation to services: Distributed generation, dispatchable demand, and the digital grid are redefining the power system. Disruptors are cutting out traditional utilities as new technologies (and financing techniques) allow customers to opt out of traditional energy supplies.

Finally, let’s think a little more speculatively and offer some views on which outlier technologies just might make it. In that vein, nuclear could be a surprise winner. Small modular reactors (SMRs) can provide baseload, 24-hour power without the immense capital expenditure of traditional nuclear reactors. Yes, nuclear is controversial in many countries, but as an emissions-free source of constant power, it may be difficult to avoid.

And then there’s hydrogen. Yes, the hype has been wrong before, but it’s interesting that Toyota remains optimistic enough to be working with the Japanese government and others to build a fueling infrastructure. Toyota is focused on making longer-range hydrogen vehicles the standard for clean transportation (the photo at the top of this article is of its Mirai prototype).

So that’s our take. If we’re wrong, let us know—in 8 years or so.

This article is published in collaboration with LinkedIn. Publication does not imply endorsement of views by the World Economic Forum.

To keep up with the Agenda subscribe to our weekly newsletter.

Author: Scott Nyquist is Director at McKinsey & Company.

Image: A worker inspects solar panels at a solar Dunhuang, 950km (590 miles) northwest of Lanzhou, Gansu Province. REUTERS/Carlos