The renaissance of gas fired power

Intro: Welcome to The Energy Shift, a podcast series focusing on the rapidly evolving energy landscape with hosts Luisa Fuentes and James Wright.

James Wright: Hello everyone. Hi Luisa, how are you?

Luisa Fuentes: Good, how are you?

James Wright: Wonderful. Great to be back in New York. I’m adjusting from the high desert heat to the lower Manhattan soup. And I think we’re all in Olympics mode, right? There’s lot happening in the office with Olympics on TV. I’ve been learning about skateboarding today and air pistol shooting, believe it or not. It’s that time every four years we all become armchair pundits of random sports. So how about yourself?

Luisa Fuentes: Yeah, indeed. I’m an expert on today in gymnastics and volleyball.

James Wright: Excellent. Well, with that, let’s get into it. So this is the first of a couple of episodes we’ve got lined up to discuss the gas markets and the role of gas as a transition fuel. On today’s discussion, we’re going to focus on domestic gas power generation, which has been going through something of a renaissance. And, Luisa, I think why don’t you help tee this up with some quite interesting statistics you’ve dug out as some background context for what we’re going to talk about with today’s guests.

Luisa Fuentes: Yeah, let’s get into it. So really, after two decades of anemic growth at, call it, half a percent per annum, electricity demand is now expected to grow at close to 2.5 % per annum through 2030. That’s quite an abrupt change. That growth is expected to be driven across the entire US with some specific regions growing at 6% plus per annum. This, of course, is a result of data center development, particularly as it relates to AI, the resurgence of manufacturing, and really just broader electrification trends such as EV adoption, charging, and energy efficiency in buildings. So just to dig a bit deeper on the drivers and to contextualize a bit more, the growth of AI-driven data centers requires exponentially more power than traditional data centers. A single ChatGPT search uses about 10 times the power of a single Google search. And with regard to America making things again, manufacturing alone is expected to require growth of 1.5 % per annum with more than 481 billion of industrial projects announced since 2021. Different regions will have different drivers, of course, for requiring more power. KISOs growth, for example, is driven primarily by electrification, while PJMs is driven by data center development. I would add that the need for baseload power to balance ISOs that have been increasing in their renewable penetration is also a driver. This, of course, will lead to opportunities in development of new reliable gas-fired assets to support the future economic growth in the U.S. However, some challenges do exist. The EPA recently issued a final rule for new natural gas-fired plants. New plants that operate at 40 percent of their maximum annual capacity or more must comply with interim emission standards. However, by January 1st, 2032, the expectation is that baseload combustion turbines must reduce emissions by 90% based on CCS. Is that feasible? What does that look like? There are some outstanding questions.

James Wright: Yeah, that was fantastic. A lot to digest there. I think that’s also against the backdrop of some pretty remarkable PJM capacity auction prices yesterday, which we’ll probably get into. So to help us discuss many of those dynamics, we’ve got two fantastic guests today. We’ve got Matt Willis, who’s a partner at Hull Street Energy, and Neil Davids, who’s a Managing Director in our Energy Investment Banking team. And Neil’s practice focuses on our buy side and sell side activities in the gas power space. So hi, Neil, hi Matt.

Matt Willis: Hi James.

Neil Davids: Hello.

James Wright: Luisa, why don’t you take it away?

Luisa Fuentes: Before we dig in too deeply, can you give us an overview of what has shifted in the last nine to 12 months, both with regard to traditional power development as well as the world of M&A in this sector, and maybe tell us what you think has been driving that sector.

Neil Davids: Thanks, Luisa. Happy to. The M&A market for conventional gas-fired power has become incredibly robust over the last 18 months, and valuations are on the rise. I believe this is really attributable to a variety of factors, and I’ll take through a few of them. As you mentioned, over the past decade, electric demand was basically stagnant. Recent electrification trends, data centers, manufacturing, on-shoring, it was like a perfect economic storm that really bodes well for reliable on-demand generation like natural gas-fired power. There is certainly a scarcity premium that is being placed for operational gas-fired assets in regions with the strongest low growth. The second driver is we see a significant number of new entrants pursuing the power space, given the attractive return proposition. Traditionally, the sector was dominated by private equity and a small number of public IPPs. Today we’re seeing utilities, family offices, Southeast Asia entities, global energy majors, commodity houses, and even some infrastructure funds that have historically been focused on renewables. The key for them is a transition lever like on-site battery storage or direct support through renewable intermittency. Further support for M&A valuations is the public IPP sector, which is really comprised of three companies. It’s traded at record multiples and has been correlated to Nvidia’s share price around 0.9 times and it’s broken through traditional trading cycles of EBITDA. And then finally, you’ve got a really, what I’ll call cooperative macroeconomic backdrop with range bound natural gas prices, interest rate certainty from a directional perspective, as well as a supportive leverage finance and bank market. So all that coming together has built up a really robust environment for a conventional power M&A.

Luisa Fuentes: Thanks, Neil. Matt, over to you. Hull Street focuses on opportunities across the energy spectrum. How are you looking at gas-fired investments versus maybe how you were looking at them a year ago? And where are you seeing opportunities?

Matt Willis: Sure. I completely agree with Neil with the gas-hired space. It’s really interesting right now. We had started our business around the thesis that flexible quick start generation in critical locations, particularly in the Northeast, were going to be increasingly valuable. And we started pivoting in about 2021 when we realized how tight certain markets were beginning to look. And we started acquiring combined cycles with high capacity factors in markets like California and Texas, including three plants last year or so. A year ago, very much the thesis was all about energy machines and constrained markets. And we remain big believers in the energy value of those units. But I think the biggest year over year change that we’re seeing is the impact of batteries. California now has a little over seven gigawatts of battery capacity hitting the market at peak time. And that’s really meaningfully affecting the price shape across the day. In terms of opportunities, to James’s earlier point, I wish I had a time machine because I would go back and buy anything I could possibly find in PJM. I think that that capacity print is, full disclosure, definitely surprised us to the upside. So I think PJM is going to prove an increasingly interesting market and you know, we’re also going to remain interested in California and Texas as those are complicated situations where the demand story around data centers, but also really a pretty diverse demand story around transportation and industrials is really playing out.

James Wright: So, pulling on that, demand sides string a bit. we start talking about new sources of demand, Neil, back to you, it feels like if we start talking about data centers, we really have to straight off to start talking about the words reliable power. Could you maybe just dig a bit on that in terms of the generation side and the capital investment going in there? What are you seeing from your chair?

Neil Davids: Yeah, I’ve seen research that says data centers are going to make up anywhere from 8 to 12% of our power demand by 2030, and that’s up from 2 to 3% currently. That’s going to drive the demand for around 47 to 50 gigawatts of incremental power generation capacity, the majority of which really needs to be natural gas fire generation to support the reliability. But markets are in action to support the investment required for the build. I’ll give you an example. The Texas Energy Fund. $10 billion of low-cost loans for dispatchable generation. The Public Utilities Commission of Texas recently received 72 applications requesting $24 billion to finance 38 gigawatts of generation. This is going to help but not solve the problem with ERCOT reliability as there are about 60 gigawatts of new load requests, large load requests that have reportedly been seeking interconnection by 2030. But most of that is data centers or crypto. And if this materialized, the ERCOT reserve margins might even go negative. And then we have the PJM print, right? What a record print yesterday, exciting for the power generation crowd, a 960% increase for the PJM region to $269 a megawatt day, but a specific breakout zone in PJM dominion. That’s interesting as that broke out around $444 a megawatt day. The reserve margin in PJM also declined to around 18 and a half percent. That’s the lowest it’s ever been. But in Northern Virginia, that really remains the top data center market in the US. About 4.6 gigawatts of demand currently growing around 15 gigawatts by the end of the decade. And seeing this breakout of the PGM dominion region is really a clear indicator that electric reliability is going to be required to power this data center thesis.

James Wright: That was excellent. Luisa, side note, we’re going have to put in the show notes all these statistics. I’m having trouble keeping up with these numbers right now. This is impressive stuff, guys. So Matt, turning it back to you then, with your activities at Hull Street, I’m assuming your existing Power for Print has also seen positive impact from some of those data center tailwinds that Neil was talking about.

Matt Willis: Absolutely. We joke that the Wall Street Journal has taken over our marketing efforts because this is really clearly one of the main narratives in US business over the course of the last 12, certainly the last six months. And just generally having that bullish power narrative out there in the market, it’s great for driving interest in the sector. The impact on us, it’s a little bit of a two-edged sword, I think. We have definitely found ourselves being priced out of deals, especially in PJM, including one that Neil was selling relatively recently. But the flip side of that is we’ve seen an interest, particularly in our Texas assets, from a number of data center developers. And while nothing concrete has really materialized there, it is potentially a very interesting opportunity. And one of the things we’ve spent some time wondering about is like, why haven’t we seen more deals announced like the Talon data center deal that was done? And so it seems to be that it’s not just us not quite realizing the potential value here yet, but there’s possibly a good bit of deal flow still to come.

James Wright: Absolutely. And I think maybe with that, you both mentioned a couple of the key regions where most of the activity has been happening recently. But let’s dig a bit deeper on that if we think about the regions themselves across the US. And I think it’s often a misnomer when we talk about the quote unquote US power system, right? Because it’s obviously comprised of many different regional authorities that have very different characteristics. So maybe with that, could you discuss, you know, which systems are most attractive to you, Matt, with your business? What are the features that make it a good area to invest in? How are you thinking about some of the features of those markets in terms of who has capacity markets, who doesn’t have capacity markets, et cetera, et cetera? That’d be great.

Matt Willis: Sure. you’re absolutely right. I mean, there’s just a ton of variation regionally and even intraregionally, depending on the congestion topology. What makes an interesting market for us is really the confluence of a number of different factors that create dislocations. I think at a minimum, you need some sort of supply demand imbalance. And that could come from just a lack of supply, right? Retirement of coal plants, for example, or the demand side that we’re for the first time in 20 years now seeing, or both. I think you also need some kind of a regulatory or market framework that limits some critical elements of the system. And California and Texas, I think, are both really good examples of this situation. They’ve arrived at pretty similar places by very, different pathways, as you might imagine. But both have tight and dynamic supply situations, as well as some real barriers to entry that make the incumbent assets really interesting for people like us. And with respect to your examples on capacity markets and stability, transparency, et cetera, those are all things that may de-risk an investment. And as a firm, we’re not seeking infrastructure like returns. a little further up the risk spectrum. So those are not necessarily factors that would appeal to us, although we are happy to price those into the elements of a deal.

James Wright: Sounds like maybe Neil, a takeaway, we should do a separate pod on each RTO. We could spend a lot of time on each of those. But let’s move on. I mean, Matt, sticking with you for a second, though, is there any particular investment that you guys have made recently you’d to highlight that maybe touches on some of those features?

Matt Willis: Sure. as Neil knows as well as I do, as he’s on the sale side, this was just announced this week, we’re buying four power plants on Long Island. And Long Island is one of those really interesting markets for us as the power flows are very, very constrained and the flood of offshore wind power is going to put a premium on units that we believe can provide critical reliability services.

James Wright: Fantastic. Neil, guess back over to you then. One aspect I’m quite interested in is where the utilities sit and all this and how their behavior may be evolving in this new mini gas renaissance we’re living in at the moment. What are you seeing there? What are the themes on the utility side?

Neil Davids: Yeah, it’s a dramatic shift and a little kind of history here. But a decade ago, nearly all utilities were in the process of divesting themselves of their unregulated generation with a back to basics mentality. Many of those assets went to private equity and the IPPs. And if you think just a few years ago, the core focus of utilities was decarbonization and the build out of renewables. Fast forward today, this surprise load growth, many utilities are in a position where they face significant demand growth and requests for reliable power in 2030, more stringent reserve margins from the regulators, and a growing renewable intermittency concern. So that equation leads you to, we need more cost-effective gas-fired generation. That’s achieved through acquisitions of unregulated assets within or in close proximity to your region, or you can also strike tolling agreements with those specific assets. So now regulated utilities and load serving entities are actually a top buyer of existing gas fire generation, and they have a very competitive cost of capital when they need to be. They’ll also build and add to rate base whenever possible, but that build cycle is a 30-month construction cycle plus approvals. So it’s going to take time and the load has showed up today. So you just you take AEP for example on their Q2 earnings. They acknowledged that Public Service Oklahoma signed an agreement subject to regulatory approval to acquire a 795 megawatt gas-fired facility called Green Country. And this was to help ensure resource adequacy and affordable energy and CIBC served as sell side advisor on this transaction. So the utilities are back looking for cost effective ways to serve their customers and gas is it.

James Wright: Hey Neil, you’re a good banker. Put the shameless plug in there. I like it. Excellent. But always get a credential in when you can.

Neil Davids: Can’t help myself.

James Wright: (laughs) Yeah, go on, Luisa. Take it away. Back to you.

Luisa Fuentes: Just to focus a little bit on the decarbonization topic and the idea of natural gas as a transition fuel. What do we think about natural gas as a transition fuel? Recently, the word transition has been dropped from lot of places. Maybe, Neil, can you discuss your view on this?

Neil Davids: Sure, so I’ll get on my soapbox for a little bit here. So the US has become a global energy superpower, right? We were once the largest importer of energy and became a net exporter in 2019. We’re now the largest producer of oil and gas and I believe the largest exporter of natural gas as well. But we’re also a clear leader in new energy and emerging technologies. So from my perspective, calling one of our greatest economic and geopolitical assets, natural gas, a transition fuel was never the proper term. Given the macroeconomic growth prospects driven by AI, manufacturing, electrification, all the themes that we went through on this call, we really need an all of the above energy mindset that maximizes production, funding for new technologies, eases permitting, et cetera. And the EPA regulations, Luisa, that you talked about at the outset, where you’re kind of constraining the ability to build new combined cycles unless they have CCS by a certain point in time, which is an earlier stage technology. That could be an impediment to U.S. economic growth. So we need policies that are incentivizing this exciting next segment of the economy that we’re seeing. And I would say, you know, natural gas fire generation is back when California, the leading transition market in the U.S., basically states that all existing gas fire generation is needed and will be retained long-term to support the grid. So that’s always a good signal.

James Wright: I got to ask Neil, at this point in the election cycle, are you running for office? That felt like an election stump speech.

Neil Davis: (laughs) It was from the heart, James. It was from the heart. 

Luisa Fuentes: I can vouch. This is not the first time I’ve heard that. No, and it is a very practical approach and sensible. To stay on that topic, Matt, how does this current iteration of gas-fired new-build differ from previous ones? Does it feel like business as usual with regard to fossil fuels? What are you seeing as far as residual values, et cetera?

Matt Willis: Sure. I think that the short answer is that this feels very different. The last big build out 20 plus years ago really resulted from a decade or so of under investment due to concerns about the coming deregulation. This is different, right? This is a demand story and a demand story combined with a pretty profound change in the hourly shape of demand because of renewables and also because of the existing mix of generation assets on the grid. To kind of furthering what Neil was saying, there’s been an enormous switch from coal generation to natural gas generation in the US. And our peak carbon emissions in the US were in 2007. And despite the fact that we’ve had economic growth and growth and energy demand over that time, what’s really happened is that the less carbon intensive gas units have filled in for the coal units. In terms of your question about is business as usual for fossil fuels, I think there’s just no such thing as business as usual in this industry. There’s so much going on right now. Just even look at the capacity markets. In addition to the big upside surprise in PJM, the changes due to unit accreditation or slice of day in California combined with a really uncertain regulatory situation post-Chevron and also to one of Neil’s points, the increasing integration of the US natural gas markets into the global market through LNG, I think means that there’s really no great corollary to the past.

Luisa Fuentes: In that context, Matt, what do you see as the variables that could either impact demand or supply on the power side?

Matt Willis: This is a great question. We’re spending a lot of time on this. And obviously there are some technological elements here where we’re not experts, right? And what’s going on with chip technology and things like that. But clearly if there are advances where those AI chips that are, you take 10x the processing power, if that changes that could substantially impact the 40 to 50% of load growth that we see coming from the data center sector. And I think one thing we also worry about a lot is big swings of sentiment in the capital markets, right? The AI sector feels a little bubble-ish. And if the investment flows change, if things cool down, what does that mean exactly for those of us in the power sector? And then of course, you know, there’s sort of these more systematic risks around inflation and economic growth and what the impact in both of those might be if there’s a change over in administration here.

Luisa Fuentes: Just out of curiosity, do you see battery storage as a long-term duration storage as a challenge potentially to the deployment of gas-fired reliable power?

Matt Willis: I think they’re largely complimentary at the moment. We tend to think of the battery storage more as a temporal shift in transmission. As you get more and more penetration for batteries in Texas and in California, it is having an impact. But there’s really a seasonal storage element that nobody talks about very much, right? And you see this through the injection of natural gas into storage facilities across the country, right? And that happens all throughout the summer and then is pulled down into the winter. And you can’t really have a battery in any kind of economically sensible way, performing that seasonal storage role in a way that the natural gas fleet currently does.

Luisa Fuentes: Great, thank you, Matt.

James Wright: That was great, Matt. I think my takeaway from this conversation is you and Neil have got yourselves back for at least a few more episodes. We’ve got a number of themes we’ve teed up here and teased with people that we could spend a lot of time talking about. So that was a great conversation. So let’s try and wrap this up. I think what we like to do on The Energy Shift is just finish off with asking each of you to mention something that’s been kind of shifting your week, if you like. Louisa, why don’t you kick us off?

Luisa Fuentes: Yeah, I think consistent with the acceleration of natural gas deployment, AI -driven data center deployment, conversations that we weren’t having a year ago, things change quickly. Just to align back to the US political landscape, in three weeks, it’s completely shifted as well. So who knows where we’re going to end up in November, but it’s been a roller coaster, that’s for sure.

James Wright: Yeah, for sure. Matt, what about you?

Matt Willis: This is not power related, but my wife just had an emergency appendectomy and that definitely shifted my view of how the healthcare system works. That sort of created this 48-hour odyssey for us through the system and was a pretty stark reminder that even when you have access to great healthcare and good insurance, et cetera, there can still be some real material challenge in negotiating these things.

James Wright: Yeah, absolutely. I hope she’s doing well, she’s recovering okay?

Matt Willis: Yes, she’s doing just fine. Thank

James Wright: Good, I’m glad to hear it. Neil?

Neil Davids: Yeah, I guess my shift comes from the Northeast heat wave and Con Edison keep asking me to shift my thermostat up and to avoid using air conditioning by sending out cell phone alerts to which my children ask me why they’re being asked to do this. And then I get again on my soapbox talking about the retirement of Indian Point and a perfectly good piece of long-term, low cost green energy infrastructure that was retired and now we’re all paying more for electricity. But nonetheless, that was my shift.

James Wright: Point well made. All right. So I’ll wrap up. I think maybe a couple of things for me this week. Maybe a slightly sort of sad note that really did kind of resonate with me a bit, just seeing these awful wildfires up in Canada ravaging through BC and beyond. And I’ve been speaking to colleagues up there where some of the stories have just been pretty heartbreaking. And we’ve probably seen the news of the town of Jasper, which was hit really bad, about a third of the town has been destroyed and some pretty heroic but tragic stories of the firefighters there who’ve been battling those fires and losing their own homes at the same time. So it kind of reminds us, why as a species we’ve got to either learn to mitigate this stuff or live in a bit of a different looking world going forward, so bit of a negative one, but then on the positive side, I’m going to keep in theme with the biking from last week or two weeks ago. Going to give a big shout out to Tom Piddock and his heroic goal for Team GB in the mountain biking. If you haven’t seen it, it’s one to watch on YouTube. The last lap was one of the best bits of mountain bike racing you’ll ever see. Yeah, that was great to watch, so go Team GB. So with that, we’ll call this one a wrap. Big, huge thank you to both Matt and Neil. That was really fantastic. Thank you guys. Great conversation. I found that fascinating. Really kind of reminded me about many of the quite complex dynamics happening in our power markets right now. And there’s a real smorgasbord of technologies. all looking at driving this transition going forward. So thanks again for listening, everyone, and have a great rest of the week.

Neil Davids: Thank you.

Luisa Fuentes: Thank you.

Matt Willis: Thanks.

Outro: Please join us next time on The Energy Shift as we continue to tackle some of the hottest topics in the US energy transition landscape, providing fresh insights and viewpoints to help you shift your perspective.

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