Energy is Cheap. It’s Going to Get Cheaper

We’ve had a wild ride over the summer with energy prices, and the winter promises to be even wilder. With Putin doubling down in what looks to be an unwinnable (to Russia) war in Ukraine and Europe scrambling to replace Russia gas and oil to make it through the winter, it seems like a strange time to talk about how cheap energy is these days and how much cheaper it’s going to get.

And yet.

The recent price shocks make it easy to forget just how little of our effort we spend in the modern industrialized world on energy. The classic study by William Nordhaus showed that over time the amount of illumination you could get per hour of labor has steadily dropped throughout history, and today is an astonishing 1.4 million times higher than it was about 4,000 years ago at the beginning of recorded history. Lumens-per-work-hour is one of the few measures of the cost of energy that can be consistently calculated over such a long timespan, though there’s no doubt that there’s been similar declines in the cost of other energy-intensive activities (transportation and shipping, heating, cooking, etc.).

While the current inflation is certainly disruptive for many people’s lives, the energy needs of most people in the industrialized world can still be paid for with only a modest fraction of a day’s labor. And for this most people get a level of comfort and luxury which would have been unimaginable to even the wealthiest even a century ago: as much light as you want any time of day or night, living spaces heated and cooled year-round with no effort, transportation almost anywhere on the planet within a day, and on and on.

Energy Is Going to Get a Lot Cheaper

The long-term decline in the cost of energy-related activities has been been driven by technology changes in both the sources of energy we use (which have gotten ever cheaper) and the uses of energy (which have gotten ever more efficient).

Today we are in the beginning stages of another major round of improvements in both our energy uses and sources.

The current drive to electrify everything and improve efficiency has already led to major improvements. Light bulbs today use roughly one-tenth the power to produce the same amount of light as what we used 20 years ago, and cars of comparable size have gotten about twice as efficient over the same timeframe. Even with higher upfront costs for a LED ligthbulb or hybrid vehicle, the energy usage has improved enough that the actual cost of the energy service (light, transportation) has dropped.

Other nascent technology shifts (electric vehicles, heat pumps for heating/cooling, induction stoves for cooking) promise another 2-3x improvement in efficiency over burning fossil fuels.

Where things really get exciting is in the coming changes in how we produce energy. With renewable power in general, and solar power in particular, the cost of producing energy will plummet because the economic model will change in two fundamental ways: from extraction to manufacturing, and from consumption-based pricing to capacity-based pricing.

Extraction vs. Manufacturing: Extraction is any process where we get something by drawing down some finite, preexisting supply; for example, drilling for oil or gas, or mining coal. As demand goes up for something we can only get through extraction, the price will also go up because the supply is limited. Manufacturing is the process of taking one thing and turning it into something else, such as turning silicon and aluminum plus a few trace elements into a solar panel, or turning lithium, carbon, iron, and phosphorus into a battery. And while a short-term increase in demand for a manufactured product will increase the price, long-term demand for manufactured products tends to decrease the price as volume increases leading to economies of scale and more competition.

Solar power is already the cheapest form of energy ever invented, thanks to technology improvements and rapidly increasing manufacturing capacity. With global demand for new solar installations still growing rapidly, we can expect further economies of scale in the coming years. Commercial scale wind power has been following a similar (though not as steep) cost-and-capacity trajectory, and large-scale batteries are not too far behind.

Consumption vs. Capacity Pricing: Today we pay for energy based on the amount we consume: by the kilowatt-hour for electricity, or by the gallon for gasoline. This makes sense because the biggest cost of producing energy is the cost of the fuel (oil, coal) and there’s a 1:1 correspondence between the amount of fuel consumed and the amount of energy used.

With renewables this is completely the opposite: almost 100% of the cost is installing the solar panels or wind turbines (or hydroelectric dam), and the marginal cost of each kilowatt-hour is nearly zero. You pay for the capacity to produce a certain amount of power, not the amount you actually use. It’s the difference between buying flat-rate Internet service and paying by the megabit.

If you’re a utility and can keep charging your customers by the kilowatt-hour then you’re going to be very happy: selling something by consumption when you can buy it by capacity is a great way to make money—as long as your customers don’t have the ability to buy capacity at a similar price. But because many electricity users do have the ability to buy solar panels at a similar price as the utility, there’s the potential for a lot of disruption in the energy markets.

However things shake out, it’s going to be generally good because the cost of energy will drop substantially. It may take a long time before we know how much of that benefit will go to ordinary consumers or utilities and energy companies. There’s likely to be a lot more political maneuvering as today’s incumbents try to position themselves to maintain today’s revenue streams in a future world where many customers can “opt out” of the grid any time.

What Next?

It’s going to take decades for the energy transition to fully play out: there’s a tremendous amount of long-lived infrastructure which will be replaced, and a lot of political battles which will be fought over who the winners and losers will be.

This is not the first time our economy has switched wholesale from one source of energy to a different, cheaper, and/or more plentiful source. It’s almost impossible to predict what new technologies will be enabled by cheap and widely available energy priced by capacity rather than consumption, but I have no doubt the world of 2042 will be very different than the world of 2022.