It's no secret that General Electric (NYSE: GE) has faced significant problems with its power segment in recent years. Some analysts and industry commentators believe its core gas turbine equipment faces long-term structural declines in demand due to the rise of renewable energy as a source of electricity production.
However, it's far from clear that this will be the case, and there's evidence to suggest GE Power could have the potential to surprise on the upside. Let's take a look at both sides of the story.
The case against gas turbines
GE's management has acknowledged that the falling cost of renewable energy and storage -- a key factor in using a variable supply source -- has negatively impacted gas turbine demand. Indeed, according to industry figures, the end demand for heavy-duty gas turbines (measured in Gigawatts) was roughly halved from 2015 to 2019.
Image source: Getty Images.
It gets worse. According to the U.S. Energy Information Administration (EIA), the competitiveness of renewable energy is going to continue to increase in the future. One way to measure this is to look at something called the estimated Levelized Cost of Electricity (LCOE) from the EIA. This is defined as "the average revenue per unit of electricity generated that would be required to recover the costs of building and operating a generating plant during an assumed financial life and duty cycle." Measured as dollars per Megawatt-hour ($/MWh), a lower number is better as it implies a cheaper cost.
As you can see below, the LCOE for onshore wind is estimated to be lower than that for advanced combined cycle plants in 2021, and the comparative advantage will increase over the next 20 years, according to the EIA.
Total System LCOE ($/MWh)
Advanced combined cycle (gas and heat recovery)
Advanced combustion turbine (gas)
Data source: U.S. Energy Information Administration.
Based on the EIA estimates, there appears to be a strong case for arguing that gas turbine demand looks set for a long-term secular decline.
Six reasons why gas turbines have a future
That said, it's far from given that renewable energy will completely triumph over gas, and there's even some reason for GE investors to be optimistic from recent data. First, it's incredibly difficult to predict gas turbine demand.
For example, GE's ill-fated acquisition of Alstom's energy assets in 2015 is widely criticized, but the truth is that Siemens (NASDAQOTH: SIEGY) and Mitsubishi also bid for the assets. So if the three leading players in the industry are incapable of accurately predicting gas turbine demand then predicting future demand must surely be extremely difficult. This point is compounded when you consider that GE and Siemens both have substantive renewable energy operations, so they can see all sides of the demand situation.
Second, the EIA figures quoted above are averages, and they don't reflect differences in LCOE between energy sources in different regions of the U.S. In fact, based on the EIA estimates, there'll be regions of the U.S. where it'll be significantly cheaper to use gas-powered plants rather than wind or solar.
Third, just as there's a difference between regions of the U.S. in terms of using gas versus renewables, there are also huge differences between countries. In this way, GE can grow internationally, even if the U.S. gas turbine market is set to slow.
Fourth, the EIA estimates include assumptions for the long-term variable cost of fuel sources for gas-powered plants -- wind and solar fuel costs are free until they start metering sunshine -- and these estimates could be revised upwards or downwards depending on gas prices.
Fifth, as you can see in the chart below, if there's a clear structural shift, it's that renewables and gas are taking over from coal. In fact, there's been an increase in gas usage since the spring of 2018, possibly in line with the general drift downwards in gas prices. Again, this sort of data suggests that gas turbine demand will prove cyclical rather than structural.
Data source: U.S. Energy Information Administration. Chart by author.
Sixth, renewable energy is attractive for environmental reasons but also has its detractors. For example, the U.K. -- a country with the best wind resources in Europe -- might be seen as a potential promoter of wind energy. However, successive governments have come out against onshore wind power, simply because it's politically expedient to do so.
Wind and solar power farms attract political resistance because they often look unseemly and take up significantly more land mass than the same energy produced by a gas-powered plant. They're also believed to endanger wildlife.
It's a similar situation in Germany -- often seen as the home of wind power -- where onshore wind power also faces political opposition.
Gas turbine demand: A structural or cyclical problem?
All told, the answer to the question is far from clear, and the assumption that GE's core power product is facing a structural decline is subject to questioning.
It appears that gas turbines have a future after all, and now that GE CEO Larry Culp has set more realistic targets for the company's (and the power segment's) earnings, it's possible that the uptick in usage of gas as an energy source for electricity could actually lead to some upside surprise in the coming years. It's a figure that investors should follow closely because if it keeps going up, then gas turbine orders will surely follow.
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