Powering Bitcoin Miners with Stranded CarbonMatthew Sigel, Head of Digital Assets Research - Van Eck Associates CorporationNovember 18, 2021
"One day, he struck on an opportunity to buy some fuel oil. The situation was a microcosm of the inefficiencies of the Soviet system. An oil refinery in Ukraine was producing fuel oil to supply several power stations. When a mild winter came, the power stations used less, and so the refinery had excess supplies. With no other instructions on where to deliver it, the director of the refinery simply told his employees to dig holes in the nearby forest and pour the fuel oil into them. From a situation like that one, Tarasov soon found himself with meaningful quantities of Soviet fuel oil to sell." -The World for Sale: Money, Power and the Traders who Barter the Earth’s Resources, by Javier Blas & Jack Farchy
"Due to supply chain challenges and geopolitical factors, China is experiencing a coal shortage that has resulted in higher energy prices and government-mandated power restrictions against parts of the manufacturing sector. Given the majority of global polysilicon capacity is located in Mainland China, higher coal costs, mandated reductions in energy consumption and reduced operating capacity have further exacerbated the supply and demand imbalance in the polysilicon market, contributing to an ongoing increase in pricing for both polysilicon and solar modules. This, coupled with the challenging freight environment, has caused many Chinese-based manufacturers to prioritize availability of solar module supply to the local market where the major investors in utility-scale solar are the country's state-owned enterprises. This is yet another potent reminder of the risk of having climate goals tethered to supply chains that lead a single nation in the PV technology and demonstrates the irony of America's clean energy transition currently being hindered by reliance on coal to produce crystalline silicon solar models." -Mark Widmar, CEO First Solar (FSLR, mkt cap $12B), November 11, 2021 earnings call
Europe’s Energy Supply Constraints Fuel Rising Inflation
COP26 ended with no binding agreements. Rich countries are still sitting on the $100B/year promised, then delayed, to fund the energy transition in emerging markets. India introduced last-minute language into the COP26 communique that changed plans for coal usage from "phase out" to "phase down"; and China this year alone has announced plans to build 43 new coal-fired power plants.1 As if on cue, U.S. coal prices have surged to their highest point since 2009, while UK power prices hit GBP 2,000/per megawatt-hour—10x the month’s average—on a wind outage on November 15, and still sit 460% above 2020 averages.2 Meanwhile, polysilicon prices are also up 330% this year, a rise that one energy consultancy says may delay more than half of global utility solar developments planned for 2022.3 Put simply, the natural variability of renewable power, supply-side constraints on fossil fuel production, and a global shortage of battery capacity are contributing to rising food and fuel inflation, highlighting the enduring appeal of stable baseload power, which has been starved of investment capital for much for the last decade. For perspective, consider that coal and gas contributed 36.4% of German electricity supply in 2020; last week, they comprised 56.4% as renewable production stalled.4 The outage highlights the uneasy state of European energy supplies: even with German renewable power production up 50% since 2015, capex by German electricity suppliers has fallen at an annual CAGR of 5% over the same period, making Russia a more crucial supplier of European fossil fuels.5 In order to pay for the costlier, less reliable renewable energy, the average German household is now paying 48 euros a month in taxes, up from 12 Euros in 1998, with those taxes now representing 53% of the annual electricity bill—up from 24%.6 No wonder the ruling CDU/CSU, which had led a grand coalition with the SPD since 2013, recorded its worst ever result in September's federal election with just 24% of the vote.
The UK seems to be following a similar path. Electricity demand is down 19% from its 2005 peak, but UK natural gas production is down an ever starker 65% since 2000.7 Meanwhile the Bank of England has aligned its monetary policy with a green agenda, last week introducing new eligibility criteria to tilt its bond purchases "towards the stronger climate performers within their sectors," the BoE said in a statement. There is also the matter of the upcoming UK gas boiler ban, which mandates heat pumps or hydrogen boilers in place of gas boilers for any new construction after 2025. Thus the current market prices for UK power—more than 4x higher than 2020 average—may be a signal of the required return for these non-market-based climate policies.
UK Natural Gas/U.S. Natural Gas Price Ratio
Source: Bloomberg. as of 11/16/2021.
Europe's recent energy experience raises the question of whether Americans might bear a similar burden if domestic production growth does not re-accelerate. According to an October Politico/Morning Consult poll, 89% of Americans are somewhat or very concerned about inflation, and 62% say "Biden administration policies" are "very or somewhat responsible".8 Keep in mind that food and fuel inflation is highly regressive: top quintile American wage-earners spend 19% of total expenditures on food and fuel vs. 28% for the lowest income quintile.9 Inflation is also a lethal weapon to ruling politicians, a lesson repeated in Argentina last weekend when President Alberto Fernandez's ruling left-wing bloc were thrashed in midterm elections amidst 52% inflation.10
Bitcoin Miners Seek Stranded Carbon
What does this all have to do with digital assets? Well in our view, politically driven and thus artificial supply-side constraints in primary energy markets are creating more arbitrage opportunities in global energy markets thanks to Bitcoin, vs. pre-Satoshi. Whereas in the past, jurisdictions or households who disagree with the forced “energy transition” might have struggled to export their stranded carbon because of the high cost, long lead times or environmental hassle associated with transporting energy, now they can co-locate a Bitcoin mining rig close to the energy source and send the money instantly to anywhere in the world with an internet connection. No need for transmission lines! In a world short of battery capacity, Bitcoin’s energy storage capability is actually quite helpful—particularly if the miners promise to turn off their machines when the base load demand is needed, as many contracts are now structured, or if they find energy that would otherwise have gone to waste.
You can see this phenomenon most clearly in Texas, where flared gas alone could power nearly a third of the total Bitcoin network11, and where miners are rapidly signing power purchase contract agreements to exploit the state's frequent negative energy costs. (U.S. market share of Bitcoin hash rate has risen from 4% to 42% in just two years). We expect Bitcoin miners, in the midst of rapid capital formation thanks to 100% annual IRRs at the $60k BTC price12, to deploy profits upstream to acquire stranded carbon in remote locations. Indeed crypto mining company Enegix announced plans this month to build its own hydropower plants in Kazakhstan. Of course the extreme example of this is a government using its own stranded energy directly to mine Bitcoin, as El Salvador has begun to do, and which is also under consideration in Miami, FL.13 Last week's news that the Russian Duma is also considering whether to legalize Bitcoin mining shows Moscow understands the value of stranded carbon as well. Certainly Germany's delay of Russia's Nord 2 gas pipeline on November 16 should also provide further incentive.14
U.S. Electricity: % Negative Pricing Frequency
Source: Berkeley Lab, as of 2020.
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1 CREA Briefing, August 2021
2 Bloomberg, 11/15/2021
3 Rystad Energy, Bloomberg, as of 11/16/2021
4 Fraunhofer ISE
7 Bloomberg, Statista
8 Morning Consult/Politico tracking poll October 16-18, 2021
9 BofA Global Research, BLS
10 Argentina Census Bureau, Bloomberg, October 2021
11 EIA, CBECI, Nic Carter presentation at Texas Blockchain Summit, 10/8/2021
12 Permian Chain, Compass Mining, Hashrateindex.com
13 Coindesk November 9; Miami Mayor Francis Suarez, CNBC interview, 6/17/2021
14 Statement from Russian Duma, 11/11/2021
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Authored byMatthew Sigel
Head of Digital Assets Research - Van Eck Associates Corporation