AI’s Energy Hunger, Middle East Volatility, and China’s Green Tech Dominance

Microsoft Goes Nuclear | Oil Prices, OPEC & Israel | Europe Tariffs on China

A New Hope - for Nuclear Energy?

AI’s Energy Appetite: A New Challenge Amid Growing Electrification

The AI boom is turning power-hungry data centers into one of the fastest-growing consumers of electricity. According to the Electric Power Research Institute, by 2030, data centers could account for as much as 9% of U.S. electricity use, up from 4% in 2023 (source).

The IEA projects that by 2026, global electricity consumption by data centers could more than double, reaching levels comparable to the total electricity use of Japan, the world’s third or fourth-largest economy by GDP (source).

This surge in demand poses a serious challenge to an already strained grid, which is struggling to support the widespread electrification of nearly all forms of energy use—from electric vehicles to home heating. Since 2000, U.S. electricity demand has remained mostly flat, thanks to efficiency improvements and the offshoring of manufacturing to China. However, the U.S. Department of Energy now expects electricity demand to at least double by 2050 in order to achieve net-zero emissions.

Why Data Centers Can’t Rely on Solar and Wind Alone

Big Tech companies with ambitious goals of eliminating carbon emissions by 2030 are instead witnessing a rise in their emissions. Microsoft and Google, for instance, have seen their carbon footprints grow by 30-40% over the past four or five years, largely due to the increasing use of AI products (source).

Data centers require firm power—uninterrupted, always-available power. To achieve this through renewables like solar and wind would require a geographically diverse network of generation sites, interconnected by a resilient grid to balance supply. Alongside this, robust backup systems—whether batteries or natural gas plants—would be essential to ensure uninterrupted power.

Utility companies and analysts alike, including Goldman Sachs, believe natural gas will play a major role in supporting renewables for delivering firm power. Goldman Sachs predicts data centers will rely on natural gas for about 60% of their rising power demand, with renewables covering the remaining 40% (source). The continued rise in emissions suggests Big Tech is struggling to secure reliable, carbon-free electricity for its data centers.

The bottleneck is not the renewable energy sources themselves or even battery storage but the grid, which is already overwhelmed by the rapid electrification of transportation and heating (source).

Nuclear power offers a potential solution. By situating data centers adjacent to nuclear plants, these facilities could sidestep dependence on the strained grid while securing a steady supply of carbon-free electricity.

The Microsoft-Constellation Deal: A Major Shift for Nuclear Energy

Last month, Microsoft signed a 20-year power purchase agreement with Constellation Energy to restart Unit 1 of the Three Mile Island nuclear plant in Pennsylvania, which was shut down in 2019. The plant is expected to be operational by 2028, with all of its 800 MW of power dedicated to supplying Microsoft's data centers (source).

Why Big Tech is Backing Nuclear’s Comeback

Nuclear energy has faced criticism for decades, despite being a carbon-free source of power. Its growth has been severely hindered since the 1990s, and even now, despite being the largest single source of carbon-free energy in the US, environmental groups argue that it cannot scale quickly enough to combat climate change. However, data centers are emerging as a critical use case where nuclear appears to be a superior option compared to alternatives.

The benefits of nuclear's firm, clean power—without the need for extensive grid upgrades—are increasingly seen as an advantage. Big Tech companies are becoming vocal supporters of nuclear energy, and major financial institutions like Goldman Sachs and Morgan Stanley have also pledged their backing (source).

An important note here - as tech companies struggle to secure enough energy to power their data centers, they are likely to pay a premium for reliable, 24/7 power. This creates a strong financial incentive for utilities experienced with nuclear, such as Constellation Energy and Duke Energy, to restart shuttered plants and push for new construction. For them, this shift could be a highly profitable decision.

Not Just Microsoft: Amazon and Google Eye Nuclear for Data Centers

Microsoft’s deal is not the first of its kind. Earlier this year, Amazon (AWS) acquired a data center campus near a nuclear power station in Pennsylvania and signed a 10-year power purchase agreement with the plant (source). By being next to the station, the data center bypasses reliance on the grid and benefits from a constant supply of clean electricity.

Google, not wanting to be left behind, has also started exploring nuclear energy options for its data centers (source).

Nuclear Startups and Big Tech: Opportunities for VCs and Institutional Investors

Investment in nuclear power has historically faced significant challenges. Large plants require massive upfront capital and often suffer from unpredictable construction timelines. A key question remains: who bears the financial risk—investors or the public? If it’s the public, then public sentiment becomes critical, and recent polls show growing support for nuclear energy (source). Smaller, modular reactors—factory-built and faster to deploy—could provide greater certainty in both construction and investment.

However, Big Tech companies with AI-driven ambitions want excess power immediately, or as soon as possible. While a wave of startups is working to bring advanced reactors to market, they are still years away from full realization. In the nuclear sector, nothing moves quickly. As a result, these startups may not be an attractive investment for tech companies. The risks—construction delays and reputational fallout if something goes wrong—are too high. The recent Microsoft deal suggests that instead, tech companies are willing to offer guarantees, pay premium prices, and provide long-term demand projections, giving investors more confidence.

For Big Tech, the cost of energy is less of a barrier than its availability. With the grid becoming a bottleneck to their growing AI ambitions, on-site energy sources and co-locating data centers with nuclear projects are increasingly appealing. New reactor designs, like Radiant Energy’s small modular reactor, which are quick to install and maintain, offer a feasible option. An assembly of such reactors could even allow data centers to operate completely off the grid.

For VCs, this could present a lucrative opportunity. With deep-pocketed buyers eager to secure reliable power and a political climate favorable to nuclear, reactors designed specifically for use cases like data centers could become the next big investment. As data center demand continues to grow, these reactors might become modular components—much like NVIDIA chips—that are essential to the infrastructure of tomorrow’s data centers.

A word of caution—history has shown that public sentiment around nuclear energy can shift rapidly and turn hostile. Will this time prove to be different?

OPEC concerns + Middle-east tension. Impact on Energy Transition?

OPEC's Frustration with Falling Oil Prices and Production Cuts

Saudi Arabia, the leading force in OPEC, has been increasingly frustrated with the decline in oil prices since early summer. The market's sentiment toward oil became so weak that, for the first time in September, the number of short positions in Brent futures outstripped long positions over a two-week period (source).

This price slump threatens the kingdom's ambitious Vision 2030 project, which seeks to modernize and diversify its economy, especially as it prepares to host Expo 2030 and the World Cup in 2034. Saudi Arabia has been spending vast sums, relying on high oil prices to support these initiatives. According to the IMF's April 2024 forecast, the kingdom needs oil prices above $96.2 per barrel to balance its budget (source). Internally, the kingdom targets a price of $100 (source), and OPEC's production cuts were designed to support this. However, increased production from the U.S. and slowing demand from China have undercut these efforts, reducing OPEC's market share from 51% in 2022 to 48% in 2024 (source).

With OPEC set to abandon its production cuts and increase output by December, bearish sentiment in the oil market has only deepened.

Tensions in the Middle East: Israel, Iran, and Rising Oil Prices

This was the oil landscape before news emerged that Israel might retaliate against Iran's energy infrastructure following last week’s missile attack. Over the past month, Brent crude prices have risen from a low of $70 to $81 earlier this week. The central fear now is the risk of uncontrollable escalation in the Middle East, with the potential for conflict to spiral out of control. The most alarming scenario would involve disruptions at the vital Strait of Hormuz, a chokepoint for global oil shipments. Speculation is rife, with some forecasting that prices could surge beyond $100 or higher.

OPEC's production cuts over the past two years mean there is considerable spare capacity—up to 5 million barrels per day (source). Additionally, the U.S. Strategic Petroleum Reserve (SPR), which helped stabilize markets after Russia’s invasion of Ukraine in 2022, could be tapped again. However, the SPR is not at full capacity yet. U.S. shale tycoon Harold Hamm argued that SPR’s aggressive use as a buffer against oil price declines in recent years has left the nation exposed and vulnerable. Currently, the SPR sits at its lowest level since the 1980s, though the U.S. has been attempting to refill it since June 2023.

Even at 50% capacity, the SPR holds approximately 383 million barrels, with an additional 413 million barrels stored in commercial crude inventories. To put this in context, the U.S. consumes about 20 million barrels of petroleum daily (source). Despite the recent rise in prices, many analysts expect this rally to be short-lived, given the slowing Chinese economy and the persistent bearish sentiment in the market.

Inflation on the Horizon? How Oil Prices Could Shake Things Up

The impact on inflation remains uncertain. A brief spike in oil prices to $100, followed by a quick return to current levels, is unlikely to have a significant effect. However, a deepening geopolitical crisis in the Middle East could introduce sustained upward pressure on oil prices, which has been largely absent. The extent of this pressure—how high prices rise and how long they stay elevated—will play a critical role in shaping the inflation outlook.

The bigger concern is how this could complicate the Federal Reserve's plans to lower interest rates. With a half-point rate cut already behind us and a quarter-point cut widely expected in November, this new development could either have minimal impact or force the Fed to reconsider its approach entirely.

High Borrowing Costs: Slowing Down the Energy Transition?

Borrowing costs have risen significantly over the past two and a half years, reaching their highest levels in over two decades. This poses a greater challenge for renewables, which require higher upfront investment compared to oil and gas projects. As a result, elevated borrowing costs undermine their competitiveness in the power market. According to Wood Mackenzie, a 2% rise in the risk-free interest rate increases the levelized cost of electricity for a renewable project by 20%, whereas for natural gas combined-cycle plants, the increase is only 11%. Prolonged higher rates will likely slow the pace of the energy transition and raise costs for investors. With most of the $75 trillion required to reach net-zero by 2050 expected to be debt-financed, the financial burden is substantial, and high interest rates will have a material impact (source).

Europe terrifs + US bans. What now for China?

The issue - China's Control Over Green Technology

The West is growing increasingly aggressive toward China on trade, particularly in the realm of clean energy. Over the past two decades, China has built an impressive lead in green technology—not only in manufacturing but also in research and development. This dominance extends deep into the supply chain, particularly in its control over critical metals.

China’s hold on refining these metals is staggering. The nation refines 90% of the world’s rare earth metals, 35% of its nickel, and between 50-70% of global lithium and cobalt. Without diversifying supply chains, any disruption in the flow of these materials could undermine America’s transition from fossil fuels, threatening national security and stalling progress on renewable energy initiatives (source).

China also dominates in technology manufacturing, producing over 80% of the world’s solar manufacturing equipment.

China’s EV Expansion: Taking Over Europe and the US

As electric vehicles (EVs) gain traction, Chinese automakers are expanding their reach in Europe and the United States. In Europe, Chinese brands now account for 8% of the EV market, while Chinese-made vehicles—under both Chinese and Western brands—make up over 20% (source).

Moreover, Chinese manufacturers often sell their cars in Europe at a significant markup compared to domestic prices. BYD, the world’s largest EV manufacturer, charges double, even triple, in Europe for the same models sold in China (source). With extensive government subsidies and vertically integrated operations, Chinese EV companies enjoy cost advantages that Western competitors cannot match. This enables them to compete fiercely on price, gain market share, and rake in substantial profits with hefty margins.

Europe Strikes Back: Tariffs on Chinese EVs

EU member states have agreed to impose tariffs of up to 45% on imports of Chinese EVs, following a year-long investigation into unfair subsidies provided by the Chinese government. Other nations have adopted similar measures. Both Brazil and Turkey imposed levies this year to incentivize EV manufacturing within their borders (source).

The US Pushes Back: Security Concerns and Bans

EU tariffs on Chinese EVs may seem steep, but they are far lower than the 100% import duties imposed by the US and Canada. In the US, the issue extends beyond trade fairness—it's deeply tied to national security. These internet-connected cars are, in many ways, akin to smartphones, raising fears of espionage and potential sabotage. Concerns range from Beijing eavesdropping on conversations inside vehicles to the chilling prospect of disabling entire fleets of EVs remotely.

In response to these risks, the US recently proposed a ban on Chinese software and hardware in internet-connected EVs—essentially, all EVs—sold within the country. The proposal, introduced just two weeks ago, underscores the gravity of the security concerns surrounding Chinese technology in the American market.

China’s Game Plan: Adapt or Fight Back?

Europe, the third-largest automobile market, is transitioning to EVs at a much faster pace than the US. For Chinese companies, this presents a significant growth opportunity in a market less hostile than the US. While retaliatory threats from the Chinese government have already surfaced, and more may follow, Chinese companies recognize that shifting production to local markets in the EU is not a catastrophe. Even Beijing likely understands that expanding Chinese brands within these markets benefits its broader goals, more than merely exporting goods manufactured at home.

Chinese EV makers have already begun investing in European manufacturing. BYD is constructing a plant in Hungary, while another Chinese automaker, Chery, has teamed up with Spain’s Ebro EV Motors to produce vehicles locally (source). Additionally, Stellantis has partnered with China’s Leapmotor and begun EV production in Poland (source).

While it is unlikely that the US will embrace closer economic ties with China, Europe may be more open to Chinese manufacturers, especially as they localize production and create jobs within the EU.