February 04, 2020
The Economics of Renewables
Professor Brian Sturgess

Renewable energy is not just the means by which humanity will deal with the existential threat of climate change. Instead the switch from the use of finite fossil fuels to renewable and sustainable sources of energy such as wind, solar and other emerging technologies heralds an entirely evolutionary change in the relationship between human economic activity and the planet. Like the on-going widening applications of digital technology and robotics, the switch to renewable energy is being driven by a combination of both government agency and spontaneous market forces.

At the 2020 Davos World Economic Summit politicians, business leaders and financial institutions renewed their joint commitment to the goal of achieving a net zero target for global emissions of planet warming gases by 2050. The next decade will be one of immense change in the energy sphere.

In this emerging world of potentially infinite low cost energy and de-carbonisation, EnviroTech Energy Solutions (EES) will act as a technology and a business partner to help organisations take advantage of the new and exciting economic case for renewables. 

 

Economic Drivers

The economic case for investing in renewable energy now matches the ethical case for combating climate change. Fossil fuels have driven economic growth since the industrial revolution, but the basic economics behind their use differs fundamentally from renewables. Renewables require significant capital spending, but as long as the sun shines or the wind blows the marginal cost of generating energy is effectively zero. Investment in the extraction of coal, oil and gas, on the other hand, will generate eventual rising operating costs and eventual diminishing returns as these are finite unrenewable resources.

In contrast, to take one example of a sustainable energy source, the cost of solar panels has dropped dramatically and continues to fall as the industry enjoys large scale economies and learning effects improve efficiency. In 2009, in the United States the cost of a solar panel installation was $8.50 per watt and by 2019 the price of solar has fallen by more than 65 per cent, to around $2.96/watt. Irrespective of the need to combat global warming the compelling economics of the renewable energy revolution is driving a shift in the energy industry which will transform the global economy.

 

Investment in Renewables is rising

Economic activity has always been dependent on energy, but the sources of energy generation utilised are undergoing a global revolution. The level of investment in renewable energy is rising rapidly as the switch from fossil fuel use accelerates. In the last decade the economic benefits of renewable energy has led to a large uplift in global generating capacity.


According to the International Renewable Energy Agency (IRENA) which monitors global trends across over 160 countries, total installed renewable capacity rose by 93 per cent from 1,222 GW in 2010 to 2,351 GW in 2018. The largest source of renewable energy in 2018 remained hydropower (excluded pumped storage) which accounted for 1,175 GW, nearly half of all renewable capacity although down from three quarters in 2008. In contrast, most of the rise in renewable capacity over this period, 73 per cent was accounted for by an expansion of solar and wind power because of the low operating and falling installation costs due to scale economies. The rise in the solar industry with a share of total renewable installed capacity rising from 3.4 per cent in 2010 to 20.6 per cent of total capacity by 2018 was spectacular. The rapid growth in the main sources of renewable energy measured in MW is shown in the Chart. 

 

Global Renewable Energy Installed Capacity MW

Source: IRENA


Investment in capacity also continued into 2019 with BloombergNEF estimating a total of US$280.2 billion spent despite slowing world economic growth with the largest increase occurring in China, followed by the United States and Europe respectively. Low interest rates, the new policy of central banks to promote investment in assets which mitigate the financial risks of climate change and falling costs will mean these trends will continue and accelerate in the new decade of the twenties given the commitments made by business and financial leaders at Davos and the intensified fear of climate induced damage brought on by forest fires in California and Australia. 

Renewable Energy and Economic Growth

The share of renewables in global power generation is currently around 26 per cent and is expected to rise to 30 per cent by 2024 according to the International Energy Agency and could double by 2030. It is a flawed argument that such a major shift to renewable energy will harm economic growth in the developed world and hold back the rise in living standards markets in developing economies who are still reliant on fossil fuels.

 

Developed Economies: There are three main reasons why the shift to renewables from fossil fuels will not harm Gross Domestic Product (GDP) growth in the developed world.

 

  • First, the rise in installed capacity will push down energy costs in the long term. The cost of generating electricity from distributed solar PV systems is already below retail electricity prices in most countries and the IEA forecasts that these costs will decline by a further 15 to 35 per cent by 2024 creating a virtuous circle of higher rates of return on capital and increased adoption worldwide.

  • Second, private and public spending the investment in new energy infrastructure will have multiplier effects on GDP. Macroeconomists have argued since the 1930s that investment expenditure will generate additional rises in economic output, consumption and employment greater than the initial spending. The IMF estimates that the long-term multiplier in advanced economies for infrastructure investments is around 1.4, but this could be a lot higher for spending on renewable energy projects since imports, leakages which reduce the size of the multiplier, will be minimised.

  • Finally, cheaper green energy will stimulate the creation of new products and incentivise existing markets to use and improve on renewable energy solutions. This will prompting further innovation in the generation and storage of electricity.

The first global quantification of the macroeconomic impacts of renewable energy deployment was undertaken by IRENA in 2016 which found that doubling the share of renewables by 2030 would increase global gross domestic product (GDP) by up to 1.1 percent and improve global welfare by 3.7 percent and create millions of jobs.

 

Renewable energy will not only affect the rate, but also the direction of economic growth. The European Commission launched a Green Deal which emphasises not only the magnitude, but the direction of economic growth. The deal announced by Commission president Ursula von der Leyen at the COP25 Madrid summit at the end of 2019, seeks to legislate a European climate law focus all EU instruments to make the transition to climate neutrality irreversible.

 

Developing Economies: The role played by renewable energy in the future growth and development in emerging markets is essential. Despite the obvious advantages of solar energy in many poorer countries, there is an overreliance on fossil fuels which are expensive, often imported and hold back development in addition to their contribution to CO2 emissions. Currently, approximately 3 billion people across the world lack access to clean-cooking solutions relying on wood, charcoal or animal waste and are exposed to dangerous levels of air pollution. Furthermore, around 870 million people are functioning without electricity and 50 per cent of them are found in Sub-Saharan Africa alone. A greater use of renewable, clean energy will produce enormous benefits for the poorer economies of the world many of which already face the brunt of climate change through drought or flooding impacting on agriculture and social cohesion. The United Nations (UN) has placed the increased adoption of renewable energy at the heart of Sustainable Development Goal (SDG) Number 7: Affordable and Clean Energy. By 2030, the UN has set a number of targets under this SDG including to ensure universal access to affordable, reliable energy sources, to increase substantially the share of renewables in the global energy mix and to double the rate of energy efficiency. 

 

Wealth Risk

The shift to renewable energy will not only impact on global economic growth and the income generated it will have a major shift on the distribution of global wealth including the assets held by pension funds and insurance companies. In what one famous economist described as the ‘gale of creative destruction’ market forces will result in the writing down of assets which extract and use fossil fuels while raising the value of renewable assets.

At the start of 2020, Larry Fink, one of the world’s most influential investors, whose asset management company Blackrock controls around US$7.4 trillion of clients, has stated that its funds will divest holdings in companies deriving more than 25 per cent of revenues from coal production. He has also insisted that companies disclose climate risks.

The impact of such initiatives by private wealth managers and hedge funds on asset values will be reinforced by the emerging role of central banks. In 2015, then governor of the Bank of England, startled the conservative banking community by warning starkly of the risks climate change poses to the value of financial assets and the stability of the financial system. His lead has sparked off a central banking revolution and the creation of a new organization the Network for the Greening of the Financial System (NGFS) announced by eight central banks and supervisors in December 2017 growing to 46 by September 2019. The NGFS believes that central banks should use their monetary powers to set incentives to penalize carbon polluters and support the transition to a carbon neutral economy.

The switch to renewable energy will cause significant disruption across the globe, particularly for those economic sectors involved in the use of fossil fuels in the generation of electricity, the transfer of heat and in transport. EnviroTech Energy Solutions (EES), an owner and operator of renewable energy generation and storage assets, is technology neutral and will assist its clients to find the solutions best suited to their short and long run economic needs.

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