Why the renewable energy market doesn't work

One thing to start with: Don't miss the Ethical Money Forum's latest in-depth report, in which Sarah Murray examines what a responsible approach to AI in business and finance looks like, and how executives are trying to take AI risks seriously.

In today's newsletter, I spoke to the author of a new book that made waves by asking whether liberalized energy markets — and capitalist economies — can build solar and wind power at the speed needed to avoid catastrophic climate change. Is he on to something? Let us know your thoughts at moralmoneyreply@ft.com.

Renewable energy

Are wind and solar energy a bad business?

In a provocative new book, British academic Brett Christophers argues that free enterprise is unable to deliver renewable energy at the rapid pace required to tackle climate change.

The price is wrong: why capitalism won't save the planet? The book finds that although wind and solar power can now produce cheap electricity, their low cost is not always an asset. In fact, Christophers argues that the rates at which renewables can now be supplied to the grid may actually reduce profits and discourage private investment.

Christophers, a professor at Sweden's Uppsala University, is the rare academic who can weave references to the Italian radical Antonio Gramsci into a careful analysis of feed-in tariffs or offshore wind contracts. His in-depth study finds that wind and solar profits, across a wide range of markets, are structurally poor.

“If the energy transition requires anything, it requires a coordinated response,” Christophers told me. “I don't think the market comes close to providing that.”

If renewables aren't a very attractive business, then what? Coverage of the book suggested that state ownership could overcome obstacles facing wind and solar power. However, as Christophers told me in an interview, the question of how governments might be able to stimulate investment is far from resolved.

He argues that much of what's wrong with renewables goes back to four decades of electricity market liberalization, privatization, and especially “unbundling” — the separation of power generation, transmission and distribution.

The restructuring of the energy market was a global story. Some rich countries responded enthusiastically to it, then it was imposed on poor countries in the 1990s because of the World Bank's commitment to “vigorously pursue the commercialization and corporatization of energy sectors in developing countries, and the participation of the private sector in them.” Even China, which has no intention of privatizing or commercializing its energy sector, is “pretty disjointed,” says Christophers.

Since the 1980s, governments have been largely successful in promoting competition in power generation, through measures such as requiring grid operators to allow independent power producers to deliver electricity. However, low barriers to entry for generators have reduced profits and stifled investment.

What's more, Christophers says, the sale of renewables on wholesale markets is particularly vulnerable to price collapses due to their intermittency. When the wind blows and the sun shines, the grid is flooded with electrons. Government subsidies aimed at stimulating investment in renewable energy sources may intensify this price “unbundling.”

The problem for Christopher is not only that profits are low, but they are also uncertain. Revenues from selling in wholesale energy markets are volatile. “Developers are often willing to take these risks, but banks are very reluctant,” he said. Political risks, such as the threat of subsidies disappearing, have another chilling effect.

Don't just depend, achieve stability

The oil and gas sector runs through the book as a dramatic counterpoint. As a more mature industry, it is better able to self-finance new investments from operating cash flow.

Last year, major oil companies rewarded shareholders with record dividends. Their disdain for wind and solar, at a time when companies like BP and Shell have promised a strategic pivot and have the cash reserves to make it happen, may be the best evidence of the weak underlying returns of renewables, Christophers writes.

The structure of the fossil fuel market contains another lesson. “Perhaps the biggest factor shaping the relatively low profitability in renewables is that, unlike oil and gas, there is an absence in the market of monopoly or oligopoly,” Lee said. “The OPEC cartel plays a very important role in providing investment confidence [for fossil energy]”.

However, the US shale revolution in the 2000s disrupted OPEC's stabilizing role by bringing a huge new source of oil supply to the market. In fact, the shale story seems to contradict Christopher's narrative about the importance of predictable profits. Investors have long viewed shale oil as a “cash furnace,” as our former colleague Jimmy Powell wrote.

Profits for natural gas extracted from hydraulic fracturing have been uncertain and low for long periods, yet investors have repeatedly backed shale projects even when they have been flared. Perhaps one of the reasons behind this is the commitment of US policymakers to achieving energy security.

So, what does Christophers think of US President Joe Biden's new energy investments, including the inflation reduction law? Could this fuel animal spirits?

“The IRA is very important, but these tax breaks support; they don't stabilize,” he said. Renewable energy developers have had to look to tools to boost investor confidence and generate more predictable returns, such as financial hedging instruments and corporate power purchase agreements (PPA). ).

Christophers points to two long-delayed onshore wind projects in Norway that struggled for years to borrow to finance construction, until they obtained power purchase agreements from major companies that purchase energy such as Norsk Hydro and Google. But he argues that corporate underwriters are hardly solving the larger problem of stabilizing earnings expectations. There are simply too few of them.

Big green country

Christophers hopes to see the public sector take a more active role in building or financing renewable energy sources, because in theory, the state can afford lower profits. But he acknowledges that state-owned companies and public utilities in the US and Europe have not yet been leaders in decarbonisation.

I think they have fully captured the types of incentives that we see in the private sector. I expect that if Labor comes to power and launches Great British Energy, it will work in exactly the same way, a reference to Labour's plan to create a new publicly owned clean energy company.

However, Christophers wants to see more public ownership in rich countries. But he says it will take a huge political effort to get the public sector to bear lower returns in order to build faster.

Christophers believes the outlook in the developing world is even bleaker. Private capital flows for green projects have been weak, but Christophers is skeptical of proposals for developing countries to turn their attention instead towards building a “green development state”.

“It is a kind of Western arrogance to say that the public sector should do this,” he said. “With half of GDP going towards paying off existing debt, this is not possible at all.”

Moreover, Christophers believes that even if macroeconomic risks in emerging markets are no longer seen as an issue and private sector financing starts flowing tomorrow, investors will still face the same profit hurdles he identified in richer economies.

Governments in the Global South have been persuaded that all this can be done cheaply. They have been convinced that you can have renewable energy sources without subsidies. “When developers turn around and say, 'Actually, we can't do this without support' — they understandably say, 'What do you mean?'

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