Why the renewables market does not work

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For today’s newsletter, I spoke to the author of a new book that’s making waves by asking whether liberalised power markets — and capitalist economies — can build solar and wind at the speed needed to avoid catastrophic climate change. Is he on to something? Let us know your thoughts at [email protected].

RENEWABLE ENERGY

Are wind and solar simply bad business?

In a provocative new book, British academic Brett Christophers argues that free enterprise cannot deliver renewables at the rapid pace required to tackle climate change.

The Price is Wrong: Why Capitalism Won’t Save the Planet finds that while wind and solar can now produce cheap electricity, their low cost is not always an asset. In fact, Christophers argues, the rates at which renewables can now be supplied to the grid may actually depress profits and dampen private investment.

Christophers, a professor at Sweden’s Uppsala University, is the rare academic who can weave references to Italian radical Antonio Gramsci into fine-grained analysis of feed-in tariffs or offshore wind contracts. His deeply researched study concludes that wind and solar profits, across a wide variety of markets, are structurally lousy.

“If the energy transition calls for anything, it calls for a co-ordinated response,” Christophers told me. “I don’t think the market comes close to providing that.”

If renewables just aren’t a very attractive business, what then? Coverage of the book has suggested that state ownership could overcome the hurdles facing wind and solar. Yet, Christophers told me in an interview, the question of how governments could stimulate investment is far from solved.

Much of what afflicts renewables, he argues, dates back four decades to electricity market liberalisation, privatisation and, especially, “unbundling” — that is, the separation of generation, transmission and distribution of energy.

Power market restructuring was a global story. Tackled zealously by some rich countries, it was thrust on to poorer ones in the 1990s by the World Bank’s commitment to “aggressively pursue the commercialisation and corporatisation of, and private sector participation in, developing-country power sectors.” Christophers finds that even China, which did not set out to privatise or marketise its energy sector, “substantially unbundled”.

Since the 1980s, governments have been largely successful at fostering competition in energy generation, with measures such as requiring grid operators to let independent power producers plug in. Yet lower barriers to entry for generators have ground down profits and stifled investment.

What’s more, Christophers argues, renewables selling into wholesale markets are especially prone to price crashes due to their intermittency. When the wind blows and the sun shines, the grid is awash in electrons. Government subsidies intended to stimulate renewables investment may intensify this price “cannibalisation”.

The problem for Christophers is not only that profits are low but they are also uncertain. Revenue from selling into wholesale power markets is volatile. “Developers are often willing to take on that risk, but banks are very reluctant,” he said. Political risks, like the threat that subsidies will vanish, have a further chilling effect.

Don’t just subsidise, stabilise

The oil and gas sector runs through the book as a dramatic counterpoint. As a far more mature industry, it is more able to self-fund new investment out of operating cash flow.

Last year, oil majors rewarded shareholders with record profits. Christophers writes that their snub of wind and solar, at a time when companies such as BP and Shell had promised a strategic pivot and had the cash reserves to pull it off, may be the best evidence of renewables’ poor underlying returns.

The market structure of fossil fuels contains another lesson. “Probably the biggest factor in shaping relatively low profitability in renewables is that, unlike in oil and gas, there’s a market absence of monopoly or oligopoly power,” he told me. “The Opec cartel plays a very important role in providing investment confidence [for fossil energy].”

The US shale revolution of the 2010s, however, disrupted Opec’s stabilising role by bringing a huge new source of oil supply on to the market. Indeed, the story of shale would seem to cut against Christophers’ story about the importance of predictable profits. Shale was “long considered a cash furnace” by investors, as our former colleague Jamie Powell wrote.

Profits in fracked natural gas were uncertain and, for long intervals, low, yet investors repeatedly backed shale projects even when they had been burned. One reason may have been US policymakers’ commitment to achieving energy security.

What does Christophers make, then, of US President Joe Biden’s new energy investments, including the Inflation Reduction Act? Could this kindle animal spirits?

“The IRA is very important, but those tax credits subsidise; they don’t stabilise,” he said. Renewable developers have had to seek out tools to boost investor confidence and lock in 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 secured PPAs from major corporate energy buyers Norsk Hydro and Google. But corporate offtakers hardly solve the bigger problem of stabilising profit expectations, he argues. There are simply too few of them.

Big green state

Christophers hopes to see the public sector take a more active role in building or financing renewables since, in theory, the state could tolerate lower profits. But to date, he acknowledges, state-owned companies and public utilities in the US and Europe have not been leaders on decarbonisation.

“I think they have completely internalised the types of incentives we see in the private sector. My expectation is that if Labour gets into power and launches Great British Energy, it will operate in exactly the same way,” he said, referring to a Labour party plan for a new publicly owned clean energy company.

Still, Christophers wants to see more public ownership in rich countries. But he says it would take an enormous political effort to make the public sector bear lower returns for faster build.

In the developing world, Christophers thinks, the outlook is even grimmer. Flows of private capital for green projects have been weak, but Christophers is sceptical of proposals that developing countries turn their attention instead towards building a “green developmental state”.

“It’s kind of a western conceit to say the public sector should do it,” he said. “Where half of GDP is going to existing debt repayments, that’s not remotely possible.”

What’s more, even if macroeconomic risk in emerging markets were no longer seen as a problem and private-sector finance started flowing tomorrow, Christophers thinks, investors would still hit the same profit hurdles he has identified in richer economies.

“Governments in the Global South have been persuaded that all of this can be done cheaply. They’ve been persuaded you can have zero-subsidy renewables,” he said. “When developers turn around and say, actually we can’t do this without subsidy — understandably, they’re like, ‘What do you mean?’”

Smart read

The global market for medicines looks dangerously dysfunctional, according to this FT Big Read.