To those in the energy industry, it seems to be stating the obvious to observe that the price of oil has little to do with the renewables market, but global corporate consultant Nexant sees a connection.
Oil is essentially a transportation fuel and only provides about 4% of global electricity generation, while wind and solar primarily compete for market share in electricity markets. But the money that finances energy projects has no problem jumping that market divide, and therein lies the reason that low oil prices could help boost the growth of renewables.
“The observed historic correlation between crude oil and renewables primarily results from the secondary influence of market perception,” Nexant’s recent white paper, "Crude Oil’s Impact on Renewable Energy" reports.
It is important to note, according Nexant Consultant and white paper author Bonaire Le, that “crude oil is subject to a lot more market volatility than renewable energy," and that volatility could influence what energy investors do.
The 2014 drop in Brent Crude and WTI oil prices from above $110 per barrel to below $50 per barrel highlights the unpredictability in crude oil's price, Le said. Though there is presently “a slight uptick” in prices, indications from reliable market-watchers like the Bank of England and the International Monetary Fund see the price settling at some point “around $70 per barrel to $80 per barrel,” although they stress that prices could still fluctuate.
Those price estimates, and their uncertainty, have had investors focused on the oil and gas sector worried for months. At the same time, steady gains in market share for wind and solar generation highlighted how isolated they are from fuel price fluctuations, and Le said that big investors are taking notice.
“When we are working with banks and law firms who are the funding bodies to energy or chemical projects,” he said, “they want to understand – if there is an issue with crude oil, what else is there to finance?”
Investors are the connection
The 2014 drop in the price of crude oil was a straightforward supply-demand issue mixed with geopolitics, Le said. Energy efficiencies and sluggish global economy compromised demand. Burgeoning volumes of U.S. crude over-supplied a market that eventually became over-saturated when the Organization of Petroleum Exporting Countries (OPEC), determined not to lose market share, refused to cut output.
Solar and wind provide some insulation from such fluctuations in fuel prices. While they require high upfront capital investment based, they have “an input cost of ‘zero’” because their fuels are essentially free, the white paper explains. The history of oil price volatility “has demonstrated that investing in crude oil is an increasingly risky strategy," it continues, while renewables could offer a safer, more appealing option.
Banks and other investors “are comfortable with looking at crude oil price scenarios and forecasts and how that impacts their potential return on investment,” Le explained. But with the 2014 oil price crash, they realized new investments in unconventional, hard-to-reach resources would not be as likely to pay off.
At the same time, advances in technology and market forces were driving the price of wind and solar projects down and the projects were providing reliable, if more modest, returns.
Renewables are technology dependent “and at this stage of the experience curve costs will continue to go down with the refinement and improvement of manufacturing methods, installation techniques, and development of know-how,” the paper explains.
Fossil fuels, on the other hand, are “extraction-dependent” and “costs increase as resources become harder to find.”
Distinguishing between “technology-based” and “extraction-based” industries is a crucial point to get across to potential investors, the paper stresses. As investors become more comfortable with the new set of risks and returns associated with renewables ownership, it predicts, “they will be increasingly willing to underwrite debt positions where the cost of capital is lower than experienced with traditional power project financing.”
An indication of this kind of investment decision, Le said, was last year’s announcement of a move from fossil fuels to alternatives by the $860 million Rockefeller Brothers Fund, founded with John D. Rockefeller’s oil fortune.
Though the fund did not specifically identify divestment from oil, it noted “uncertain and volatile markets” as part of the basis for its move. It was an example of investors “making the call to shift their investment to wind or solar or hydro-electric,” Le said.
Between the fast-falling costs of wind and solar and the significant progress toward affordable energy storage, the paper finds, “renewable energy could leverage the opportunity spurred on by the current state of crude oil to depress or possibly reverse further penetration of conventional power sources.”
Fossil fuel subsidies
The International Energy Agency has made a strong case for the detriment fossil fuel subsidies do to the climate change effort. And Pope Francis made a strong moral case against them in his recent encyclical as well. But there is an economic case to be made as well, Le believes.
“The drop in crude oil prices has caused many nations to reconsider the allocation of their current subsidies,” the paper reports. “With crude oil prices cut by more than half, at least 27 countries have elected to decrease or end subsidies that currently regulate fuel costs for electricity generation (including coal and natural gas).”
This offers an opportunity for renewables “to transition from an energy alternative and into an energy staple,” the paper explains, because it “could potentially drive renewable energy technologies to reach a strong competitive position against their fossil fuel-based alternates for power generation.”
The topic of subsidies is complicated and specific to the government providing them, its energy mix, and its intentions, Le explained. One possible speculation is that fossil fuel subsidies could migrate to renewables.
Another possibility is that a country would recommit to its fossil fuels, Le said. The OPEC nations decided to continue the current rate of production because of their determination not to lose market share to the U.S., and other fossil interests aren't likely to allow their position as incumbent transportation energy providers to be compromised.
It is important for countries developing subsidy policies to remember that subsidies distort markets and the 2014 crude price drop was not the first time that led to oil price volatility, Le said. Countries tend to want to look past such episodes when they should be thinking about what the impacts will be on their economies in the long run.
But even if nations don't make a coordinated effort to reduce their fossil subsidies, Le thinks that the private sector may shift resources to renewables anyway. It just may take some time to get financiers comfortable with the capital requirements of renewable energy investment.
“The point I am making is that with renewable energy you have a high upfront capital cost which many banks are not comfortable with, but you have a relatively zero raw material cost moving forward and much lower risk,” Le said. “With a petro-chemical based project tied to crude oil and exposed to crude oil price fluctuations, the revenue from operating the plant or trying to get the investment back in the future is much more subjected to uncertainty.”