As the United States is on the verge of joining the Paris Agreement under the new Biden administration and the proliferation of net zero commitments from various governments, the romance between the stock markets and renewables grows stronger. .
But in all the enthusiasm for the future of renewables, a bigger truth is overlooked: the underlying reason for the amazing transformation of renewables over the past decade, from a niche to dominant competition in the face. to fossil fuels, is economical rather than environmental.
Wind and solar are inherently deflationary, while fossil fuels are inherently inflationary. This has huge implications for the distribution of value in the global energy system over the next three decades.
Just consider the difference between saving renewable energy and saving oil.
80%
is the amount that the average cost of large-scale installations decreased in 2010-19
With wind and solar, there is no need to explore reserves or drill a well to exploit them – you just need to build the infrastructure in the right place to harness the energy that is already there and that. is available for free once it has been built.
These are therefore economies of scale, and as these apply and are then supplemented by technological improvements, the costs of capital investment decrease considerably over time, while the marginal cost of production at short term is zero.
For solar power, in particular, the decline in costs has been dramatic, with IRENA estimating that between 2010 and 19, the average cost of large-scale installations fell by 80%. Onshore and more recently offshore wind turbines have also seen dramatic cost reductions over the past decade.
In addition, as new renewable energy projects are generally accompanied by off-take contracts giving long-term visibility on prices, financing can be mainly provided by debt. With interest rates at historically low levels, this has the dual advantage of giving new projects a very competitive overall cost of capital while allowing the small equity-financed party to achieve high single-digit or high returns. even low double digits.
In contrast, with oil, the cheapest reserves are tapped first, and as they run out, more expensive sources of supply are tapped, more difficult to access, and therefore more costly to find and locate. develop.
Technological improvements may alleviate the additional cost of exploring and developing more expensive resources to some extent – as evidenced, for example, by the experience of the U.S. shale industry over the past decade – but the essential point is that the geology of oil production is inherently inflationary. .
And because the upstream oil industry has always been a risky business, it has always been funded primarily by equity.
Equity investors are willing to accept a higher level of risk than lenders, but they expect higher returns in exchange. And with growing concern about the structural pressures on demand posed by the political imperatives of decarbonization, air pollution reduction, and transportation electrification, the required rate of return for investors in petroleum stocks is failing. will only increase over time.
Add to that the impact of COVID-19 on oil demand this year and it’s not hard to see why the market is collapsing in the face of renewables while degrading with fossil fuels: According to the IEA, only wind and solar will see demand increase this year, with all other energy sources declining year on year.
As such, 2020 is a huge moment in the history of global energy markets, as it will be the first year in which wind and solar account for 100% of the increase in global demand for energy. ‘energy. To put that number into context, data from BP shows that in 2019, wind and solar only accounted for 34% of the increase in global energy demand.
Of course, demand for fossil fuels is likely to rebound strongly in 2021 as vaccines are rolled out and economic activity begins to normalize. But a psychological Rubicon has nonetheless been crossed, with 2020 offering a taste of what’s to come in energy markets over the next decade.
As the market share of renewables increases sharply, more of the global energy system will come under deflationary pressure. Indeed, perhaps the price of a significant chunk of oil may have to shift to long-term contracts, with the returns that have characterized the global oil industry for 75 years being wiped out for everyone except the producers at the cost. the lowest. like Saudi Arabia and other countries in the Middle East.
Mark Lewis is Chief Sustainable Development Strategist at BNP Paribas Asset Management
The commodity note is a vsFinancial Times Industry Commentary