Long live altruism
Cost curves often explain how technology which has previously been only featured in our most detached Sci-Fi fantasies makes it into the real life. Once the cost side of the scale starts tipping down, simultaneously catapulting up efficiency, innovation can finally become disruptive. In fact, Moore’s law – in some variation – seems to be as applicable to microchips as to the sequencing of genomes; one is slowly reaching the end of the curve, while the other is just getting started. Renewables? Depends, but at this stage we are likely somewhere in-between.
In the early days, renewable energy sources had to cut corners to get ahead, with governments often playing a willing accomplice. Direct financial transfers, grid priority, favourable tax treatment, price control. However, over the last decade, in many cases renewables have already reached cost parity and are even incrementally more cost competitive than their old foes: coal, oil, and natural gas.
According to data from the International Renewable Energy Agency (IRENA), bioenergy, geothermal, hydro and wind are, on average, as or more cost effective than the lowest-cost fossil fuel alternative – without financial assistance. Even solar photovoltaic (PV) farms managed to break into the cost band of fossil fuel-fired electricity production1; and while concentrated solar power (CSP) and offshore wind farms are still trading towards the upper end of the range, their economics have improved meaningfully in the 2010s. In 2018 alone, average costs for CSP dropped by 26%, followed by bioenergy (-14%), and solar PV as well as onshore wind (-13%). The expectation is for costs to come down even more significantly across most categories over the coming years, especially in the areas of wind and solar. This view is underpinned by leaps in existing technology including the employment of more efficient turbines and solar modules.
Now, let’s address the oil tanker in the paddling pool. Crude oil prices took a deep dive earlier this year making the stock market sell-off look like a non-event. Prices tumbled from $70 to below $20 with WTI even going negative at one point – if not in 2020, when else? We already touched upon the detraction of oil demand due to the economic repercussions of the pandemic in our previous publication ‘Taking a Breath’. Against this backdrop, oil prices might be challenged for the next 6-12 months, expected to trade in the range of $40 to $50 per barrel.2 This poses the question of how the above cost range for fossil fuel alternatives might look like today. The short answer: probably not that different. Oil makes up only ~3-4% of the global electricity sector, unlikely to drive a meaningful correction in overall price levels. Additionally, when committing to transition towards renewable energy sources, governments and corporations are taking a long-term strategic view and are unlikely to change course due to short-term price volatility.
The above cost analysis certainly has additional limitations, however, it appears evident that, in many cases, going green is no longer a philanthropic endeavor, but simply the smart thing to do economically.
The economic and social benefits of the reduction in air pollution or harm to the natural environment are impossible to quantify with a great degree of accuracy. But we know they exist and are likely to be meaningful. One estimate puts the global health costs from air pollution due to fossil fuel use alone at ~$2.3tn, further strengthening the case for shifting assets to cleaner alternatives.3 Knowing all this, how are policymakers reacting?
In December 2019, the European Commission put forward the European Green Deal, making a sweeping commitment to effectively turn the Union carbon neutral by 2050. To get there, the body announced it will bump up its greenhouse gas emission reduction targets for 2030 to 50-55% compared to 1990 levels. Lawmakers estimated the required annual additional investment to be around €260bn to arrive at the 2030 milestone alone. This represents 1.5% of 2018 GDP and pencils in public as well as private money.
The challenge is now two-fold. As we have said previously, due to COVID-19 the opportunity became more tangible than ever, but the challenge got equally more complex. European Commission President Ursula von der Leyen and her staff now need to steer the country bloc through an economic crisis, while preventing the next. However, we also gave governments our vote of confidence that, once committed, state heads are unlikely to completely topple their policy agenda. In fact, in March, the Commission took the next step, kicking-off the process of integrating the Deal into EU law. Additionally, at the end of May this year, the Commission unveiled its plan for the recovery ahead, making the European Green Deal the cornerstone of its proposal.
It is reasonable to argue that adoption rates in certain areas targeted by the European Green Deal might be delayed given the new operating environment; however, there are certain must-have investments which are likely to be insulated from the new normal and will remain a fixed part of the recovery. Goldman Sachs Global Investment Research (GIR) categorizes these must-have investments into three main buckets: renewables, power grids and storage (see chart below4). According to GIR, excluding all other areas of the policy agenda, investments in these areas would translate to a total of €2.6tn by 2050, or approx. €80bn per annum. Most of this spending will be carried out by utility companies, but other parts of the climate value chain, in our view, might also enjoy elevated earnings growth, as the entire ecosystem needs to be re-calibrated to achieve net zero.
Evidently, the EU and its member states are leading the charge as far as climate-conscious recovery planning goes. The hope now is for other regions to follow suit, facilitating an accelerated economic recovery by pushing us towards a greener tomorrow.
