Can We Afford Renewable Energy?

Over a decade ago we got involved in the development of the biofuels industry in Europe, when it began to take off in earnest there.

 

At that time estimated profits from biodiesel production created considerable enthusiasm, which at one point turned euphoric with new production facilities being announced almost on a weekly basis.

What was not to like? Europeans would get to drive their cars using green, very low-carbon, seemingly affordable fuels, saving the environment in the process. And investors would make a ton of money.

However, reality turned out to be rather more complicated than that, much to the chagrin of those investors. Production margins were quite volatile and very difficult to hedge into the future. All that new demand ended up spiking the prices of vegetable oils – the key biodiesel production input – way above those of fossil fuels. Entire domestic production complexes went bust as a result, prompting governments across Europe to eventually implement a range of support measures to make biofuels part of the fuel mix.

Biodiesel became the biofuel of choice in Europe for many reasons. It can be used as a blend component for diesel or replace it completely (typically referred to as B100, or biodiesel 100%). Both options were available in many pumps across Germany, the industry’s pioneer and largest European market by far at that time. Despite being staunch environmental supporters and relatively wealthy, when the price of a liter of B100 was higher just by one cent German consumers immediately switched to its fossil fuel counterpart.

In other words, when push came to shove the willingness to pay for a “green” premium was not there – even in one of the most environmentally conscious countries in the world. This stunned us at the time.

Making green energy affordable is a real challenge since it faces a number of constraints that drive up its cost especially in relation to fossil fuels, which remain society’s lowest common energy denominator (current biofuel production itself depends at various points on fossil fuel availability). This cost disadvantage is particularly evident in a related – and far less elastic – energy sector: renewable power.

This relates to the production of electricity as opposed to transport, although progress in electric vehicle technology is gradually merging the two (very gradually in fact). Since the turn of this century much of the expansion of this sector across Europe has centered on wind and solar (photovoltaic) energy. This was part of the Old Continent’s efforts to become less dependent on foreign sources and meet its carbon reduction goals.

2016 Installed Wind + Solar Capacity (W/head)

The graph above shows installed wind and solar capacity across the European Union on a per capita basis at the end of 2016.

Generally speaking, wealthier member states tend to have more installed capacity in these types of renewable power (more on that below). On a per capita basis Denmark is the indisputable wind champion of Europe and Germany has much higher solar than anyone else, including its Southern European counterparts that benefit from much more favorable Sun exposure.

The graph above shows the substantial growth in renewable power in Germany in recent years. Impressive indeed. What is perhaps less obvious is the impact of all that investment in new energy sources on electricity prices.

And that is what the graph above investigates, correlating installed wind and solar capacity per capita with household electricity prices.

The results are pretty striking. Despite the many factors that can influence electricity prices installed wind and solar capacity appear to be particularly significant as evidenced by the high fit of the regression (almost 78%, 100% being a perfect fit).

Germany and Denmark stand out again, this time in terms of high electricity prices. Given that both have significant domestic industrial sectors, particularly Germany, how can they charge such high prices for electricity?

The keyword in the graph is *household* electricity prices. Industrial and other large users do not pay anywhere near in those and other countries across Europe, as shown in the following graph.

1H 2016 Household and Industry/Other Prices (€/kWh)

The difference in prices charged to both groups is significant. In particular, households in Denmark, Germany, Belgium, Sweden and Portugal pay considerably more than their industrial / other counterparts.

How so?

Industries need to be competitive to stay in business and electricity is generally a major cost component. As such governments try to mitigate the impact of their energy policies on them, otherwise they close shop and the jobs go elsewhere. Since households cannot leave as easily they are the ones that end up footing a disproportionate amount of the national electricity bill, especially in Germany where industry accounts for the largest share of consumption. Unlike B100 consumers cannot switch out so easily.

But since carbon mitigation is high on policy agendas, how can this greening of the energy power mix be replicated elsewhere? Is Germany an appropriate case study for the rest of the world?

The graph above correlates the premium paid by households relative to their industry/other counterparts with nominal expenditures on a per capital basis across the EU. We excluded Luxembourg from this analysis, a small country with extremely high expenditure per capita given its focus on services, which would skew the results in a relatively small sample, although not by much.

A positive correlation can be observed with a regression fit of about 47%, which is significant in light of all other factors that impact such differential (like government policy and differences in consumption profiles, for instance).

Renewable power is expensive. Quite expensive in fact.

As a result, using current technologies governments are forced to make a choice between expanding their domestic production of wind and solar or having cheap electricity. There are no two ways about it.

This is based on the results for Europe, but there is little reason to believe this would be largely different elsewhere. In the US, for example, it is no secret that “coal country” states offer much cheaper electricity prices than “green” states like California.

A possible way to avoid this trade-off is to find some really cheap renewable power technology. Even if this could be done tomorrow, it takes quite a bit of time for those projects to reach critical mass and make a difference in the electrical pool. We are talking decades here, not years.

In the meantime, to avoid hitting the productive sector too much, households will be called to continually bear a disproportionate amount of the bill. This is easier to achieve both in political and financial terms in wealthier countries. Indeed, this is the main goal of the Paris Climate Accord, where wealthy Western households are being asked to subsidize not only green power in their own countries but across much of the developing world as well.

So can we afford renewable energy?

The answer, as always, depends on how rich you are.