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With oil prices below $50 and still struggling to find a bottom there is growing concern that it will be increasingly difficult to meet climate change goals going forward and that much of the momentum gained around renewables and energy efficiency will be reversed.
It does not seem to look good for direct oil substitutes such as biofuels, which are already under pressure from cheap oil. This is especially the case in countries like Brazil where customers have a choice of filling up with either ethanol or gasoline. It is also the case in the U.S. where you would think that biofuels would be somewhat sheltered by a mandate that gasoline be mixed with 10% ethanol. But ethanol future prices are still down in the U.S. over 25% in the last three months.
The oil price fall is probably also not good for solar in places like the Middle East where it competes with oil to generate electricity. Saudi Arabia is a good example. It generates 50% of its power needs using oil (nearly 1m barrels a day), and the oil price fall must raise questions over Saudi’s 41GW solar target.
To make the situation more complex the other fossil fuels coal and natural gas have also fallen in price which again should put pressure on technologies such as renewables. The end result should be lower energy prices for the end consumer which in turn should also reduce the incentive to invest in energy efficiency technologies. On the face of it doom and gloom for all involved in renewables, energy efficiency and climate change.
But there are a ten reasons why this is not the case.
First and foremost, renewables do not compete directly with oil in the vast majority of the world. In fact only 4% of global power is generated using oil and in Europe and the U.S. it is below 1%. And these regions do not have the oil generating capacity to switch to oil and it highly unlikely that these regions will built oil generation because even with oil prices at $50 other technologies are cheaper for generating power.
Secondly, the better benchmark for most renewables is the wholesale power price which is determined by lots of factors including but not limited to fossil fuel prices. In Europe, power prices have been at ten year lows for all of 2014 (i.e. before the fall in oil price) and in the U.S. wholesale power prices, despite collapsing oil prices and falling coal and gas prices, rose at every major trading hub in 2014 (as can be seen in the graph below) .
Thirdly, the world is going digital, and all those digital devices require electricity not oil. The computer, Internet, mobile phone, and the vast array of electrically powered devices that are so essential to us, are all products of the digital age. They all require electricity, making electrification indispensable to our modern lives. As times goes by, everything will go digital (including our transport system) and we will need increasing amounts of electricity and renewables will not only remain but become a larger part of that energy generation mix because of decreasing costs, concerns about the environmental impact of fossil fuels and nuclear and the increasing cost competitiveness of self-generation using solar and other related technologies. Whatsmore the competition from falling fossil fuel prices should push innovations and costs for renewable down even quicker.
Fourthly, demand for renewables across most of the world is driven by government policy, which is not dependent on oil prices. China is moving renewable because of a need to move its energy mix away from coal which is having a disastrous impact on air quality across the country. In Japan, the Fukushima disaster has caused the shutdown of nearly all Japanese nuclear power stations and renewables is clearly seen as a viable alternative. In Europe, climate change motivations as well as energy security concerns are pushing a strong move towards renewables which is reflected in the so called 20/20/20 targets. Then there is the United States, which despite low gas and coal prices for the last years has been very aggressively pushing renewables. This will continue as 30 states have renewable portfolio standards (RPS) in place which mandate increases in renewables in the coming years. What’s more, energy price falls will be good for renewables as U.S. states will be less under pressure from energy price sensitive voters to get rid of RPS.
Fifthly, subsidies for fossil fuels have distorted many markets against renewables. According to the IMF, we subsidise fossil fuels by over $1.3tn each year. The recent fall in fossil fuel prices and in particular oil prices gives countries a chance to reduce them, to level the playing field which can only be good for the build out of renewables. We are have already seen subsidies cut in Indonesia, India, Egypt, Malaysia and Morocco and in China we have actually seen increases in gasoline fuel taxes.
Sixthly, there is a very clear cultural shift in many countries such as Germany, Japan and Denmark by their people who are pushing their governments to move away from fossil fuels and in some cases nuclear. This is probably related to the realisation by most people that the climate is changing. And the facts speak for itself. 2014 was the warmest year on record in the U.K., Germany and initial estimates are that it could be the hottest globally.
Seventhly, much of renewables is distributed generation such as solar, which is largely insulated from commodity price movements. The retail customer who puts solar on his roof is comparing the cost of doing so with the cost of buying from the utility which includes not only generation costs but transmission, distribution and taxes. In the case of Germany where wholesale power prices only make up 10-15% of the rate the customer pays, even a substantial fall in commodity prices has little or no effect on the viability of solar. Even in the United States where the commodity prices comprise 30% of what the consumer pays, the economics of solar do not change much. And already in place like Africa and large parts of Asia solar is the most competitive way to bring power to the people. In Bangladesh for instance, some 2-3 million people use home solar systems.
Eighthly, renewables provide a shelter from oil and fossil fuel price volatility. We are clearly back in a world of oil price volatility, and fossil price volatility, not to mention currency volatility, which is particularly bad for European and Japan consumers noting that both these currencies have lost almost 10% against the US$ over the last few months. It is complicated to predict the oil price going forward but clear is that at the current price many oil projects are not covering cash operating expenses and that production will begin to close. More importantly though investments in extreme oil (deep sea, tar sands, Artic Circle, North Sea) will be cut back and so oil prices should rise again, but when and how fast is not clear. Add to that the political element i.e. what will Saudi Arabia do and it clear that we are in for a volatile and unpredictable time on the oil market. But it is not just oil as the gas and coal prices are somewhat determined by the oil price. Wind and solar, on the other hand, do not have any fuel costs and they have very low and highly predictable variable costs (basically some O&M costs) which reduce risk for both power producers and users.
Ninthly, the low oil prices mean that we are more likely to get a Climate Deal in Paris later this year. The low price makes it is easier for governments to put in carbon schemes such as carbon taxes and higher carbon prices will make fossil fuel generation more expensive relative to renewables.
Finally, over 45m barrels of oil are used every day for transport for which there has been no real alternative up till now. If electric vehicles continue their technical progress this might change very quickly and you could see oil going the way that whale oil did a 140 years ago in which it disappeared overnight because there was a cheaper and better technology out there. In 2000, Sheikh Yamani, the former oil minister of Saudi Arabia, gave an interview in which he said: “Thirty years from now there will be a huge amount of oil – and no buyers. Oil will be left in the ground. The Stone Age came to an end, not because we had a lack of stones, and the oil age will come to an end not because we have a lack of oil.” Only time will see.