by Dan Vermeer, Associate Professor of the Practice and Executive Director, EDGE
Until recently, I thought I understood the factors that were setting the pace of clean energy investment, at least in the U.S. Before the passage of the Inflation Reduction Act (IRA) in 2022, I would have argued that the lack of government support for investment in new technologies was the primary barrier to accelerating energy transition. While the cost of clean technologies had dropped significantly in recent years, there was still a critical role for government subsidies to reduce the “green premium,” the cost gap between incumbent (mostly fossil fuel) energy technologies and their carbon-free alternatives.
When the IRA passed, I was optimistic that the investment of hundreds of billions of dollars in the form of tax credits would eventually have a powerful effect on clean energy investment, and to some extent this has happened. Over 32 gigawatts of electric capacity in the form of solar, wind, and batteries was added in the United States in 2023, but this is still lower than the 46 to 79 gigawatts that had been projected.[1]
This may be due to several other factors that continue to slow down the flow of capital to these new technologies. For example, the passage of the IRA coincided with dramatic increases in interest rates and in costs of many materials need for clean energy manufacturing. These trends were felt even more acutely by clean energy investors and developers because so much of the costs of renewable energy are in upfront capital that will eventually be paid from the profits of low-cost no-fuel energy sources. When interest rates and costs of materials go up significantly, this all has to be absorbed at the beginning of the project, and cannot be distributed across the life of the project like it is for fuel-based sources like coal or natural gas.
Other experts in the field also point to the many non-economic factors that have been challenging for renewable development. For example, the inter-connection queues to get the renewable energy sources on the grid are backed up many years. This means that you can build lots of new solar and wind, but you will not be able to sell those electrons for years as the inter-connection backlog is processed. Lack of transmission and congestion can also challenge the economics of new renewable projects. Building new infrastructure can also trigger resistance and criticism in many local communities, especially if they don’t see tangible benefits that come back to their region. These challenges have become even more evident now that the capital is theoretically available from both public and private sources.
A final factor that may be less obvious is that, while costs for renewable energy are dropping, this may not be sufficient to motivate investment. In his new book The Price Is Wrong: Why Capitalism Won’t Save the Planet (2024), economist Brett Christophers argues that the core barrier to scaling renewables is not cost, but rather lack of expected profits. Compared to other investments, renewables are typically less appealing because of the limited potential for large returns. Intense competition in the renewable energy market has driven down costs significantly, but that also means that the developers struggle to maintain margins, and investors are not able to capture the upside potential. A related factor is that electricity prices are exceptionally volatile in competitive markets, so it is often hard to know what kind of profit can be expected over the life of the asset. In an assessment of risk and return, renewables suffer from both higher risk and lower potential return than other investments, including fossil fuels.
This dynamic has at least two implications. First, while the energy industry is likely to grow at a robust rate in coming decades, it is unclear that its companies and investors will enjoy profitable growth. The business of energy is fundamentally about meeting the needs of society, and the pressure to provide affordable energy to everyone may structurally limit its ability to compete with the potential profits of investment in other industries. As one energy expert I recently spoke with quipped, “energy will inevitably grow, but it will be growth without profits.” A second implication is that ongoing government investment in clean energy is likely necessary, even as prices of renewables reach parity with fossil alternatives. In this case, government intervention is not so much about direct subsidization of renewables, but more about making profits visible and dependable to the market. Given these realities, it would be naïve to think that the market will solve problems of energy access and climate change on its own. Society has a huge stake in this process, and government will need to be an active, generous, and strategic partner with market players to achieve a just energy transition.
[1] Plumer, B. (2024, Feb 21). “Here’s Where Biden’s Climate Law Is Working, and Where It’s Falling Short”. New York Times.
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