Investment: Does investment in renewables stack up

One reaction to climate change is investment in renewable energy and, today, spending on renewable energy technologies is growing dramatically. However, business strategist Aiman El-Ramly, questions whether the current trend is economically and technology feasible when baseload energy requirements need to be met.

In the current global energy mix, renewable generation represents about 2% of the total energy mix. The 2% figure, however, is wildly at odds with the current trend in energy investment, which sees about 20% of current generation investment in renewable technology. Last year, a massive $117 billion was spent on renewable resources.

What is even more dramatic is the year over year growth in renewable spending. Although accounts differ, year over year growth in the last few years has been 20%-40% and investment is up in all areas: venture capital, private equity, public market, capital financing and mergers and acquisitions. It is difficult to argue that, today, renewable energy markets are anything but liquid and global. The fact that there is debate as to whether China or the US is the larger investor is indicative of just how big it is, and how difficult the market is to pin down. China holds about 10% of the global investment and another 20% is seen in developing countries. The European Commission is looking to see a fifth of all its energy from renewable sources by 2020, while similar targets were debated, but not set on a national basis, in the US.

It is also interesting to see who is investing in renewable generation. These players may be indicative of a sustainable industry, or a sign of individual and corporate investors riding a trend. As an indicator for large corporate energy investment, General Electric, already an established player in renewable energy, has stated it will increase its investment in renewable energy to US$6 billion by 2010. The company sees that within two years, renewable energy will make up almost a quarter of its total investments in energy, up from 10% in 2006. Big name entrepreneurs, such as Vinod Khosla, Bill Gates and Richard Branson, are also in the mix.

The investment banks are also at play, but it is hard to tell if they are the drivers or the followers. Morgan Stanley, Merrill Lynch and Goldman Sachs all have tooled their banks to take advantage of global interest in renewable investment. Meanwhile, NYMEX, the New York-based exchange that ushered in the age of the gas and electricity futures contract, announced on 12 December, 2007 the formation of a consortium of financial institutions to launch a Green Exchange to trade Renewable Energy Credits.

It may be unfair to compare the interest in renewable energy to the gold or rush, as the interest in renewable energy is in response to a real global crisis related to the conflicting needs for more energy and less pollution. The desire for profit in the renewable energy market may be tempered with a desire for a sustainable earth and renewable energy investment serves the triple bottom line of social, environmental and economic pay-off, while enjoying significant regulatory support.

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Renewable technologies tend to have limits to dispatch given their intermittent generation profiles. As such it is difficult to meet baseload power requirements using solely renewable resources and typically a renewable resource is part of a larger generation portfolio.

Today, wind, solar and biofuels dominate the renewable investment landscape, but do not provide a basis for easily fulfilling baseload requirements. Scale and cost of development have historically been limitations in the investment of renewable resources. However, a shift in market sentiment and triple bottom line costing may change return on investment (ROI) calculations.

Comparing renewable with fossil-fuelled generation we see that renewable energy development as part of the social consciousness is being realized in regulatory mandated Renewable Portfolio Standards. The true ecological and social cost of fossil-fuelled generation is also starting to be realized with regulatory imposed limits, penalties and costs related to emissions.

Furthermore, the market pays a voluntary premium for renewable energy as part of the promotion of global sustainability and has become vocally more opposed to the prospect of new fossil generation and the ecological and social costs at both the local and global levels. Consequently, investment in renewable energy is moving dramatically upward as the market demand is internalized – the risk profile has changed. Meanwhile, investment in fossil technologies has stagnated and is in decline with the realization that fossil generation in its present form is not sustainable.

The ‘renewable versus fossil’ comparison shows that in the current environment, renewable energy development can attract a price premium and may also be a regulatory requirement as part of a utility’s renewable portfolio standard. Similarly, the true ecological and social cost of fossil generation may not have been factored historically. The question remains whether corrections in cost structures, as either incentive or penalty, are sufficient to affect a long-term change in generation development trends. There is also a question over what happens if renewable energy is unable to meet increased demand. Will the economics of real demand for reliable energy outweigh arguments for environmentally sustainable renewable energy?

Investment rules

One advantage investors see in renewable energy, aside from biofuels, is their insulation from input fuel costs. As any observer of energy markets in the last twenty years can tell you, price volatility is a given and foremost on many analysts’ minds is the future price of oil and natural gas on the simple basis of availability. However, it is not fuel prices and volatility, but rather fuel consumption and the impact on global warming that has largely driven the development of a series of policies in US states which are designed to promote cleaner sources of electricity. The most common approach that state regulators have adopted to encourage the development of renewable energy is Renewable Portfolio Standards (RPS) or Renewable Electricity Standards (RES), which require certain percentages of the electricity supplied to consumers to come from renewable resources.

Twenty-five states and the District of Columbia have adopted their own RPS. Regulators set targets for electricity to be produced by renewable sources, and have varying specifications for eligible technologies, requirements for hydroelectric generators, deadlines, goals, potential for import and such like. In many cases, the target can be met through generating the qualifying MWh of electricity, or by credits purchased from other regions and retired to offset unqualified retail sales.

The Renewable Portfolio Standard in California established by Senate Bill 1078 (SB 1078, Sher, Chapter 516, Statutes of 2002) which became effective in September, 2002 was the most progressive policy at that time. The goals included requirements for each electrical corporation to increase its total procurement of eligible renewable energy resources by at least an additional 1% of retail sales per year to reach a target of 20% of retail sales procured from eligible sources by 2010. Senate Bill 107 made it state law. This target was revised in 2005 by the California Energy Commission and the California Public Utilities Commission with the goal increased to 33% and the deadline pushed to 2020. The revised standard has not yet been legislated, however.

Furthermore, even though there is no federal policy in regard to RPS, there were attempts to develop the policy at the national level in the US. The Democratic-controlled US House passed a Federal Renewable Electricity Standard (RES) House energy bill (H.R. 969). Originally the bill required that 20% of the nation’s electricity come from renewable energy by 2020. However, this goal was reduced to 15% by 2020 allowing states to meet 27% of that mandate through energy efficiency measures and trade credits.

Sustainability is not sustainable

The reaction to the proposed federal standard was mixed. Advocates claimed that the RES provisions, while helping save the planet from global warming, would not have a negative impact on industry and the economy. Since many states are already pursuing these policies, the federal RES would moderately expand the impact of these policies, while spreading the benefits to states that do not currently have renewable energy or energy efficiency policies in place. In addition, it would assist the US to reduce dependence on foreign oil and cut off the massive subsidies provided by Congress to fossil fuel industries, thus helping to level the playing field for renewable energy to compete.

The opponents to the bill, mostly supported by the biggest utility companies in the south of the country like Southern Co and American Electric Power Co, warned they would not be able to meet that standard and would be forced to pass along higher costs to their consumers. On 7 December, 2007 the Senate failed to get the votes needed to move the legislation forward, a day after the House of Representatives approved it.

The arguments at national level show that consideration of renewable generation, in the US, is driven by both social and economic drivers. In the majority of cases, renewable sources of energy without government subsidies are not yet economically viable. And, even if the generation itself is not subsidized, alternative energy can frequently be located in remote places and therefore requires subsidies for the development of the necessary transmission connections.

The US Federal Energy Regulatory Commission (FERC) is moving towards developing regulations recognizing RPS implementation through facilitating renewable resources development. As an acknowledgement of the growing importance of green power, FERC announced on 20 September 2007 the creation of the Energy Innovations Unit. The Unit will be involved in the Commission’s activities in regard to renewable energy, global warming, greenhouse gas emissions policies and advanced technologies relevant to the transmission grid and wholesale markets.

One of the FERC’s steps towards providing the actual assistance to the utilities in their efforts to meet RPS goals was the approval of the California Independent System Operator’s (CAISO) proposal for a mechanism to facilitate financing to interconnect location-constrained renewable resources to CAISO’s transmission grid.

Another gesture by FERC in the same direction was the application of Orders No. 679 and 679-A to accommodate renewable energy projects. The Orders allow incentive-based rate treatments for transmission, on a case-by-case basis. For example, on 20 December, 2007 Xcel Energy Services Inc. was granted approval for incentive-based transmission rates under the Midwest Independent System Operator (MISO) open access transmission and energy markets tariff for six transmission upgrades needed to accommodate renewable energy, including 300–700 MW of anticipated wind power. In its approval justification statement, the Commissioner linked the expected improved reliability of the grid from the upgrades with the expansion of the renewable market in the region.

Hitting the ceiling

Because of intermittent nature of many forms of renewable generation and the constraints of the current level of technological advancement, it is considered by some that the renewable energy share can increase to maximum of around 15%–20% of the traditional generation stack without impacting on reliability and system operation.

If not mandated by regulation, the current surge in renewable energy development would plateau as these limits are reached. Thereafter, new renewable generation would be developed more in line with demand growth. Current limitations in scale, siting and storage need to be mitigated if renewable energy is to move from the bottom of the stack and the 15% represented in the RES House energy bill probably represents the current upward limit from a regulatory, economic and system perspective.

Nonetheless, the effect of renewable generation on electricity prices may not be substantial, or at least not direct. Without significant increases in renewable generation, greater than demand growth ,there will not be enough pressure to displace current marginal-cost generation resources, typically either coal or natural gas.

Generally speaking, the renewable industry is in its infancy and from an investment perspective, is not dissimilar to the early opportunities afforded investors in the tech industry, but many obstacles have to be overcome. The very basic questions such as technology, scale and logistics need to be answered. Can renewable energy be produced economically and reliably and can that energy be stored and shipped? There are no conclusive answers.

The other basic question is what role will more traditional energy resources play in the future. Will nuclear make a comeback, can coal ever be clean, is there enough oil and gas, and can regulators sustain renewable portfolio standards if utilities do not support the premise and demand continues to grow?

Is fear of climate change enough to alter the energy landscape or does the physical landscape have to degrade to a point that the earth is at crisis? (Perhaps the earth is at crisis now, Al Gore and others certainly think so.) The need for sustainable energy solutions is imminent, the investor desire is demonstrated, but that still may not be enough to topple conventional generation resources without both technology and a realisable opportunity.

Aiman El-Ramly is the Senior Vice President Strategy and Business Development for the consulting and data management software firm ZE PowerGroup.

Global annual investment in renewable energy (billion US $/year)

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