An Inquiry Into The Wealth Of Renewable Energy: Part II

by: Jonathan Fishman


Renewable energy investment environment.

Germany costly but crucial support.

Grid integration potential.

For Part I go here.

In this part, we will go over investment flows in different renewable technologies, think about the future role of renewable energy, and discuss the case of Germany.

Investment Flows

Examining the investment environment of renewable technologies over the past 10 years reveals a true growth story, from $40B in global investments back in 2004 to $214B in 2014. That is an 18.5% CAGR. The following chart reveals another story, that of Germany.

Source: REN21 annual report, June 2014

Over the past three years, global investments in renewable energy went down from a peak of $279B in 2011 to 2013's level of $214B. There are many reasons for that, but the main ones, in my view, are:

  1. Europe's attempt at repositioning its renewable energy market, happening mainly in Germany.
  2. Reduced costs, mainly of solar modules, enabled the world to build more projects for less investment costs.

Let's further understand where investment in renewables comes from.

Source: REN21 annual report, June 2014

Source: REN21 annual report, June 2014

Except for Europe, we can see most of the world is growing its investments in renewables, although in a bulky manner. In 2013, China invested more than all of Europe for the first time, which demonstrates the ongoing growth of China vs. the world. Of course, the reduced cost of investing in solar distorts the real picture, given that 53% of all investments in renewable energy went into solar.

Source: REN21 annual report, June 2014

It's fairly easy to see that the majority of new investment is going into solar and wind, which offer the best economics to deploy as of now.

Let's go back a second to a chart I attached in the last article.

Source: REN21 annual report, June 2014

As I said, the reduced cost of solar just explains one part of the story; the other part is that of Europe and Germany.

Germany: The Chicken and the Egg

I like to think of Germany's solar story as that of the chicken and the egg. Which came first? It might be an interesting debate for game theory professors. I claim that Germany sacrificed its own power market for the world, without ever intending to do so.

"Energiwende" is the German phrase for "energy transition." In 2010, Germany had outlined its Energiwende targets, including: up to 90% reduction in greenhouse gases emissions and achieving 60% share of renewable energy in the energy mix, all by 2050.

From 2006, when Europe reached the level of 1 GW of annual solar installations for the first time, that figured quickly ramped up as more European countries joined Germany in its pursuit of renewable energy. In 2010, 2011, and 2012, Germany installed about 7 GW of solar, annually.

When Germany and Europe started ramping up the installations of solar, the Chinese industry was nearly nonexistent. To provide developers with incentives to develop solar projects and other renewable projects, a very fat rate, unimaginable these days, was offered for electricity generated from these projects.

These "fat" rates, in many cases locked for 20 years, enabled developers to achieve lucrative IRRs on their projects. It also burdened utilities to a great degree, as they were forced to purchase that electricity from those developers, which in some cases, were residential PV system owners.

The drastic rise in European demand for solar did not go unnoticed by the Chinese solar industry, which quickly ramped up its production capacity. It was that production capacity that enabled them to reach the economy-of-scale they enjoy today and reduce costs by a staggering rate. Prices plunged as supply grew well beyond demand, and the market forces did what they do best.

In the meantime, Germany's utilities were losing a lot of money by purchasing electricity from developers at prices that reached $0.43/KWh in some cases and selling it to their customers at market prices of lower than $0.10/KWh. Costs began to mount and quickly forced the Germans to cut subsidies. More than that, given the debt crisis situation in Europe, Germany started to think about fixing the situation by charging a renewable tax from electricity consumers.

Recently, that tax was announced to be close to 6.42 eurocents per KWh in 2014, which is a huge fee. That tax issue further escalates as we speak. Many politicians jumped onto the wagon and suggested to include different added components to the suggested tax as a support for energy-intensive industries, as a compensation to utilities for falling electricity prices and more.

Germany's renewable energy race was the trigger that enabled the cost of solar modules to plummet; now, it has to face its past, when it offered very high subsidies without thinking ahead. If the subsidies were laid out today, given the much better cost of solar, Germany's problem would have never developed. But if it had waited, very cheap solar modules would not be available, as the solar industry wouldn't have an incentive to grow capacity. Hence, the chicken and the egg problem.

After the expansion of the Chinese solar industry and the plummeting prices of solar, project developers could achieve lucrative IRRs (7%-10%) even with very little or no subsidies in many electricity markets around the world. Pursuing a renewable-rich energy mix using no subsidies (or very low ones) is the driving force behind governments around the world setting aggressive solar installations targets.

The Grid-Connection Issue

Until economical energy storage is available, solar power can be used only during times of sunlight. The current role of solar energy in a country's electricity mix is that of reducing the amount of fossil fuel-based base load power plants.

There are two main kinds of power plant: base load power plants and peaking power plants. The first kind is meant to generate a constant level of power throughout the year. These plants generate the base load amount of power demanded by the consumers; they do not fluctuate in output over time to a great degree.

Peaking power plants are meant to generate the electricity demanded by consumers during peak hours of the day, when we use a lot of electricity. The causes for peak demand include air conditioning, TVs, computers, water heating, and more. These plants utilize a responsive capable technology, such as natural gas turbines, that can be ramped on and off fairly quick.

Let's take a look at a German intra-day power consumption chart:

In this chart, I used a yellow marker to mark the base load power needed by Germany on that particular day. You can see it's about 33 GW. Now, let's focus on conventional power plants:

I hope you'll excuse me for my drawings. This time, the yellow marker shows the minimal power generation needed from conventional power plants, which you can see is about 18 GW at 3:00 PM. The red markings show the maximum generation Germany needed from conventional power plants that day, which is about 33 GW at 10:00 PM.

Let's analyze the situation. In Germany, according to the above chart (which represents the summer), there is a need for 18 GW of base load conventional power plants and 15 GW of peaking power plants, which start to ramp up at 3:00 PM.

If no solar and wind were used, given that about 5 GW constantly comes from hydropower, the conventional power plants would have needed to supply a base load of 25 GW at 3:00 AM. Then, at 12:00 PM, conventional would have needed to supply an additional 15 GW of peaking power plants.

The meaning for utilities is that they had to retire about 7 GW of conventional base load power plants. If more solar will be adopted (as is expected), it will push the minimal generation needed by conventionals at noon even lower, thus decreasing the base load (meaning more base load power plants will be retired), and increase the amount of peaking power plants needed (to ramp back to the 33 GW mark at 10:00 PM).

This conventional power plant transition to fit into a renewable-rich energy mix carries a cost on utilities, as they need to handle the extra "smart-grid" work and operate more and more gas turbine-based peaking power plants and fewer base load plants (which are cheaper to operate).

It's easy to see it would be logical for a government to compensate these utilities for the added cost of transition and share the cost by taxing the solar power plants a small KWh-based charge. Given the current roadmap of solar cost and price, that would still allow developers to achieve those lucrative IRRs.

It's also easy to see there is a limit to how much solar can be integrated in a grid (as a certain amount will exceed the country's peak demand and completely eliminate base load power plants). But don't get nervous; the limit is more than 20-30 times the current global mix (0.7%) on a global scale, without energy storage.

That day in Germany, the country had 20.9% of its electricity generated by solar.

This will push solar installations to decades of growth, even if it is able to supply just 10% of global electricity demand by 2040 (up from 0.7% today and a conservative estimate, in my view). Even without storage, getting to that 10% solar share is very feasible.

To Be Continued

In this article, we went through the global investment profile and saw the trends in investments that illustrate the change from Europe to Asia.

We went through the "chicken and the egg" story with Europe and Germany, which had an extremely important role in enabling the feasibility of solar installations around the world, but are paying a high price, as they used huge subsidies to accomplish that goal.

Finally, we talked about the grid integration issue and saw that we are nowhere near to fully taking advantage of solar power on a global scale, even without storage. Of course, storage makes the potential of renewable energy to supply close to a 100% of electricity generation.

In the next part, we will focus on why solar power is the key player inside the renewable energy story, the growth rate the solar market can reach in the next few decades, and the profitability and growth of the industry going forward.

For Part III go here.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.