Liebreich: Reasons to be Fearful, Reasons to be Cheerful

By Michael Liebreich
Chairman & CEO
New Energy Finance

Project developers are finding it much more difficult to get debt finance. Ambitious companies are having to shelve plans to go public. Large corporations are trimming back some of their ambitions in renewable energy. Clean energy share prices have fallen by more than 50%. The price of emitting a tonne of carbon dioxide in Europe has dropped. The oil price has tumbled by an astonishing $90-a-barrel in just four months. The biggest US ethanol company, VeraSun Energy, has gone bankrupt.

It is all doom and gloom, right? Actually, no: there are indeed reasons to be fearful, but there are also reasons to be cheerful. And the more I think about the two, the more I feel that the balance of the scales is tipped towards the latter rather than the former.

I will say that I expect demand for clean energy products to fall back towards levels consistent with policy mandates, except in places such as Germany where feed-in-tariffs will sustain a higher figure. Companies that might have dipped their toes in the water a year or two ago and built some capacity, are likely to have more pressing priorities now.

What about a worse outcome than that? Sceptics of renewable energy and climate change have often regarded “greenery” as a luxury opinion that populations can espouse during good economic times, but quickly jettison when conditions get more difficult. Similarly, pessimists have analysed the implications of the world economic downturn, and concluded that countries are likely to put climate change and energy security concerns on hold, while they throw the kitchen sink at trying to create jobs and minimise unemployment.

I am not saying they are completely wrong. Some politicians are likely to toy with that sort of thinking. The environment has slipped down voters’ agenda, although it is still there. What is different this time however, compared with the early 1990s recession, when the environment did recede out of sight as an issue, is that some of the economic influences are aligned in favour of clean energy.

Take fiscal policy. The sharp recession that the US, Europe and most other developed economies are now experiencing will push governments into adopting Keynesian policies of cutting taxes and introducing targeted spending programmes, in order to fire up demand. Monetary policy, with interest rates cut to long-time record lows, might do the trick on its own, but many administrations will prefer not to wait to find out if it does.

Finance ministers designing a fiscal boost are likely to see infrastructure spending as one of their possible tools. Roads and bridges were built aplenty in Japan in the 1990s when Tokyo belatedly tried this approach, but in this cycle, infrastructure spending may reflect a different priority – energy security. I expect to see some governments putting public money into improving grids and stimulating clean energy R&D; and unveiling further tax measures to stimulate private sector construction of renewable energy capacity.

In his last campaign speech, at Jacksonville, Florida, on the evening of 3 November, President-elect Barack Obama said: “I will invest $15bn a year in renewable sources of energy – in wind and solar power and the next generation of biofuels. We’ll invest in clean coal technology and find ways to safely harness nuclear power. And we’ll create five million new energy jobs over the next decade – jobs that pay well and can’t be outsourced.”

At New Energy Finance, we have always been sceptical about the number of “green collar jobs” that can be created, since this is a capital-intensive industry. However there is no doubt that western economies need to replace ageing generating plants and reduce reliance on unstable or unfriendly energy exporters, and if you are going to increase public investment, then it makes sense to do it in an area where the resulting assets are actually needed.

The other side of fiscal policy is the collection of revenue. Although this is not the first priority of policy-makers right now as they try to kick-start economic growth, it will quickly become important. Fiscal deficits on both sides of the Atlantic will mushroom next year, and the pressure will be on to find tax measures to bring money into the public coffers.

In that situation, governments exposed to the wrath of voters are unlikely to want to saddle their voting populations with extra income or spending taxes, if they can help it. Instead, they may go for a softer target – the fossil fuel energy industry. If so, clean energy could make a double gain from fiscal policy moves.

Take also monetary policy. So far, sharp cuts in central bank interest rates in the US, the euro area, the UK and elsewhere have not reduced the real borrowing costs for project developers. Interbank rates are still far above official rates, and also banks are charging a much wider spread on project finance loans than they were in 2007.

Wider spreads are likely to stay. But at some point in the months ahead, order will return to the banking sector, and the gap between interbank and official rates will narrow again. That, together with further central bank rate cuts, should be enough to cut the overall cost of borrowing for renewable energy project developers. Providing, of course, that they can find a bank!

Take commodity prices. Although sky-high oil prices in the summer of 2008 were regarded by many as good for the clean energy sector, the commodity bubble also saw exorbitant prices for many of the sector’s key inputs – from corn and palm oil for biofuels, to steel for wind turbines and silicon for PV panels.

The economic downturn has already hit the prices of many of those inputs hard. Steel is notoriously sensitive to the business cycle, and Asian producers have been peppering the news wires with price and output cuts in recent weeks. New Energy Finance analysis suggests silicon prices will fall by around 30% in 2009. Corn prices have halved from their peak.

Of course, output prices for the renewable energy sector have also come down, so the short-term impact on margins has been mixed. Oil prices have slumped from $147-a-barrel, to the $50 to $60 range. German base-load electricity prices for 2009 have declined from a peak of EUR 90.70 per MWh, to EUR 62.80.

The question is which of the two – input prices or output prices – will be more resilient in the medium term. My view is that it will be output prices. More land will come into cultivation to add to feedstock production, steel mills will continue to run because it is cheaper to have them producing something that can be sold than having them shut down. Meanwhile the price of oil should get some support from Opec action, and from the medium term supply problem cited again by the International Energy Agency in its World Energy Outlook this month.

In fact, the IEA’s sternest warning of all this year concerns the danger that the fall in oil prices will deter energy producers of every sort from investing in the new plant and exploration work they need to do, if supply is to increase.

Fatih Birol, the agency’s chief economist, said when he launched the WEO: “We hear almost every day that many energy investments are being postponed. This is definitely a major trouble. When demand does start to pick up, say in 2010, if investments are postponed, we may find the supply crunch is worse than we were expecting before, and that we see much higher oil prices than this summer.”

Take the clean energy sector’s “experience curve”. These curves tell us that in every new industry, costs of technology will come down over time, increasing competitiveness. This trend has been obscured in clean energy in recent years, as the ferocity of demand has created bottlenecks in the supply of turbines, components, solar modules and silicon. The temporary shortage of project finance we are seeing now is already easing these bottlenecks. Wind turbine makers such as Vestas and Repower have revised down their growth forecasts for 2009, in reaction to project delays reported by some of their customers, and Gamesa has decided to shut factories around Christmas.

This lull in the pace of growth, combined with lower raw material costs, should enable the “experience curve” to reassert itself in the sector’s economics. Technology costs should start to fall, improving the cost competitiveness of renewable energy against fossil fuel alternatives, and enlarging the potential market.

What of the reasons to be fearful? Well, oil could fall back to its levels of the early 2000s, and stay there. Governments could direct their infrastructure spending towards “dirty energy”. The credit crunch might get even worse, perhaps as emerging markets melt down. Interest rate cuts might not be passed on at all by banks to project developers. There might be discord, rather than agreement, at Poznan and Copenhagen.

It is all possible. But with the new US President committed to re-engage in climate negotiations, and the G20 talking the talk on international cooperation, I prefer cheer to fear.

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