Oil Price Volatility Will Give A Boost To Renewables
Everyone loves low prices, but what the business community values most of all is predictability. The recent volatility in global oil markets — spearheaded by a fight to the death between Saudi Arabia and Russia — has sent the price of oil plunging to lows not seen in years. You might think that is good news for electrical energy generators who rely on fossil fuels, but that may not be true.
Thermal generating plants typically have a planned service life of 30 to 50 years. The financing that makes building new facilities possible relies on stable prices during the term of the loans. Disruptions that detract from that stability are bad for investors even if lower prices result, but lower average internal rates of return as a result.
Valentina Kretzschmar, vice president of corporate research for Wood Mackenzie, writes in a recent research note, “Could low oil prices slow down global growth in renewables? Historically, the oil price has shown no correlation with investment in renewables. The installation of both wind and solar continued to increase through the last oil price downturn.” She offers the chart below as proof.
The upward trajectory of renewables is attributable primarily to investors being able to predict a stable rate of return over time. The internal rate of return is “the interest rate at which the net present value of all the cash flows (both positive and negative) from a project or investment equal zero. [It] is used to evaluate the attractiveness of a project or investment. If the IRR of a new project exceeds a company’s required rate of return, that project is desirable. If IRR falls below the required rate of return, the project should be rejected,” according to Investing Answers.
In addition to price stability, low oil prices are also making investments in renewables more appealing. Kretzschmar says, “At US$60/bbl, solar and wind assets — with average returns of 5-10% IRR — have found it difficult to compete with expected double digit returns for oil and gas. But at the current oil price, returns from oil and gas are now in line with what investors can expect from low risk solar and wind projects.” Price parity and stability may be the formula that turbocharges the renewable energy industry in coming years.
Forget About Environmental Concerns
Kretzschmar warns that low oil prices may signal an end to efforts by oil and gas companies to trim their carbon emissions.
“A growing number of oil and gas companies, led by the European Majors, have set targets to reduce carbon emissions. In a US$60/bbl oil price environment, most companies were generating strong cash flow and could afford to think about carbon mitigation strategies.
“But now, the sector will struggle to generate enough cash to maintain operations and honor shareholder commitments. All discretionary spend will be under review — that includes additional budget allocated for carbon mitigation. And companies that haven’t yet engaged in carbon reduction strategies are likely to put the issue on the back burner.”
But if Big Oil pulls back from investments in renewable energy, will that hurt the renewable sector? Not at all, says Kretzschmar. “Oil and gas companies make up a tiny proportion of global investment in renewables. The sector accounts for less than 2% of global solar and wind capacity. Even if Big Oil stopped investing in renewables altogether, that would have a minor impact on growth.”
She thinks despite oil wars and the coronavirus, demand for lowering carbon emissions will only increase going forward. “Time will tell how clean energy spend is affected as budgets are cut. But the energy transition is here to stay.” Amen to that.
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