Investors beware: “Cheap" renewables are very expensive

For years, it’s not merely been conventional wisdom; it’s become a pillar of the zeitgeist and a litmus test of acceptable opinion: electricity generated from intermittent sources, particularly solar panels and wind farms, is much cheaper than baseload power from coal- and gas-fired plants. Respected sources underpin this orthodoxy. On 11 December 2020, for example, the Commonwealth Scientific and Industrial Research Organisation stated:

A new report from CSIRO … has found that solar and wind continue to be the cheapest source of energy in Australia … This is projected to continue to be the case throughout the projection period to 2050.

On countless occasions, the mainstream media has repeated (or uncritically accepted) claims such as CSIRO’s. “Renewable energy is the cheapest form of energy, and that includes transmission and storage,” Chris Bowen, the new Minister for Climate Change and Energy, told ABC 7.30 on 9 June. On 1 June, however, ABC News reported:

Australia is on the precipice of a UK-style energy crisis that could send many of its power retailers broke and fuel a surge of households unable to pay their bills … The soaring cost of wholesale energy has triggered widespread alarm among observers and there are fears a significant chunk of Australia’s retail electricity market will be wiped out in the crunch.

The consequences of the crisis extend well beyond Australia’s energy markets. “Here we are,” commented Ian Verrender on 6 June, “faced with a critical failure in energy and electricity supplies that threatens to wreak havoc on the economy, shut down major manufacturing industries and cause a potential spike in both unemployment and inflation.” According to The Sydney Morning Herald (1 June), this is the “biggest energy crisis in 50 years.” Moreover, Australia is hardly alone: the world presently faces a “much bigger” energy crisis than it did in the 1970s, the Executive Director of the International Energy Agency (IEA), Fatih Birol, told the German daily, Der Spiegel, on 1 June. “Back then it was just about oil. Now we have an oil crisis, a gas crisis and an electricity crisis simultaneously.” 

Today’s crisis shouldn’t surprise you

How is this possible? If solar and wind produce the cheapest power, and since intermittent sources have generated a significantly greater share (and coal-fired generators a materially lower percentage) of Australia’s electricity over the past decade (for details, see Decarbonisation: A doubter’s guide for conservative investors), why has the wholesale price of power on the National Energy Market recently reached an all-time high?

 The current crisis isn’t a mystery: power prices haven’t surged despite the fact that renewables are cheapest; they’ve skyrocketed because “renewable” energy is intermittent, and unreliable sources of power are expensive. Taking their full cost – including their considerable external costs into consideration, today’s crisis should surprise nobody.

It doesn’t surprise Leithner & Company. Moreover, we welcome situations where “what everybody knows” is actually highly questionable. Members of a herd – including advisers, funds managers, journalists and others – don’t take the time and effort to think for themselves. Indeed, people seek safety in numbers precisely in order to let others do their thinking. This abdication eventually causes their clients and customers to suffer severe losses (see also Are you a customer, client or partner?).

“Experts” regularly succumb to hope (and hype) and thus misprice certain assets – sometimes egregiously. Their mistakes create attractive opportunities for conservative investors who’re prepared to conduct their own analyses, draw their own conclusions and when necessary, defy the conventional wisdom. Today’s energy sector in Australia and elsewhere is a prime example. 

The cost of electricity

Table 1 summarises the cost of electricity along two dimensions (a full elaboration appears in the full report (pdf) appended to this article). Reading along its left-hand column, the total cost of generation (and analogously for the other links of the chain) is the sum of fixed (capital) cost, variable (running) cost and external cost. Fixed (capital) costs are those that don’t vary according to the quantity of output; variable costs are those that do. Fixed and variable costs vary from one type of generation to another, and from one stage of production to another.

 Table 1: The Cost of Electricity – Two Dimensions

Many members of the public – egged by lazy journalists, venal politicians and self-interested promoters – mistakenly think: “sunshine and wind are costless; therefore renewable energy is (or should be) virtually free.” They simply ignore intermittent generation’s considerable capital and external costs.

Power generation’s external costs (“Externalities”)

The fixed and variable costs of generating and supplying electricity are hard enough to estimate. What’s most difficult is what’s seldom mentioned: identifying – never mind quantifying – its externalities. An externality (“external cost”) is an indirect, usually unquantified, sometimes undetected and thus almost always uncompensated cost to a third party that arises from another party’s (or parties’) activities. Pollution is probably the most commonly-cited example: its producers seldom pay its cost or otherwise compensate its “consumers” (which is often society as a whole).

Enthusiasts of intermittent energy vociferously denounce coal- and gas-fired electricity generation’s externalities – but furiously deny the external costs of solar and wind power. It’s seldom recognised but vital to acknowledge: the production of electricity from sunshine and wind generates substantial external costs.

Most notably, the intermittency of their output places considerable strains upon the grid. These strains are very costly to manage – and in extreme cases can cause blackouts – yet solar and wind generators incur none of the costs of their unreliability: electricity transmission and distribution firms, and ultimately consumers, do.

In short, the actual, total (including external cost) of renewable power is significantly greater than its market price.

The “levelised cost of energy”

Different methods of generating power incur different types of cost; their magnitudes and thus their total costs also vary considerably. Yet comparisons can paint a confusing and even misleading picture. Among the many complications: some technologies are more expensive to build but cheaper to run; conversely, others’ fixed (capital) costs are comparatively low but their variable costs are relatively high. As a result, small changes of any one of a large number of assumptions, such as discount rates, can greatly affect estimates of total costs. How, then, to compare them?

The levelised cost of energy (LCOE) compares total costs of different methods of generation on a consistent basis. The Independent Review into the Future Security of the National Electricity Market (2017), headed by the Chief Scientist at the time, Dr Alan Finkel, provides background and elaboration. It states: “LCOE is a measure of the average cost of producing electricity from a specific generating technology. It represents the cost per megawatt hour (MWh) of building and operating a generating plant in order to break even over (the plant’s) assumed financial life. Key inputs to calculating the LCOEs include capital costs, fuel costs, fixed and variable operating and maintenance (O&M) costs, financing costs, and assumed usage rates for each technology type. The LCOEs do not include transmission or distribution costs.”

Likewise, they typically exclude external costs. Conceptually and empirically, the LCOE is therefore hardly fool-proof. Yet it remains the best available metric for comparing the costs of various types of power generation.

Five recent studies 

Table 2 summarises key estimates from five recent studies that attempt to quantify the LCOEs of various types of power generation (for details, see pp. 7-10 of the full report). To varying extents, these studies disclose their assumptions and methods. From these disclosures it’s evident that their conclusions rest upon a variety of assumptions and complex analyses. Yet they also contain a crucial similarity:

All of them strive (for example, by estimating the effects of carbon taxes) to take into account the externalities of coal- and gas-fired power – but none attempts to “internalise” the external costs of solar and wind generation. As a result – and like governments’ policies – they punish fossil-fuels and privilege intermittent generation.

Table 2: Levelised Cost of Energy ($US per MWh), Five Studies and Nine Types of Generation

Similarly, these studies estimate the LCOEs of solar and wind on a “standalone” basis – that is, without the backup from batteries or gas that they often require.

Incorporating backup into the calculations doesn’t just greatly increase renewables’ LCOEs: it renders them uncompetitive. In 2020, Bloomberg New Energy Finance estimated that the LCOE in Australia of wind power backed by battery storage is $US87/MWh, and that the LCOE of solar power backed by battery storage is $US118/MWh. These “bundled” estimates are at least twice as large as the CSIRO’s “standalone” estimates.

Considered as a whole, these studies flatly contradict “what everybody knows”:

Despite the favourable treatment they receive from analysts and policymakers, “green” methods of generation aren’t demonstrably cheaper. The mean ranking of the four varieties of solar and wind is 6.0; the mean of coal-fired, gas-fired and the two varieties of nuclear power is 4.75. If anything, in aggregate the tried-and-true forms of generation are cheaper than the “trendy" ones.

Electricity’s price is innately volatile

Why has the wholesale price of electricity in the National Energy Market recently skyrocketed to an all-time high? Three points, which pp. 10-11 of the full report detail, explain it:

1. Although the retail price of power in Australia is heavily regulated, its wholesale price is relatively unregulated.
2. Consumers’ demand for power is inelastic. A sudden shortfall of supply relative to demand (as occurs, for instance, when the wind doesn’t blow) thus causes its price to skyrocket, and a surplus of supply causes it to plunge.
3. The innate characteristics of electricity exacerbate its wholesale price’s volatility. Among the essential goods and services that underpin a modern economy, in one crucial respect electricity is unique: its consumption occurs almost instantaneously after its production. As a result, a sudden shortfall of supply relative to demand can cause the grid to become unstable; an unbalanced grid, in turn, can cause “brownouts” and outages.

The influx of “Cheap Renewables” can cause the wholesale price to skyrocket 

We’re now in a position to address two critical questions:

1. If over the past decade the cost of generating renewable power has fallen greatly and renewables’ share of total power output has risen sharply, why has the wholesale price of electricity recently skyrocketed to an all-time high?
2. More generally and over longer periods, can the increasing proportion of “cheap” renewables in the generating mix actually raise power’s wholesale price?

The analysis on pp. 11-13 of the full report concludes:

The rising incidence of “firming,” which is a consequence of the increasing role of “cheap” renewable in the mix, when combined with the imperative of balancing supply and demand and power’s inelasticity of demand, doesn’t just produce short-term upward spikes of wholesale prices: over longer periods, it also boosts wholesale prices. Hence renewables’ rising share of total generation can raise the wholesale price of power even as renewables’ LCOEs decline. In short, the growing incidence of intermittent generation increases the external costs it imposes upon the system.

Testing 3 hypotheses against Australian reality 

As a rough rule, the higher is intermittent generation as a percentage of total output, (1) the higher will be the level and (2) the greater will be the volatility of wholesale power prices. Over the past decade, intermittent generation has provided a rising share of power into the National Energy Market; that is, during the first decade of the century it provided little or no power, but since 2010 has contributed a rapidly-rising and now significant percentage (for details, see Decarbonisation: A doubter’s guide for conservative investors).

Throughout this period, this percentage has been highest in South Australia. According to data compiled by OpenNEM, “wind and solar met 60.2% of South Australia's electricity demand over the 12 months to 7 February 2021. Wind energy accounted for 42.2%, followed by rooftop solar (13.7%) and utility scale solar (4.3%).” Accordingly, and notwithstanding the sharp decrease of solar and wind generation’s LCOE but given its high and rising external costs, we can expect to observe that:

1. the real (that is, CPI-adjusted) wholesale price of wholesale power was roughly flat in 2000-2010 but thereafter has risen;
2. since 2010, the real wholesale price has become more volatile;
3. since 2000, given its high share of intermittent generation, the price won’t be lower, could be higher and will be more volatile, in SA than elsewhere.

Figure 1, which plots the combined, CPI-adjusted average wholesale price of power per quarter in NSW, Queensland and Victoria, supports the first hypothesis (Q2 of 2022 covers the period 1 April-1 June). It groups these three states together because their grids are relatively well interconnected. As a result, their prices and volatility are similar: the mean and standard deviation in NSW are $43 and $26 respectively; in Queensland, they’re $44 and $31; and in Victoria they’re $41 and $29. Before 2010, the quarterly mean was mostly below its overall (23-year) mean; since then, it’s mostly been above it. The average price in the most recent quarter has spiked to an all-time high; other spikes occurred in Q1of 2001, Q1-Q3 of 2017 and Q1 of 2019.

Figure 1: The Wholesale “Spot” Price ($A per MWh) of Power, Mean for NSW, Queensland and Victoria per Quarter, CPI-Adjusted

Figure 2, which plots the standard deviation of wholesale prices’ average price per quarter over selected intervals, upholds – at least in NSW, Queensland and Victoria – the second hypothesis. Since 2012, the variability of prices in these states has risen dramatically. So has their dispersion in South Australia – yet the variation in 2007-2012 exceeded the one in 2022.

Figure 2: Standard Deviation, Wholesale Spot Price of Electricity ($A per MWh), Quarterly Data, CPI-Adjusted

Figure 3 compares these three states’ quarterly spot price of wholesale power to the corresponding average in South Australia. It shows that volatility in the form of short-term spikes has been much more numerous and severe in SA than in the eastern states. Indeed, the current spike in SA isn’t the severest: the one in Q1 of 2008 was much worse, and the one in Q1 of 2019 was only slightly worse. Because SA’s wholesale price has fluctuated so much for so long, it shows little upward trend.

Figure 3: The Wholesale Spot Price ($A per MWh) of Power, Mean for NSW, Queensland and Victoria per Quarter, CPI-Adjusted

Although Figure 2 indicates that the volatility (measured by its standard deviation) of prices has been lower in South Australia since 2017, Figure 4 supports the third hypothesis for the entire period since 1999. On a quarterly basis since 1999, the CPI-adjusted average of wholesale prices in New South Wales, Queensland and Victoria ($69) has been much cheaper than in South Australia ($86); these spot prices’ standard deviation has also been much lower (and hence less volatile) in NSW, Queensland and Victoria ($32.50) than in South Australia ($51.48).

Figure 4: Mean and Dispersion of Wholesale Spot Price of Electricity ($A per MWh), Quarterly Data, CPI-Adjusted, 1999-2022

Since 1999, the price of power generally hasn’t cheaper in South Australia than in NSW, Queensland and Victoria: quite the contrary, it’s been dearer. Moreover, both in terms of short-term spikes and its long-term fluctuations, the price in SA has been more volatile than in the eastern states. These results occur not despite the high percentage of renewables in SA, but as a result of them.

 Conclusions and implications

It’s NOT clear that renewables produce the cheapest power

A little humility goes a long way. The cost and wholesale price of power are impossible to predict with any useful degree of accuracy because, financially and technically, its generation, transmission, distribution and retailing are enormously complex. Conceptually, its costs – particularly its external costs – aren’t easy to specify; empirically, they’re even harder to quantify. Nevertheless, the LCOEs of solar and wind power have decreased greatly over the past decade. But so has the cost of gas-fired power.

 As a result, and bearing in mind their externalities and wholesale prices in the NEM, it’s NOT clear that solar and wind energy is cheaper than coal- and gas-fired electricity; if anything, the opposite is true. Moreover, given these external costs it isn’t apparent that in the future intermittent power will become cheaper than baseload power.

My results are hardly the only ones that conclude that an influx of renewables actually means dearer power. One of the most recent refereed studies, published in January, analysed data from 34 OECD countries (including Australia) from 1997 to 2015. Its results “show that the influence of the renewable energy share in the energy mix on retail electricity prices is positive and statistically significant.” Depending upon its market structure, an increase of one percentage point of renewables’ share of a country’s generating mix boosts power’s retail price 3.8-5.3%.

The causes of today’s crisis

Is the rising tide of renewables in Australia’s mix of power sources the sole cause of today’s crisis? Certainly not: nonetheless, governments’ policies of the past 15-20 years, which have increasingly favoured intermittent and penalised baseload (particularly coal-fired) power, are clearly a major – and perhaps its most fundamental – cause. The wholesale spot price of power is innately volatile. And as a result of the significant externalities of intermittent energy, over the past decade its price net of CPI has risen and become even more volatile.

Like the generation of its electricity, Australia’s power crisis is complex. It has proximate (superficial and short-term) and ultimate (deep-seated and long-term) causes. According to advocates of solar and wind power, the crisis results primarily from the unavailability (due to breakdowns and maintenance) of approximately one-third of Australia’s ageing fleet of coal-fired power plants, secondarily from the sky-high cost of coal and gas, and thus from the unreliability and high cost of generation from fossil fuels. These factors, insist the supporters of intermittent energy, have caused power’s wholesale spot price to skyrocket. The solution to the crisis, they add, is to accelerate the use of solar and wind power.

The mainstream’s diagnosis of the crisis isn’t completely false, but it’s woefully incomplete – and thus highly misleading.

It’s true that since February the Russo-Ukrainian War has caused the price of coal and gas to rise. But their prices were increasing smartly during most of 2021. What underpinned their rise? A shortfall of supply vis-à-vis demand. What explains this shortfall? Producers’ reticence to invest in existing and new fossil-fuel projects. And what explains producers’ reluctance to invest? Governments’ policies increasingly favour solar and wind energy, and penalise fossil fuels. An editorial in The Australian (3 June): summarises the sorry state of affairs in this country:

coal-powered plants are failing because they have been driven to the brink by renewable energy policies that have been designed to destroy them … (And) there is a shortage of gas on the domestic market because state governments, in Victoria and NSW in particular, have failed to stand up to a runaway climate agenda that has adopted a puritanical view on quitting fossil fuels. The result is that electricity generators have resorted to burning diesel to keep up with demand.

“Net Zero” Is Gross Fantasy

In response to today’s crisis, the new ALP Government insists that “the push to net zero emissions” must continue. It refuses to acknowledge – indeed, it strenuously denies – that this will at best be technically very difficult and financially extremely expensive. At worst, it’s an enormously wasteful delusion. Alinta Energy’s CEO, Jeff Dimery, identified the crux of the crisis: poor government policy has

swamped the country with renewables (and) in turn made coal uncompetitive. To illustrate his point, he said renewable energy plants in South Australia last Wednesday at 6.15pm were producing one MW of electricity, a tiny fraction of capacity. There was no wind in Victoria either.
“So it wouldn’t have mattered if you had doubled the capacity of transmission, and it wouldn’t have mattered if you had quadrupled the capacity of intermittent generation. Without coal and gas, the lights would have gone out (last week) in South Australia, that is a fact” (see “In the Dark on the Power Struggle: Inconvenient Truths Prove Renewables Can’t Cut It,” The Australian, 10 June).

In this country and elsewhere, intermittent sources supply a significant portion of the total demand for electricity. Equally clearly, given their fatal flaws – namely that they’re intermittent, and their unreliability boosts wholesale prices and exacerbates their volatility – they cannot carry the main burden of supply; still less can they replace the use of fossil fuels in agriculture, mining and transport. 

Although they can’t permanently replace (as opposed to temporarily displace) baseload power, non-hydro renewables can supply as much as ca. 15-25% of a grid’s capacity before their external costs become prohibitive. Australia, Britain, much of the EU and parts of the U.S. have reached or exceeded this threshold – and now find themselves in crisis.

According to Vaclav Smil, the author of How the World Really Works: a Scientist’s Guide to Our Past, Present, and Future (Viking, 2022),

Complete decarbonisation of the global economy by 2050 is now conceivable only at the cost of unthinkable global economic retreat or as a result of extraordinarily rapid transformations relying on near-miraculous technical advances.

Adam Creighton (“Net-Zero Target Is Pure Fantasy,” The Australian, 9 June) rightly concludes: the effort “put into … emissions targets is a waste; they are simply not going to be met.”

Reality Isn’t Optional: Mainstream Politicians Will Eventually Abandon “Climate Action”

Meg O’Neill, Woodside’s CEO, hit the nail on the head (“Energy Security ‘More Vital than Low Carbon,’” The Australian Financial Review, 26 May): “the customer wants energy that is reliable, affordable and lower carbon. But if it’s not reliable and affordable, lower carbon goes out the window.”

The implications are obvious: once the public recognises that “climate action” is a bigger threat to their well-being than climate change, renewables’ popularity will tumble. The “sustainable energy” lobby is a powerful vested interest, but politicians ignore the public – and particularly its hip pocket – at their peril. Accordingly, as renewables’ popularity tanks, politicians will obfuscate, weaken and eventually abandon their pious promises of “climate action.”

The new ALP government intends by 2030 to treble intermittent generators’ current share of Australia’s total output of electricity. Politicians’ rhetoric and journalists’ babble has obscured the key fact that the government’s policy is (more or less) bipartisan: the previous (Coalition) government intended that renewables would supply approximately two-thirds of the market by 2030; the ALP means to raise their share above 80%. The Coalition and ALP claim that their policies will cause retail prices to fall, but “only the most gullible would believe that … After 30 years the promised land of cheap and reliable wind and solar remains a distant mirage.”

Every Prime Minister since John Howard has eventually been forced to choose between “saving the planet” on the one hand and crucifying businesses and households on the other. Anthony Albanese will be no different. The new PM will examine opinion polls, ascertain his electoral self-interest and – damn his solemn promises at the recent election – act accordingly. He will “end the climate wars” by surrendering to reality.

CEOs and funds managers, too, will belatedly realise that their climate posturing is a costly indulgence – and thus toss overboard “ESG” and related terms such as “sustainability.” As The Wall Street Journal (“Climate-Change Sanity Lost and Found,” 10 June) put it: “Michael Moore and Donald Trump can both be right about something – climate politics (is) a corporate welfare scam.”

Investors in the “Energy Transition,” prepare to suffer

Just as surging prices grab consumers’ attention, a bracing bear market brings investors and speculators to their senses. Globally, funding for “clean tech” projects has recently experienced an unprecedented boom. In 2020, according to BloombergNEF, the private sector poured more than $US500 billion into the “energy transition” and governments billions more. Late that year the Wilder Hill New Energy Global Innovation Index, which tracks the shares of 125 global companies that claim to address “climate change,” scaled an all-time high (Figure 5).

Figure 5: Wilder Hill New Energy Global Innovation Index, Monthly, 2000-2021

But events of 15 or so years ago remain highly relevant. In 2006-2011, according to a report published by the MIT Energy Initiative in 2016, venture capital firms in Silicon Valley allocated more than $US25 billion into clean energy technology. These investments soon encountered problems. The GFC – which caused the Index to collapse almost 70% – was hardly the least of them, but it wasn’t the only one. Venture capitalists who’d become accustomed to hefty returns after no more than five years held portfolios full of energy tech startups that struggled to deliver. By 2012, venture capital deals in this space slumped to $US1 billion – tainting the sector and crimping the Index for the next decade.

Since then, much has changed. But none of these changes affect the crucial reality that startups and complex new technologies always carry big risks. “The question is whether this time around, investors are prepared to stand by their climate convictions and stay the course, even if things get tough,” said CNN Business (23 April 2021).

 A year later, things are getting very tough. Will “climate action” withstand rising inflation and rates of interest? Will it survive today’s energy crisis and what might become a recession during the next year or two?

I doubt it. Spruikers, abetted by central banks’ artificially cheap interest rates and governments’ lavish subsidies, have once again gulled investors – including and perhaps especially professionals – into high-risk, low-return bets. Last year, these wagers began to sour (Figure 5). During the next few years, will these losses accelerate more rapidly than renewables’ share of the generation mix? Those who conduct their own analyses, draw their own conclusions – and when necessary, defy the conventional wisdom – won’t be surprised.

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