A Change in Climate Part I: The Global Economic Environment
What follows is the first post in our series on the Obama administration and its likely policy on climate change. In this piece, we focus on the challenges presented by the global economic slowdown.
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One of the major symptoms of the current economic crisis has been the dire state of global credit markets. These frozen credit markets have made it very difficult to finance renewable energy projects. These projects require significant amounts of capital up front and provide returns over long periods. With debt financing so scarce, and alternative energy stocks mirroring the general decline of world markets, the necessary capital has become increasingly difficult to obtain.
Investment in clean energy technology achieved record highs in 2006 and 2007. Public investment in clean energy cratered in 2008; the WilderHill New Energy Index, which tracks leading alternative energy companies, has fallen over 60% since December 2007. Financing concerns led even T. Boone Pickens, who recently became one of the most publicly visible advocates of alternative energy, to drop-at least for the time being-his plans for a multi-billion dollar wind farm in west Texas.
The stock market meltdown has caused significant collateral damage for many sectors. For renewables, the damage has been the drying up of “tax-equity” funding; trading investment dollars for the tax credits available to alternative energy sources (specifically the production and investment tax credits available to wind energy producers). The tax equity market is constrained because the major players in that market (for example, GE and Wachovia) are no longer in a position to benefit from tax equity investments-others, such as Lehman Brothers, no longer exist. Even where profitable companies are operating, the complexity of tax equity deals and the uncertainty of the markets create hesitation, even where a tax equity deal would lower the company’s effective tax rate.
Notwithstanding the recent bad news on renewable energy investment, there are reasons to believe that in the long term, investment in renewables will return to its previous high levels. First, the economic downturn will lower commodity prices, meaning that the raw materials that go into turbines-and the turbines themselves-will be considerably cheaper. One of the largest suppliers of wind turbines to Europe expects its profit margins to increase next year, even with turbine demand falling.
Perhaps even more importantly, the renewable energy sector is supported by public policy. President-elect Obama has already indicated his support for an investment program built around “green collar” jobs and clean technology. The Obama program would create 5 million new jobs and would include investment in commercial renewable energy projects, as well as improvements in energy efficiency and in converting to a digital electric grid. Many see this “Green New Deal” as a way for government investment to create new jobs and rebuild the economy while also transitioning to a cleaner economy. Direct government investment is only one policy tool available to the Obama administration. When the stock market revives, tax incentives like the PTC and ITC can again play an important role.
Renewable energy is not immune to the troubles in the larger economy. Still, the sector has several advantages that should help pull it through the downturn. Significant government support, and the likely infusion of taxpayer money, should help renewables achieve the competitiveness with traditional energy sources that has been long-expected.
The current economic downturn has also created another challenge for those looking to tackle climate change: low oil prices. When a barrel of oil reached $146 and a gallon of gas topped $4.00, the public demand for hybrids, electric cars and renewable energy accelerated. Now, however, the price for a barrel of oil has dropped to a 20-month low. Recently, oil has sold below $56 a barrel and in some places a gallon of gas can be bought for under $2.00. OPEC is now cutting production to stabilize prices between $70 and $90 a barrel. The question now is whether the momentum behind seriously reducing the United States’ dependence on foreign oil and investing heavily in alternative sources of energy has been turned back by falling energy prices.
This summer, when oil prices hit record highs, public and political scrutiny focused on the record profits of oil companies and support built for enacting a “windfall” profit tax. President-elect Obama proposed a tax on oil companies when crude prices exceed $80 a barrel. The taxes collected through that program were intended to fund a stimulus check for taxpayers. At currrent prices, this issue has been taken off the table.
Notwithstanding the recent drop in oil prices, volatile fluctuations in the price of oil and the expectation of higher prices in the near-term has maintained investor interest in alternative energies. For years, oil held constant near $30 a barrel; many alternative energy projects, however, began when oil prices were even lower than that. Even with oil prices falling from their record highs of July 2008, the fundamentals of the market still point towards growth in alternative energy investment.
Putting aside short-term fluctuations, finite-and likely declining-supplies of oil and hugely increased demand by emerging markets like China and India create a constant upward pressure on oil prices. The International Energy Agency forecasts that oil prices will fluctuate around $100 a barrel for the next few years and double to $200 a barrel by 2030.
Another reason that temporarily lower oil prices will not mean the end of investment in alternative energies is that growth in the sector is supported by public policy. Tools such as Renewable Portfolio Standards (RPS), renewable fuel mandates and mandatory carbon caps have been enacted by various states, and similar discussions are underway at the national level. President-elect Obama has proposed a national RPS requirement beginning at 10% of all power sources by 2012 and increasing to 25% by 2025.
While in the short run oil prices may remain low, the shift away from dependence on foreign oil, the effect of fossil fuels on climate change and the interest in creating new “green” jobs will continue to spur development of alternative energy sources in spite of temporarily lower oil prices. Lower gas prices will also not likely mean a return to the SUV-dependent focus of the U.S. auto industry. The industry is in a crisis; its struggles due to a sharp drop in sales as a result both of the economic downturn and the credit crisis’s effects on consumer finance. As a result, Ford and GM have asked the federal government for a bailout program. An infusion of taxpayer money or loan guarantees would likely come with conditions on retooling factories to produce cars with increased fuel-efficiency and other eco-friendly touches.
It is hard to see how the lower cost of oil would not in the short-term dampen enthusiasm for renewable energy projects. The longer-term view remains however, that oil prices will return to their previous heights and continue to rise, and that various broadly supported policy goals, such as reducing American dependence on foreign oil and addressing catastrophic climate change require significant investment in alternative energy sources. As President-elect Obama said in his first post-election interview
[Addressing climate change is] more important. It may be a little harder politically, but it’s more important…We go from shock to trance. You know, oil prices go up, gas prices at the pump go up, everybody goes into a flurry of activity. And then the prices go back down and suddenly we act like it’s not important, and we start, you know filling up our SUVs again. And, as a consequence, we never make any progress. It’s part of the addiction, all right. That has to be broken. Now is the time to break it.