A Freakonomics Quorum: How Will the Recession Affect Clean Technology?
Way back when in 2006, here’s what venture-capital legend John Doerr had to say about clean technology: “This field of greentech could be the largest economic opportunity of the 21st century.”
As recently as early 2008, plenty of investors and technology companies were still predicting a clean-tech boom.
But now? With a recession that has scrambled nearly everyone’s spending and investing priorities, with a government deeply focused on the mainstream of the energy economy rather than the fringes, and with gas having fallen to about $2 a gallon, what does the future look like for clean tech?
We asked George Tolley, Professor Emeritus of Economics at the University of Chicago and president of RCF Inc.; John Whitehead, professor in the Department of Economics at Appalachian State University and contributor to the blog Environmental Economics; and Ethan Zindler, head of North American research at New Energy Finance, to talk about this topic.
How is the financial crisis affecting the clean tech sector?
John Whitehead: During the summer of 2008, we were oh-so-achingly close to what economists call the Hotelling switch point. Named after the great economist Harold Hotelling, the switch point occurs when rising nonrenewable energy prices meet falling renewable energy prices and energy users switch from dirty nonrenewable energy (i.e., oil, coal) to cleaner renewable energy (i.e., wind, solar). In theory, nonrenewable energy prices are expected to rise over time as the available reserves begin to run out. Renewable energy prices are expected to fall as the technology available to harness energy from the wind and sun improves and reduces the costs of renewable-energy production. Rising incomes might also increase the demand for clean energy relative to dirty energy, further encouraging the switch.
Historically high prices for oil during the 2000’s were the result of supply and demand forces. War in the Middle East caused speculation that the future supply of oil might be seriously disrupted and the demand for oil delivered in the future increased, driving up prices today. Partially as a result of historically low interest rates, a housing-bubble-fueled increase in economic growth (and the resulting economic growth in China and India) drove up the demand for energy and, again, prices. Other factors were involved, of course, but these are my favorites since they involve historic highs and lows.
At the same time, consumer preferences in the U.S. seemed to become greener with support of two presidential candidates who supported cap-and-trade plans for mitigating climate change. Cap-and-trade will surely lead to even higher nonrenewable energy prices, pushing up the timing of the switch point. President-elect Obama was the greener of the two candidates, and he has promised millions of new “green jobs.” The inevitable renewable energy subsidies will again push up the switch point.
As a result of these reinforcing market and government factors, consumers, firms, and investors were all interested in the prospects for green energy. Green investment talk was booming.
The financial crisis has triggered what many expect to be a nasty global recession in 2009 (the first nine months of the 2008 portion of the recession weren’t really nasty). All of the market-based factors that were contributing to the inevitable (someday) Hotelling switch point are gone. The gap between renewable and nonrenewable prices is widening instead of shrinking.
A good guess is that almost all large, private renewable-energy investments will be put on hold in 2009. In these economic conditions, government subsidies in the form of fiscal policy (i.e., “green jobs”) and renewable energy standards and mandates (e.g., North Carolina state agencies must use 12.5 percent renewables by 2021; my computer may be running off biodiesel by 2015) that would actually cause consumers and firms to switch energy sources and push us closer to the switch point will need to be large and larger.
George Tolley: The financial crisis is having a significant — but not disastrous — effect on clean technologies. Wind and solar power technologies depend on electric utility demands driven by overall electricity use and by state regulations favoring clean technologies. Higher interest rates and demand downturns due to the recession are dampening demand. Florida Power and Light has reduced wind power investments by 500 megawatts, and Duke Energy has dropped $50 million of solar power projects (The Economist, “Gathering Clouds,” November 6, 2008). The hiatus in new home construction is dampening increases in green technologies that conserve energy, conserve resources, and reduce carbon footprints. The recession threatens similar deleterious effects from declines in commercial construction.
On the supply side, investments by manufacturers of green technology-equipment depend heavily on venture capital. Since venture capitalists are not among the mainstream providers of the nation’s credit, they could be affected less than others by the financial crisis. Some green technology firms are adversely affected, not by the credit crunch as such, but by price changes reducing the profitability, for example, of ethanol projects and of CNG vehicles important to the T. Boone Pickens plan (The Economist, ibid.). On net, “over 90 percent of venture capitalists and investors expect investment in green technology to increase in 2009” (Green Tech, “Credit Crunch Pinching Clean-Energy Sector,” September 18, 2008).
The incoming Obama administration makes the longer-term outlook for clean technologies more favorable than at any previous time. Public sector effects should be quite immediate, as federal funds are channeled into public buildings and transportation infrastructure.
Greater lags will occur in the private sector. Realizing the huge potential in retrofitting private buildings will require grant programs for individuals, tax credits, and code changes — none of whose impacts will come about overnight. Tax credits and loan assistance for alternative-energy supplies can increase their market competitiveness and foster private R&D on them. Whether Congress will strengthen existing solar and wind inducements and extend them to clean coal and nuclear energy remains to be seen. Congress will also have a say in the acceptability of the Obama carbon cap-and-trade plan to induce utilities and others to reduce carbon footprints, in part through sequestration. The Obama goals for mileage standards and plug-in cars have not yet passed a reality test. Other options for the future include smart-grid proposals and possibilities for more recycling, whose quantitative effects are unknown.
Many advances remain tantalizingly just over the horizon, as they have for many years. But progress is being made. Public R&D projects at the national labs in partnership with private companies are contributing to basic advances. Further progress will depend on the support and effectiveness of this research, which again brings a prediction of politics into any look at the future.
The major kicker clouding the future remains how high the international price of oil will be; this is a more powerful influence on clean technology adoption than any U.S. policy.
Beyond the technologies already discussed, clean coal technology is not going any place at the moment because, quite apart from the financial crisis, conditions for it to enter the marketplace do not appear to have been met. Nuclear power, while environmentally green in the sense of having no harmful emissions, is impeded by start-up expense and regulatory uncertainty.
Ethan Zindler: Generally speaking, our sector has been impacted like nearly every other in the economy. A sudden lack of liquidity is putting the squeeze on clean energy companies and projects under development.
For clean energy firms looking to scale up, raising capital over the public markets via I.P.O.’s has become virtually impossible in the last few quarters.
For clean energy projects such as wind farms, debt financing has become more expensive, and in some cases out of reach. In the U.S., the problem has been compounded by the fact that we subsidize clean-energy project development with tax credits. Such credits are of little use to companies or banks that have no “tax exposure” due to lack of profitability. Meanwhile, financings for first-generation (corn) U.S. ethanol plants have fallen completely off the map this year for reasons that actually predate the financial crisis.
Our firm closely tracks the flow of dollars into clean energy, and the last several years have seen unprecedented growth. New investment in the sector rose from $33.2 billion in 2004 to $148.4 billion last year. Our preliminary estimate for 2008 is that new investment will fall to $142 billion. The first clean-energy boom, based on cheap and plentiful financing and an ever-rising oil price, appears to have passed.
That said, the industry still looks good for the long run. The fundamentals that spurred its growth originally haven’t disappeared. Yes, oil has fallen since a year ago, but it is still high by historic standards. It’s important to remember that the clean-energy boom took off when crude traded at $50 per barrel or below, not $140 per barrel. Natural gas, which competes directly with wind as a source of power generation, is also by no means cheap today.
Furthermore, climate change concerns have not diminished and the president-elect has signaled he plans to engage fully on the issue.
Then there is the issue of energy security, which got plenty of traction during the recent presidential campaign. The desire in the U.S. to wean ourselves eventually off Venezuelan or Saudi Arabian oil is stronger than ever.
Finally, there is growing hope that the clean-energy sector can be a driver of economic development by providing so-called “green collar” jobs. This has gotten the attention of policymakers who now seem quite keen to support the sector with additional subsidies.
Investment from venture capital and private-equity firms was actually quite strong through the first three quarters of this year, but raising money over the public markets via I.P.O.’s was virtually impossible. Meanwhile, the banks, which had played important roles in financing utility-scale wind, solar, and geothermal projects, have really pulled back. It all adds up to less money for the industry this year than last.
Utilities are a slightly different case, however. If anything, we anticipate them taking a larger and more direct role going forward. For one thing, they have to do so in many states. Roughly 30 states in the U.S. now have some form of mandate on the books requiring utilities to source certain amounts of power from renewables. In addition, Congress recently made a key change to the subsidy for solar projects, making it more advantageous for utilities to finance them directly.
Finally, there is the natural progression of any industry. As clean energy scales up, the bigger, best-capitalized players will inevitably take larger roles, and consolidation will occur. In the power sector, those players tend often to be utilities. Consolidation has already begun and will likely accelerate in the next few years.
More broadly, I think the financial crisis will be remembered as a catalyst for public-policy changes that benefited clean energy. Already, the crisis has helped Obama to win the White House and the Democrats to score major gains on Capitol Hill. Now Congress is assembling a new stimulus bill that could total $500 billion or more and will include expanded subsidies for clean energy.
In years past, budget hawks regularly blocked the industry from receiving long-term subsidy support. As the recession deepens, those hawks are harder to find.