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ALTIF Transcripts: The price is wrong: Why free markets and climate don’t mix

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TBS Note: Here’s a one-off transcript from Jonathan Ford and Neil Collins’ “A long time in finance” podcast. We were carrying these weekly in our first year, but had to discontinue them due to insufficient transcription resources (automatic ones just aren’t good enough to post without having to double check them manually). But apparently, the below one is an unmissable episode, so here is an unedited transcript of the show. 
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What if our understanding of capitalism and climate is back to front? What if the problem is not that transitioning to green energy is too expensive, but that saving the planet is not sufficiently profitable? This is the conundrum at the heart of economist Brett Christophers’ provocative new book. Neil and Jonathan joined him to discuss why lower wind and solar costs may not equal a green bonanza.

Presented by Jonathan Ford and Neil Collins.

With Brett Christophers.

Produced and edited by Nick Hilton for Podot.

In association with Briefcase.News

Jonathan Ford 00:05
Thanks for listening to a long time in finance with Jonathan Ford and Neil Collins in partnership with briefcase news for service that brings intelligent curation and analysis to your media money. In the decade to 2020, the average cost of electricity generated from offshore wind fell by 56%. And for solar energy, the figure was 87%. So by the turn of the decade, many thought the price of power from wind and solar was actually love flow and fossil fuels for the first time.

Surely, they all said that opened the door to a massive crossover. As cheap renewables supplanted fossil fuels, there’d be no more need for subsidies to support them. But then, a funny thing happened. Despite these low prices, there was no massive increase in renewable energy. Instead, it plunged into crisis with developers scrapping projects and demanding more government support, not less on a global level. Meanwhile, renewables have scarcely made a dent in the energy picture in 1985, fossil fuel plants supplied 65% of electricity, and in 2022, it was 61%. Now, our guest today is an old friend of the show, Brett Christopher’s an economics professor from Uppsala in Sweden. Now his new book, The price is wrong claims to explain this paradox why lower renewables prices? If they really are Allah haven’t led to a crossover with renewable energy simply taking over? And I have to say, having read it, it’s a genuine tour de force and explaining the economic dynamics of energy in the energy transition, even if you don’t believe that renewables are the answer. So we thought we’d get Brett on to explain himself. Brett, welcome. Thanks for having me. Well, maybe we should start with this paradox.

And why have these price reductions that you point to at the start of the book, not driven as sort of massive switchover to renewables that people talked about?

Brett Christophers 2:08
That’s the million dollar question. I guess, why is that the case, when a the cost of generating electricity from solar and wind has has come down so much, and B when the expectation, as you also said for such a long time was that once the costs have come down sufficiently, and once it was as cheap or even cheaper to generate electricity from renewables as from gas or coal, that the transition would kind of speed ahead. So despite those price reductions, there are still some very, very fundamental economic obstacles to a faster transition. And in making that argument, what I’m not doing is saying that the other sets of factors that other people typically point to like sclerotic planning, you know, slow permissions for grid connection, all those sorts of things.

I’m not saying that they’re not relevant factors. They’re absolutely irrelevant factors. But what I am saying is that the arguments that they are the only relevant factors, which is an argument we increasingly hear, which is that look, the economics have been solved. So now it’s all about politics and planning, and those sorts of obstacles. absolutely not true, there are still some fundamental economic obstacles. And the basic argument I make I make in the book is that we’ve kind of been hoodwinked a little bit in how we think about this price, the price of generating the electricity, whether from gas and coal, or from renewables, or from or whatever else is actually the wrong thing to be focusing on and that what we should be focusing on is the profitability of developing wind and solar. And in particular, it’s the expected profitability of developing wind and solar. So when developers sit down to plan a new wind farm or a new solar farm, what are their expected revenues? What are their expected costs? And in particular, what does that mean, in terms of their ability to raise the necessary finance, which is typically debt financed, typically loans in order to fund the construction and installation of that wind and solar farm? So are they able to raise that finance at a cost that means that they are still able to make profit?

Firstly, profitability in renewables is typically very, very volatile. That’s the first thing and that in and of itself, that has a chilling effect on investment unless means can be found of
stabilising expected revenues in particular, and there are all sorts of different mechanisms for doing that. So that is a chilling effect. The second one is that even leaving aside that question of volatility profitability in the business of owning wind and solar farms and generating the electricity and selling that electricity is typically relatively low, and of course that has a significant fact on the private sectors willingness to invest in developing those facilities, I just want to make two other points before coming back to the first one is this, which is to say, none of this is to say that the price of generating it and the fact that that price has come down is insignificant. Of course not. It’s one of the factors that plays into the profitability and the expected profitability. Of course it does, it’s a very significant factor. But it’s not the only relevant factor. And in focusing on price we’ve been focusing, we’re kind of only one part of the profitability equation, and not the totality of it. The second point, which I think is very, very important, is is the question of why does this issue of profitability matter? And the reason it
matters is this is that if you look around the world today, essentially, it’s the case and there are there are certainly some some regional differences here, China would be a significant exception, which I think it’s important to come back to, but for the most part, governments around the world, the strategy, they have adopted visa vie the energy transition is to say, look, we are leaving it up to the private sector, it is up to the private sector, to develop and operate renewables facilities. And our role for the most part, as governments will not be building an
operating publicly owned renewable power facilities, our role will be essentially kind of a nudging role. But of course, if the private sector doesn’t see the consistent and high enough level of profitability, it’s not going to invest. And my argument in the book is that that has been and continues to be a very significant obstacle to the energy transition. That’s

Neil Collins 06:34
all very well, as far as it goes. I mean, I would challenge quite a bit of that. I don’t think that the cost of wind energy is what we’re talking about, has fallen anything like as much as the headline figures suggest, there all sorts of questions about the longevity of the system, the fact that the easiest ones areas to exploit, have already got wind farms on them. And that’s before you get to the point where it is intermittent, and you need something to provide the electricity when the wind isn’t blowing. These are really key points, in my view. And I don’t think that the industry is taking account of that. And I think that the reason why we’ve built what we’ve built is because of continuing subsidies one way or another, and the sort of complexity in the system, which allows the operators of the wind farms to game the system to their advantage, because they know that if they can’t produce the juice, then there’ll be backup somewhere from some fossil fuel plant, which is sitting there quietly rotting away, because it’s not being used this month. I mean, I am hugely sceptical about the ability of wind farms to provide more than a modest slice of our electricity. Right.

Brett Christophers 08:08
I agree. And I disagree. What I would start by saying is that a lot of those issues, maybe even all of the ones you point to are definitely relevant issues. And let’s take intermittency as a good example of that. So the fact that the wind doesn’t always blow in the sun doesn’t always shine. What I would say there is that opponents of renewables and maybe by extension, you know, continuing champions of fossil fuel based power, have made too much play of the intermittency issue. However, I also think that a lot of people on the other side of the fence have underplayed, the significance of intermittency. Absolutely intermittency is important. I think the second thing I would say, is that the data shows that the prices have come down very far in terms of generating cost. So I think what you were saying is, well, they’ve exploited some of the low hanging fruit. And I think that’s right. And so what I mean by that is this, let’s take a kind of hypothetical example. So put it this way, say you have a wind farm developer. And let’s say you also have a fossil fuel conventional power plant using natural gas, let’s say for the sake of argument, that those two facilities can produce exactly the same amount of power that they can sell for exactly the same price. And that let’s say that it is cheaper for the for the wind farm to generate the power than it is for the foot for the fossil fuel plant. Now, a lot of people will say, Well, that means that the wind farm will be more profitable than the power plant because it has lower generating costs, and they have the exact same revenues. But in fact, of course, that’s not necessarily the case.

As someone who has a geographical training maybe maybe I’m kind of predisposed to say this, but a big part of the reason for that is geography. The costs that an electricity generator incurs are not obvious see not only the cost of generating the power, it also incur significant cost in terms of delivering that power to where it needs to be consumed. As anyone who knows anything about renewables will tell you one of the consistent features of renewable power everywhere in the world, including the UK, but not only the UK, is that renewables facilities tend to be disproportionately located precisely where people don’t live. So in the UK is case wind is almost entirely concentrated in the north, not least in Scotland, whereas obviously, the centre of gravity of the population is in the southeast. And what that means is that the delivery costs for renewable power to where power is consumed, are typically much higher for renewables developers for renewables owners than they are for conventional power plants. So yes, the generating costs for wind power might be lower. But in a sense, that’s an artificially low generating cost, because it’s only low because of a very low land cost either land acquisition or releasing cost because of that locational decision.

Jonathan Ford 11:05
Now, Neil has attempted to thrust his pilum into the soft underbelly of your argument, I thought I turned to this one, too, down to some of the points you you raised, and the one I want to focus on is price volatility. Yes, your point you make is that the price volatility, either kind of scatter of prices that appear in in electricity markets that we’ve created are a disincentive to people to invest in new generating capacity, because they’re uncertain what the price outcome is going to be. It seems to me that renewables are not in any way a solution to that problem. Indeed, they’re potentially at a very high level of concentration, a contributor to the problem of volatility in that if you think about a grid that’s entirely dependent on wind, in theory, on days of strong wind production, that everyone is bidding in that marginal price of almost nothing. I mean, you point into your book in some of the bizarre pricing outcomes that occur when there’s just too much power on the grid and prices go negative. So you would have potentially this ridiculous situation that in the perfect condition to produce wind power, the price is zilch. And when you have no wind, the price is very high. But no one can produce any power. We’re just sort of stuck with this problem. Are we not that in a system where electricity is traded in the way we think it is? And the argument being that it’s the way of delivering the lowest cost solution? The price signal, if you like, to developers and investors is not a very friendly one?

Brett Christophers 12:48
No, I think that’s absolutely right. The prices are very, very volatile. And there’s all sorts of factors that contribute to that price volatility. But what you what you end up in is this kind of really bizarre situation where for renewables developers, and it is specifically a problem primarily for renewables developers, rather than for a company that wants to develop and raise finance for a new gas fired plan. But for renewables developers, they’re in this weird situation where in order to raise finance, to develop a facility that will then sell power into the wholesale electricity markets, they basically have to show their prospective finance years that they have done and will do everything in their power not to sell their electricity at the market price. So it’s kind of like this bizarre situation where there’ll be selling into markets, but but kind of doing everything they can not to sell at the market price is necessary to in actually incentivize that development in the first place. And of course, they do that in different ways. They can do it either through some kind of financial instrument, a hedging instrument of some sort, like buying futures contracts, they can do it through agreeing a long term fixed price power purchase agreement with say, a utility, or increasingly with a corporate purchaser, like an Amazon or Google or someone that says we’ll buy all your electricity for the next 15 years at a fixed price. Again, that helps provide the revenue stability that Financier has looked for, or through some sort of government sponsored tariff, like a feed in tariff or, or what they’re called these days a contract for difference, where developers basically effectively get promised a fixed price for their electricity over over a certain period of time.

That’s where we’re at now. And what I would say there is if electricity markets continue to be designed and structured in the way they are, then that problem of price volatility will remain and as you say, will probably become even more apparent as the share of renewables on the grid increases and therefore those mechanisms to offset that price volatility will continue to be completely necessary in order for renewables developments to get off the ground. One thing that a lot of people will say is look, then we need to completely redesign the way in which electricity is bought and sold. Those electricity markets we have in liberalised electricity markets around the world were split, specifically designed and built in a fossil fuel world. And they broadly worked in a fossil fuel world, but increasingly, they don’t work in a renewables world, I can see your hand up and just before just before you come back in those arguments these but here’s the thing, during the energy crisis of 2021 22, both in the EU and in the UK, long standing questions around the design of electricity markets came to the fore again, because suddenly everyone was apoplectic about, you know, sky high electricity prices. And those reviews took seriously the question of redesigning electricity markets. But in the EU, which has concluded its review, they’ve ultimately backed away from any significant changes in electricity market design.

Jonathan Ford 16:10
But my point is that it’s not just renewables, which don’t build in the electricity market that we have. I haven’t looked at it recently. But certainly, a few years ago, it was the case that in the UK, despite a clear need for some gas capacity to either stay on the system will be particularly be built new capacity. Nothing had been built for years and years. And it was impossible for utilities or developers to put a case to bankers to build a gas plant in the UK. And the same could be said, obviously, for nuclear energy, which shares some of the characteristics of a renewable plant in that it’s a lot of upfront capital and low operating costs. But you’ve placed your bet at the beginning. So you’re very dependent on a stable price profile to pay back the debt.

Brett Christophers 16:57
Yeah, in the case of both gas and nuclear, yeah, the price volatility is not the debilitating effect. It’s not price volatility that is principally warding off new investment. For example, in the case of gas, I think the UK gets many things wrong. And UK finance gets many thing means things wrong. But compared to the US, for example, I think investors and banks in the UK are now much less willing to finance fossil fuel intensive energy generating facilities than they are in say, the US where they’re simply happy to continue to do that. Again, this comes back to one of the questions that Neil had, I think the other thing is that as the share of renewables on the grid increases, the business plan for a new gas fired plant becomes less and less viable over time, because the proportion of time the capacity utilisation factor for that plant looks worse and worse and worse, which is why the UK has things called capacity markets were one of the ways in which you can incentivize new plants that can always provide power and called upon

Jonathan Ford 18:04
The other aspect of this, which we haven’t touched on yet is the structure of the industry, yes. And the decision that was taken in the UK in the 1990s, to effectively split it up between generators, distributors, and retailers. And while that process exists in the US, there are lots of the parts of the US where it remains the case that electricity supply is vertically integrated to the opposite model. You talk about low profitability, to what extent is that a function of that sort of structure that’s been adopted, it’s definitely a factor. If you are a vertically integrated entity by which we mean an entity that covers the whole supply chain for electricity, then there’s a certain kind of like obvious logic around switching to the lowest cost generating source. But once you disaggregate the industry, and by which I mean once you kind of cordon off the different parts of the supply chain, like the UK has done, then that logic doesn’t really work. Because the generators are not selling to the end users. They’re selling into wholesale market. And so that kind of overarching logic begins to break down, there has to be an interest in selling power. At that low price. There has to be a producer interest in doing that. And when you disaggregate the supply chain, you make things much, much more complicated in terms of the rationales of the different actors in the chain.

Neil Collins 19:31
Could I ask, we have seen the big oil companies essentially rolling back from renewables? We have because their shareholders have been saying to them, we don’t see how you can make any money out of this. And the pressure from Green activists has pushed them too far down that track. And they’re now saying, well, we’ll, we’ll still do some renewables because we want to be good citizens, but basically, the return we can get on them is not attractive to a business which is used to the sort of returns you get in oil and gas. Why do you think that has
happened? Now?

Brett Christophers 20:14
I think your reading of what has happened is completely right. The only part of that story that I would add to because I think that there’s been a very important regional difference here in the strategies of the of the Big Western oil and gas companies. So let’s leave aside the whole question of state owned oil and gas entities in the Middle East and Russia and so on. In the West, by which we mean Europe and North America here, the major European oil and gas companies, which obviously are BP, Shell, and total, and particularly BP, around 2019. And 2020, they did begin to talk an increasingly compelling game on renewables in the US that never really happened Exxon and Chevron, kind of just, you know, turned up their noses at campaigners and politicians and said, No, we’re going to just carry on with what we do we make a shitload of money, we’re happy to continue doing that and stuff it. And what happened, of course, as the two different sets of entities said these things, and as BP and Shell and total began to expand their renewables operations, two things happen. Firstly, the profits of the US ones remained sky high. And the profits of the second begun to get affected, albeit only very minimally, because their investments were still very small, and their share prices began to want to go in completely different directions. So the share prices of Exxon and Chevron can continue to climb, and the European fossil fuel company saw their share prices go down, at which point, certain sets of institutional investors kind of cried foul. And it was exactly at that point that as you say, those European fossil fuel companies began to backtrack, you know, it’s a really straightforward story that fits perfectly into the narrative I make in the book, which is that their core businesses are much, much more profitable than renewables have ever been, and are ever likely to be. Okay.

Jonathan Ford 22:04
So that raises an interesting question, which is, why are we doing all this? We’re doing all this transition, because of concern that we don’t want to pour so much carbon into the atmosphere, everything you’ve told us so far suggests that the system we have is not delivering the goods that you think it ought to. And it’s not doing it for some quite fundamental reasons. And the only pool that there is, is the government throwing subsidies in their direction. Is your argument, essentially, that we’re stuck with this system, and we just need to throw whatever subsidies are necessary at the problem to make it go away?

Brett Christophers 22:39
Before answering that question. Can I throw one little wrinkle into it? Which by which I mean, just expanding on your premise, you’re saying My argument is that profitability represents the expanding on your premise, you’re saying My argument is that profitability represents the significant hurdle. And that’s the issue. That is what I’m saying. But here’s the thing, right? If you look at the recent data for, say, 2023, renewables grew faster than ever before. And there was all sorts of very excitable press commentary about this. Here’s the thing that people forgot to kind of really focus on, which was the question of where was that progress occurring? Almost all of the increase in 2023 occurred in China 90% of that delta of that increase in its forecasts was accounted for by China. So essentially, is the one place that has been doing very, very well on renewables and is expected to continue to do very, very well on renewables is the one place in the world where renewables development is not dictated by the profit motive the rest of the world. Yeah, I think we are stuck there with this, unless governments are prepared to bear the burden themselves, by which I mean, finance, develop, own and operate energy generation facilities, principally renewables themselves, which as far as I can tell, no significant government, I’m willing slash able to do unless they’re willing to do that, then they have to do one or two things, either they have to completely redesigned the way electricity is bought and sold, or Absolutely, they will have to continue to provide the support mechanisms that they currently provide, which are a mixture of subsidy and stabilisation.

Jonathan Ford 24:26
Yeah, you say that the government taking a more leading role in financing owning operating, which I suppose if you think about a historic model would be the Tennessee Valley Authority and the Tennessee Valley Authority in the United States sort of came into being because the profitability incentives for utilities to electrify relatively poor parts of the countryside in parts of the United States was simply too low, and the government therefore took a decision to build hydroelectric dams. Build coal fired power stations or whatever in the Tennessee Valley and in the south of the United States. Why can’t that happen?

Brett Christophers 25:07
Again, I think it’s a mixture of all sorts of different things that are partly economic, partly political and partly ideological, right. And when we, you know, whatever your views on on the rightness or wrongness of the direction in which the world has been heading politically, economically, in recent decades, it’s pretty clear that we’ve been heading in a direction that is away from public ownership, rather than towards public ownership of these types of assets. The UK would be probably almost the most extreme example of that. And now it’s kind of an article of faith that the government shouldn’t be in the business of owning and financing these types of assets. But it’s not just political, ideological. I think that in certain countries, you know, there are massive fiscal constraints on the ability of governments to do that. I don’t happen to think personally, the UK is an example of that. I certainly don’t think the US is an example of that. And I can see Neil wanting to jump in here. But let’s be honest, in the parts of the world where the biggest energy transition challenges exist, Southeast Asia, Africa, in particular, there are arguably the majority of governments there have massive operate and a massive fiscal constraints, their borrowing capabilities are both more constrained and at much higher costs. And so while I think it’s very easy for the likes of me on the left to say, look, the government should just be, you know, deficit funding this because they can borrow at relatively cheap rates, compared to the private sector and so on. Well, may be in certain rich countries. But I definitely don’t think that’s the case. In other parts of the world, my

Neil Collins 26:38
underlying grumble with all this is that I don’t think that the government has been honest with the public in terms of the cost of any sort of green transformation.

Brett Christophers 26:51

Now I have I happen to agree, I don’t think they’ve necessarily done it in bad faith. But I fear as as an instinctive labour support drive, absolutely have a very strong fear based in an understanding of how this works, that the the argument, you know, that we’re going to transition more rapidly to a green electricity system, and that we will do so while bringing down costs to consumers is based on pretty profound misunderstandings of how a lot of this works. And I worry that using the cost argument as a rationale for decarbonisation is actually a really, really dangerous thing to do, because I think it can come back and bite you in the art. For me the argument about about decarbonisation should be to get off fossil fuels. It shouldn’t be a cost on me, it should be a decarbonisation. I’m in an energy security argument.

Jonathan Ford 27:47
I think I’m broadly with you all I just in Neil’s defence that I know he’s going to write fig.

Neil Collins 27:53
All right, I don’t need I don’t need you to defend me. All I would say you have the aspiration, that’s fine. And I don’t think the government is duped us. I don’t think they understand the first thing about thermodynamics and about the need for energy supplies.

Brett Christophers 28:11

Oh, I agree. I agree with you, I totally agree with you, and trying to fool us.

Neil Collins 28:15
And that’s the word I would use into thinking that this can be a relatively painless process. And magically, we will all be green by 2035 or 2050, or whatever the number is now is basically a self delusion on their part. And I’m very disappointed.

Jonathan Ford 28:37
Get the message the customer?

Neil Collins 28:39
They won’t, they won’t tell the truth. They know.

Jonathan Ford 28:41
What I take away from this is is the idea that fundamentally, you have to look at this as a question of what are you trying to achieve rather than what is the economic shift you’re going to go through? The only thing I would say is that the way in economics intersect still with this question is, there probably is a point where the behavioural changes you impose on people were the cost to be very, very high, you know, the cost to be very, very high, will be so substantial, that you might think twice, you might say the economic costs of this, maybe we need to find other ways around this problem.

Brett Christophers 29:18

The thing that I would want listeners to take away is that electricity is bloody complicated. Anyone who thinks that the these issues around the financing and the development of the energy transition are in any way kind of simple and straightforward, really doesn’t understand what’s going on.

Jonathan Ford 29:37
Well, all I can say is having read your book that it is tremendously well done in terms of you know, lifting the lid on the electricity industry and giving you a sense of quite how complicated these challenges are. So congratulations, a fantastic achievement.

Neil Collins 29:56
That was a long time in finance with Jonathan Ford and Neil Collins production editing by Nick Hilton on our sponsorship partner briefcase dot news if you enjoyed the show please rate and review it on your podcast app because that will help new listeners find us.

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