Oil and renewables don’t mix (weekly) 3

While there has been talk that falling oil prices may erode renewables’ competitiveness, the opposite view is gaining ground.

Infrastructure Investor has dedicated considerable space reporting on falling oil prices over the last couple of months. We have noted that it has affected different sectors and markets in different ways.

Moreover, it’s not only the media which is preoccupied with the topic. One analyst we spoke with said the price of oil is factored into practically every sector analysis their firm conducts.

This week, we take a look at whether – and to what extent – the drop in oil prices impacts renewable energy. In late January, rating agency Fitch cited oil price reversal as “a key factor” that is weighing against renewables’ competitiveness.

Many industry experts, however, disagree. A week after Fitch issued its note, Adam Sieminski, the head of the US Energy Information Administration (EIA), said he did not expect the drop in oil prices to have much of an impact on wind and solar energy.

Georgina Hayden, senior power and renewables analyst at Business Monitor International (BMI), agrees: “Our general view is still that it poses a limited threat and I think the consensus is coming around to that now.”

That’s the general gist – but there are nuances that need to be taken into account.

As another source pointed out, oil does not compete directly with renewable energy since oil is no longer a major component of power generation, while wind and solar are solely used for producing electricity.

“If you look at the US for example, oil has been a diminishing fuel source for power generation for the past four decades, now accounting for less than one percent of the electricity mix. It’s really very limited,” Hayden states.

And that’s where the nuance comes in. While oil no longer plays a dominant role in power generation in the US, the renewables sector in other countries and regions – such as Mexico, the Middle East and South America – which do rely more on oil for energy production, may feel the pressure.

However, while the price of oil has dropped, so too has the cost of renewable energy. Newer and better technology has made renewables more efficient and therefore more cost competitive. According to one lawyer, certain projects have even reached grid parity. A drop in coal and gas prices would have more of an impact.

Even in the case of natural gas, the damage would be limited because while natural gas competes more directly with renewables, it also plays a complementary role, serving as a back-up fuel.

What hurts the renewable energy sector most is uncertainty, one of the other factors Fitch cited in its note as threatening investment in this area.

Government policy has not always been clear or consistent. In the US, the sector is characterised by peaks and troughs in investment due to one- or two-year tax credits that come into effect, expire, and are sometimes reinstated retroactively.

One solution would be to provide a tax incentive over the longer-term that would decrease over time. That at least would provide the much-needed certainty and clarity investors in the renewables sector need to plan ahead. Another solution is to address the problem through comprehensive tax reform.

However, most industry insiders we spoke with expect the uncertainty to continue. And that uncertainty could prove more damaging than any issues around the oil price.