German Energy - Shock to the system: An industry struggles to cope with a change in government policy

An interesting article from The Economist. A nice follow up on my previous article.

You can read it here

European Energy Policy and the Future of Renewables in the EU

Since the nuclear disaster of Fukoshima, the European energy sector has been under significant political pressure to shift energy production from nuclear to renewables. Germany was the first large EU economy to dictate the closure of its nuclear plants progressively for the year 2022. This decision will heavily impact the economy in terms of costs that will ultimately transfer to society. In fact, energy analysts expect that the cost of the measure will burden the economy with 40 billion Euros and 45 million tons of additional CO2 emissions. Nonetheless, politicians across the EU hope that the development of renewable energy sources –like solar and wind- will complement the energy mix in a sufficient way as to comply with the growing energy demand.

Since the last decades and as a direct consequence of the signing of the Kyoto protocol, Europe has become one of the regions with the lowest CO2 emissions. Approximately 30% of the world’s CO2 emissions come from the EU, however EU countries assume almost 80% of the cost of the world’s CO2 emission reduction policies. While in the EU the cost of each ton of CO2 produced is approximately 17 Euros, the rest of the world does not pay a single euro for it. In stead, countries like China and India are growing at astonishing rates and are relaying on CO2-emmiting mineral sources of fuel for energy.

As a consequence of the expected future of nuclear energy in the EU, a substitution effect can be observed nowadays in the market. Investors have started to shift resources towards alternatives sources of energy like solar, wind and even gas. However, the energy outlook of the EU and the expectations of a new –green and safe- energy mix, does not ameliorate the problems of overcapacity and decreasing margins that solar and wind energy producers have been experiencing lately. The reason of the decreased profitability comes from one major factor: government policies that once assured a “prime” price for KWh of electricity produced are now expected to be progressively reversed as a consequence of downstream saturation. Lets take solar energy as an example. Even if the differences in the governmental policies are significant (feed-in-tariffs of 110 Euros/MWh in Germany vs. 290 Euro/MWh in Spain), the solar energy producers are having trouble even with the decreased costs of their main raw material (poly-silicon) and the improvements in solar cell technology. In fact, the estimated average return in terms of IRR of new solar energy farms is barely above 10%. But how is it possible that with decreasing raw material costs, new technologies allowing higher efficiencies and significant government subsidies still in place, the ROI of solar energy producers is significantly declining? The answer is wide but has its root in the initial motivation for capacity installation … easy money!

Guaranteed cash flows over a long periods of time (average 20 years) trough government feed-in-tariffs for electricity combined with large growth opportunities, have derived in overcrowding of downstream energy producers in the market. Furthermore, upstream manufacturers (solar cell manufacturers) have also “smelled the cash” and have integrated downstream production to their business, exacerbating the problem even further. The promise of guaranteed cash flows at premium price also provided the wrong signal to energy producers that have developed their projects at astonishing debt-to-equity levels averaging 80%. In fact, overcrowding of solar energy producers in the EU is not expected to disappear in the short run. As long as the barriers to entry are low and the expected revenues artificially high, new companies will keep on entering the market. However, optimal financial planning and cost reduction is the less important aspect of solar producers trying to obtain the 20-year long, guaranteed premium price-per-KWh incentive provided by many EU governments. Nonetheless, if these companies had different motivations and would develop their projects under strict methodologies aimed at decreasing costs and increasing profits, there would be a better outlook in terms of cost-per-KWh for the consumer.

Solar and other sources of clean energy could become more profitable in the near future and an important part of the EU energy mix even without large government incentives. The so-called “grid-parity” -the point where alternative sources of energy can compete with traditional sources in terms of costs- is far from been reached if the excess capacity persists and the technologies and cost efficiencies are not effectively transferred to the consumer. Furthermore, if the governmental subsidies are not effectively utilized, the persistent of pervasive signaling will be present in the industry providing further incentives for highly indebt projects and lower cost efficiencies. The misuse of government incentives and unsound financial discipline of private holdings has resulted in higher costs for the EU consumer that will ultimately pay the price for the European energy revolution. It is expected that in the following years, EU citizens will pay some of the highest electricity prices in the world.

Electricity Storage: the holy grail of the renewables industry

It seems that despite the new Smart Grids (a new type of grid that leverages on communication technology, allowing to save energy by better managing supply and demand) without a cheap and efficient mechanism to store energy, the role of renewables as a major component of the world's energy mix is still far from reality.

The intermittence of renewable energy sources (like wind and solar) is still a major factor that calls for a technological breakthrough that would allow to store energy in times of low demand and advance towards the replacement of fossil fuel energy generation.

Check out this article on FT.com here

Esther Duflo - Ending Povery

Esther Duflo, MIT economist and co-founder of the Poverty Action Lab, asks why the worlds poorest people tend to stay poor. Duflos pioneering research applies randomized trials, used extensively in drug discovery research, to development economics. What she discovers are strategies for transforming current approaches to development policy.

Source: Youtube

Which countries have had most, and least, GDP growth per person since 2001?

In a technology driven world, natural resources rich countries seem to have the best conditions for economic growth. The chart below makes me think about the accuracy of the capital accumulation model of growth (Solow Model) and it's relevance today.

Equatorial Guinea -a country that has largely exploited its oil reserves in the last decade- seem to have the highest GDP per capita growth. On the other hand, largely devastated countries with a social conflict and lack of institutions like Zimbabwe and Haiti, have the lowest measure of GDP per capita.

Check out this interesting chart from The Economist:

Source: The Economist On-Line at: http://www.economist.com/blogs/dailychart/2011/06/gdp-growth?fsrc=scn/fb/wl/dc/haresandtortoises