The Paris Climate Agreement Won’t Perish Under Rick Perry
The last 12 months have been nothing short of exhilarating for those remotely involved in climate and energy issues. After a landmark agreement at last year's Paris Conference on climate, 2016 began with heightened hope that world leaders were willing to take concrete steps to solve the climate challenge. Most recently, hope turned into doubt with the nomination of Rick Perry to head the U.S. Department of Energy. A known sceptic of human-induced climate change, advocate of fossil fuels, and critic of several government-run climate programs, the ex governor of Texas’ nomination have many involved parties worried. As the climate warms up while we discuss, the question is whether Perry will reverse the gains in renewable energy made in the previous administration, defaulting back to the age of oil and coal. Are Paris and Perry mutually exclusive?
Not quite. Policy can certainly be a catalyst for change in young industries, but once economics speak loudly enough, there is no stopping the momentum. Investors have started to lead the way in putting an end to the age of oil and coal. Renewable energy has moved on from being a niche asset class that sacrificed returns (for the sake of a greater good) to becoming an outright compelling investment opportunity. Indeed, last year investments in renewable energy capacity have for the first time surpassed those in conventional sources. Investments in renewables in 2015 were $285.9 billion, a 5% increase from $273 billion the year before, according the United Nations Environmental Programme (UNEP), and representing 53.6% of total added capacity worldwide in 2015, according to Bloomberg New Energy Finance.
Granted, policy was once very important for an infant sector that could not stand on its own amidst the risks of unproven, frontier technologies. Just a few years ago, subsidies and other incentive policies were the only objective argument to attract investors into renewables. The good news is that those incentives have already created an irreversible impact in generating demand and scale of production. As a consequence, the cost of solar cells and wind turbines is now significantly reduced. For instance, the cost of generating energy through solar sources has shrunk from $600 per megawhatt hour just 10 years ago to $100 per megawhatt hour today. Wind generation costs around $50 megawhatt hour. These numbers are not only comparable to coal and natural gas (which average $100 per megawhatt hour, but in fact more attractive, on a global average basis.
Those cost compressions are here to stay. Solar cells will not become any more expensive, and wind will not suddenly stop blowing. The momentum in research-level solar and wind technologies will continue to drive costs down. The latest boost is the plan backed by top business leaders, including billionaire tech investors Bill Gates and Jack Ma, to set up a $1 billion fund for the development of innovative energy technologies. Soon enough, fossil fuels will no longer make economic sense.
Already much beyond its infancy, renewable energy no longer depends on subsidies. Quite the opposite, it is the fossil fuel industry that still enjoyed around half a trillion dollars in subsidies in 2014, according to the International Energy Agency. That is four times the amount of subsidies to renewable sources.
Importantly, these efficiency gains and cost reductions translate directly into market returns. Before 2013, when renewable energy was largely uncompetitive, equity returns on solar and wind indices fell an average 11% and 6%, respectively. Crossing the tipping point in efficiency and cost has made returns on those sources, respectively, jump to 10% and 17% annually over the last three years, with lower volatility.
Bond returns have been quite attractive, too, once accounting for the proper benchmarks. Broader green bond indices, usually an assortment of companies and sectors often unrelated to renewable energy generation, have seen lacklustre returns, much lower than those of appropriately-defined indices. For instance, the S&P Green Bond Index which includes investments in many activities beyond renewable infrastructure has returned -0.5% annually over the last 3 years, while the S&P Green Project Bond Index that only includes such investments has returned close to 6% annually. A similar trend has been noticeable since the start of the index in 2011.
What these numbers mean is that renewable energy can attract capital from parties not exclusively engaged in impact mandates. It is finally possible to make money while saving the planet.
This is a paradigm shift. Perry may have unorthodox views around climate change, but investors can finally look beyond that. What the Department of Energy can do (energy research, managing nuclear weapons, environmental clean-up) is certainly important. Without getting into the details of how policy might move forward, renewable energy as an investment opportunity has become mature enough to stand on its own. The World Economic Forum highlights this in a recently-released handbook. Investors have started to acknowledge the opportunity, and momentum can no longer be reversed. Renewable energy is here to stay. Perry may provide no additional boost to the cause, but Paris will prevail.
Michael Drexler is head of investors industries at the World Economic Forum.
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