Guide to Challenges in International Economics

An article by: Riccardo Fallico

Unless we bring back the concept of energy scarcity, we will not be able to survive in a world powered entirely by renewable energy sources. Energy transition plans cannot ignore that to meet our needs, fossil fuels must play a role in the future energy mix.

At UNFCCC COP 28, the UN Climate Change Conference in Dubai (November 30 – December 12, 2023), despite statements by moderator Ahmed Al Jaber, Sultan of the United Arab Emirates, that “there is no scientific evidence to support the theory that by eliminating fossil fuels we can mitigate global warming,” the discussion focuses on the investments needed to phase out gasoline-powered vehicles and fossil-fuel power plants. It should be noted that more than 100 countries have already committed to tripling their renewable energy production capacity by 2030. At the same time, 22 countries declared their intention to triple their nuclear power generation capacity by 2050.

USA and Europe put forward proposals to finance green policies

The United States and Europe have already put forward concrete proposals to finance green policies aimed at reducing net carbon emissions to zero by 2050.

In the USA, President Joe Biden has made combating climate change a pillar of his mandate. During the 2021-2022 period, two bills were presented to the Senate: the Infrastructure Investment and Jobs Act, which became law in November 2021, and the Build Back Better Act, which, given strong opposition in the Senate, failed to pass. Besides, in order to combat galloping inflation, the president signed a federal law in 2022 on combating inflation, Inflation Reduction Act, which provided for reducing the budget deficit, investing in projects across the country for the production of environmentally friendly energy products, and combating climate change. According to the Joint Committee on Taxation (JCT), between 2023 and 2033, a total of $783 billion investments are expected, of which $663 billion will be in the form of tax breaks and $27 billion to create the fund, designed to directly finance projects or technologies for reducing or eliminating pollution from carbon dioxide or other greenhouse gases. The report by Credit Suisse for 2022 puts forward projections that spending on the Inflation Reduction Act could exceed 800 billion dollars. Goldman Sachs projects that total US government spending will be as high as $1.4 trillion. According to the 2023 study by Wharton University, the oldest business school in the world, founded in 1881, the costs would be $1.045 trillion, and more recently, research by Brookings Institution, a think tank focusing primarily on economic research, provided a total costs estimate of approximately $900 billion.

Europe promotes the European Green Deal

Even on the Old Continent, to avoid competition in the US energy sector under the Inflation Reduction Act, a massive zero-emission energy financing project was developed and got the name European Green Deal (EGD). The main goals of EGD are energy-neutral economic growth and socio-economic justice, whereby all citizens should benefit from a green economy. The European Commission also said it has adopted energy, fiscal, and transport policies that will reduce net carbon emissions by 55% compared to 1990 levels. In this context, already in 2020, the European Commission took the first steps by announcing a new “sustainable” financial strategy, with the mission to ensure that the financial system fully supports the energy transition, also in light of the economic challenges caused by Covid. Some of the innovations introduced included a new and clearer classification of sustainability performance categories, a standard for European green bond issues. In addition, the concept of resilience was introduced into the risk management process. In the package of 1.8 trillion euro, which was allocated to the NextGeneration EU Recovery Plan, 37% of funds, or about 750 billion euros, was allocated to EGD. At the same time, the intention was announced to fill 30% of the NextGenerationEU budget from issuing green bonds.

Commitments by Saudi Arabia and the rest of the world for a sustainable future

The United States and Europe are not the only ones who have promised more sustainable future scenarios, both economically and environmentally, but they are certainly the ones who have promised more financial resources to implement them. Suffice it to say that at COP 27 in 2022, Saudi Arabia, the world’s largest oil producer, stated it was willing to allocate $2.5 billion over the next decade to support clean energy projects in the Middle East and promised to meet its goal of achieving zero carbon emissions by 2050.

Today, the USA and Europe are already beginning to reap, albeit minimally, the benefits of their aggressive policies for financing clean energy projects. The New York Times newspaper, between September and November 2023, highlighted the positive impacts of the Biden government’s clean energy policies. Even the smallest companies in the renewable energy sector have been able to access the financing needed to implement their projects. Wall Street, according to analysts cited by the authors of the Financial Times, is able to provide a figure of about 80 billion dollars per year to finance the development of technologies to reduce greenhouse gas emissions and combat climate change.

In the beginning of December 2023, Reuters stated that the boom in investment in the production of electricity from renewable sources in Europe even allowed for a significant reduction in forward electricity prices, which fell to 105 euros/MWh throughout the first quarter. The price for the first quarter of 2024 is comparable only to that recorded before the Russian special operation in Ukraine (24.02.2022).

Economic and financial problems of companies in the renewable energy sector

However, as always, there seems to be the other side of the coin in this mad race for incentives for the clean energy sector. The Financial Times newspaper in early October 2023 and Bloomberg in the end of November of the same year highlighted the economic and financial problems of companies operating in the renewable energy sector. The main problem is that governments have started an economic process that the market no longer seems to support. S&P Global Clean Energy Index, a stock index covering the world’s 100 largest renewable energy companies, is down 20.2% over the past four months. This is the worst result recorded since 2013. In addition, over the past six months, the capitalization of the largest green companies in the USA has burned by $30 billion in the US stock market.

Renewable energy: obstacle course

The future faces obstacles for renewable energy. Three cyclical reasons can be identified. The first reason is directly related to the monetary policies of the world’s central banks, primarily in the USA and Europe, which have recently raised their interest rates to counteract rising inflation. Since renewable energy companies base their profitability on long-term future earnings, inflationary pressures that are causing, on the one hand, the economy slowdown and, on the other hand, high financing costs are stifling their profit prospects in the short to medium term. This makes the investment even more expensive as future cash flows are under pressure due to the high financial costs that must be borne. It is not surprising that financial market operators have strengthened their positions in the oil and gas sector, which, thanks to forecasted high prices, manages to withstand economic challenges caused by inflation and high financing rates.

The resurgence of nuclear power reduces the attractiveness of other renewable energy sources

Another potential reason for the future unattractiveness of the renewable energy sector is the resurgence of nuclear power. The COP 28 statements are just the latest episode in a debate leading to reassessment of the role of nuclear energy.

The trigger is the constant increase in world energy needs: in 2022, although growth was lower than in 2021 (+2.1% against +4.9%), the increase was higher than the annual average for the 2010-2019 decade, which was 1.4%. In July 2022, the European Parliament has approved a resolution defining investments in gas and nuclear projects as “green” investments. When we talk about nuclear energy, the disasters of Chernobyl and Fukushima immediately come to mind, focusing the nuclear energy debate only on the potential risks of power plant failure. Experts agree that there are only three cases of nuclear “catastrophe”: Three Mile Island (USA, 1979), Chernobyl (Ukraine, 1986), and Fukushima Daiichi (Japan, 2011).

Classification of damage caused by these three episodes is between 5 and 7 (high-consequence accident and catastrophic accident), according to INES (International Nuclear Event Scale). Looking at other aspects of energy production from nuclear fusion, it cannot be denied that from a supply stability standpoint, it is much more reliable than renewable energy sources that depend, by their very nature, on the weather conditions of the areas where they are located. In addition, it should be added that the production efficiency of today’s technologies from renewable sources is still low. In terms of emissions, nuclear power production has zero emissions. Many, however, argue that nuclear power is not a clean source of energy at all, since the radioactive waste generated in the process of thermonuclear fusion is extremely dangerous for the environment. However, in this regard, it may be worth remembering that we are often silent about the environmental and recycling costs of the infrastructure used to produce renewable energy: a study of the US Yale University has shown that in the years ahead, recycling of solar panels, which have a useful life of about 25 to 30 years, will develop very quickly, as the market for the precious materials used to produce the panels themselves could be worth up to $15 billion by 2050. However, today technologies for recycling and recovering photovoltaic panel materials are still in their infancy, and this process is not all that simple and safe as it might seem. Already in 2021, the Technology Review magazine from MIT stated that “Recycling solar panels is a pain.” As for the environmental impact, consideration must also be given to the expansion of installations: be it photovoltaic panels, wind turbines, or the creation of basins for hydroelectric dams, the associated risks include loss of habitat for animals, destruction of fauna, which leads to irreparable damage to the environment and to the relocation of animal species that need to be evacuated.

The attitude of end consumers to energy also dictates its own rules

Regardless of economic or technological circumstances that may change, what does not change is the attitude of end consumers towards energy itself. The energy transition cannot simply be a political manifesto left to “financial charity” in the form of subsidy programs or tax breaks by national governments, nor can it even be the slogan of a passing fad. We are leaving behind a period of stable and constant energy supply that led us to believe that we do not need to pay attention to the constant increase in energy consumption, be it electricity, heating and/or cooling, or fuel for our means of transportation. We cannot accept that all goods, primary or secondary, that we consume have an intrinsic energy value that arises from the energy costs associated with the production, logistics, and distribution of the goods themselves.

Unless we bring back the concept of energy scarcity, we will not be able to survive in a world powered entirely by renewable energy sources. The Sultan of the United Arab Emirates at COP 28 may have exaggerated when he spoke of going back to the Stone Age, but energy transition plans surely cannot ignore that to meet our needs, fossil fuels must play a role in the future energy mix.

It is perhaps no coincidence that all declarations talk about net zero emissions, implying that renewable sources and new technologies will have to offset greenhouse gas emissions coming from some other source.

Economist

Riccardo Fallico