The modern energy transition grew up in an era of easy money, near-zero interest rates and low inflation. Venture capitalists, project developers and governments contend today with a very different situation. Can they keep up the momentum on decarbonisation when investors expect something for their cash?
Between January 2009 and November 2015, the US federal funds effective rate did not exceed 0.2 per cent — quite a change from the early 1980s, when it reached about one hundred times that level. That climbed to a still moderate 2.4 per cent in 2019, then fell back to near-zero in response to the Covid-19 pandemic.
The European Central Bank's (ECB) fixed rate was even lower, and actually zero between March 2016 and July 2022.
Now, in a quick march of rates rises, the US Fed rate has reached 4.65 per cent and the ECB 3 per cent. Short-term rates are seen peaking at about 5.1 per cent while falling back longer-term to about 3.6 per cent.
This is in response to the need to choke off inflation before it becomes embedded. US prices began accelerating in early 2021 with the Covid-related stimulus, hit a peak of 9.1 per cent in June and have since fallen back to 6 per cent.
European inflation has been even higher, because of the surge in gas and electricity costs after Russia’s invasion of Ukraine, and reached an all-time eurozone record of 10.6 per cent in October.
Energy itself drives some of the problem. High oil and gas prices contributed to the jump in inflation in 2021 and 2022. In the longer term, decarbonisation will require heavy investment, often fuelled by government deficit spending, and throwing away much still-productive capital locked up in fossil-fuel assets.
The 2050 net-zero carbon target will require doubling the current annual energy investment to $173 trillion, according to strategic research provider BloombergNEF.
That is something like a quarter of what we currently invest worldwide across the entire economy.
Economic protectionism is particularly in evidence in energy, as the US with its perhaps misleadingly named “Inflation Reduction Act”, the EU and the UK aim to outcompete China in areas such as batteries and electric vehicles.
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They are concerned about over-dependence on China and Russia for critical minerals such as lithium, cobalt, nickel and rare earths.
China has been the key driver of falling manufacturing costs for renewable energy systems over the past decade. A complex welter of tariffs and “buy local” preferences will end such frictionless trade.
Carbon prices are an essential and more efficient economic tool, yet still add to the end-user cost of energy. Producing “green” steel, aluminium, cement and plastics using renewable electricity and hydrogen filters through to the costs of building things.
This applies not least to new energy systems, which require large quantities of materials. Low-carbon shipping fuels will lead to higher costs for delivered goods.
Eventually, these alternatives will improve to the extent they are superior to and cheaper than fossil fuels, but the transition period can be painful.
But a higher cost of capital and tighter money make it harder to deliver that transition.
Most of the key low-carbon technologies have higher upfront capital costs than the fossil alternative, but lower operating costs. A wind or solar farm, once constructed, requires only minimal maintenance and no fuel input to churn out electricity for two or three decades. An electric car is cheap to charge and, with fewer moving parts, less prone to breakdowns. This means that higher interest rates put them at a relative disadvantage.
The very low costs of delivered solar power in recent years, particularly in the Middle East, were facilitated by cheap capital. Supply chain issues mean that panels have become at least temporarily more expensive. Our calculations at Qamar Energy suggest that a solar farm delivered for 1.5 cents per kilowatt-hour in 2021 would see its cost rise to 2 cents because of higher equipment bills, then to almost 3 cents due to the greater cost of capital.
This is still very cheap by historic standards, and better than fossil alternatives, but higher than the industry had become accustomed to and on which net-zero carbon plans had been based.
The move up from near-zero interest rates also affects venture capital. Money in recent years poured into energy start-ups and growth companies: in electric vehicles, not just Tesla, but also Rivian, Lucid Motors and fraud-hit lorry maker Nikola Motor. Even without profits, revenues or a working model, they were valued in the tens or hundreds of billions, more than Ford or GM.
This was an attempt, of course, to emulate the success of early investors in stocks such as Alphabet and Meta. The energy tech space is much less forgiving: capital-intensive, long development and deployment cycles, heavy government regulation, and safety and environment imperatives. “Move fast and break things” is not an appealing motto for an electric plane.
The world still needs these breakthrough technologies, in areas such as atmospheric carbon dioxide removal, space solar, nuclear fusion and advanced fission, alternative batteries to lithium-ion, engineered geothermal, novel electrolysers and many others.
The question is how to keep venture capitalists interested when interest rates are well above zero and payoff comes — if it comes — after a decade or two.
The outlook for inflation and interest rates is critical: will demographics, maturing economies and cheaper low-carbon energy push rates down again, or will activist governments, deficit spending, a decarbonisation splurge and the end of the deflationary “China shock” keep them elevated?
Geopolitical imperatives aside, de-globalisation or “slowbalisation” indicates economic stagnation with higher inflation, hampering the energy transition.
Bureaucratic procedures and excessive deference to special interests reduce the deployment of major new infrastructure to a crawl, magnifying the impact of more costly capital.
Governments need to imaginatively bring money into long-term breakthroughs, but also accelerate their journey to reality.
After economic shocks, pandemic and war, we need to reconcile the end of near-zero with the start of net-zero.
Robin Mills is chief executive of Qamar Energy and author of 'The Myth of the Oil Crisis'
