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 / Autumn 2011 / Issue 64(originally published by Booz & Company)


Renewable Energy at a Crossroads

The wind, solar, biomass, and geothermal sector has grown in fits and starts — and now may have the momentum to become a self-sustaining industry.

In 2007, renewable energy sources were poised for accelerated growth. Then the global economic downturn intervened, depressing energy demand in general and casting particular doubt on the business case for wind, solar, biomass, and geothermal energy. Now that the sector is beginning to grow again, some industry observers are still questioning whether the market is resilient enough to continue that growth, considering the volatility of energy prices and a shifting political climate. The answer is more optimistic than one might expect, because the market has evolved in several important ways during the last few years; it is unlikely to experience the periods of decline or stagnation we have seen in the past. One of the hallmarks of the renewables sector today is its structural diversity in terms of technologies, players, and geographic regions — and that will make all the difference.

The story of the new wave of renewables begins in 2005, when a number of diverse factors came together. The first was an incentive for change: Power prices jumped as natural gas prices reached a historical high. The second was an opportunity: Technology advances led to significant reductions in renewable energy costs. Finally, the investment community, flush with capital, began to invest in the sector in earnest.

But by far the biggest driver behind the growth of renewables during this time was meaningful policy support, at both federal and state levels in the United States, and also around the world. With a focus on fighting climate change and jump-starting new industries, legislators adopted a wide range of incentive mechanisms to support the development and adoption of renewable energy technologies.

Recognizing a favorable investment environment, private equity and venture capital firms committed more and more money to the clean-tech sector, which is heavy in renewables, between 2006 and 2008. At the peak, these investments exceeded US$10 billion per year in North America alone. Then the global financial crisis hit.

Boom to Bust to Balance

During the first year of the crisis, pessimism about the sector returned. Many of the underlying factors that had converged to drive demand for renewables faded, and others became highly uncertain. For example, one of the key elements supporting the business case for renewables was the high price of electric power, which in turn was anchored to high natural gas prices. That dynamic shifted with the development of unconventional gas resources; most analysts forecast that natural gas prices will remain below $7 per million BTUs for the foreseeable future.

The worsening economic conditions have also brought a shift in political priorities, one that favors budgetary restraint over fresh spending on environmental issues. Some federal subsidies supporting renewables may be sacrificed in forthcoming cutbacks. State and local support could likewise fall prey to state budget reductions.

The economic slowdown also caused overall electricity demand to decline, resulting in overcapacity in most U.S. power markets. Less generation translated into lower power prices, which weaken the business case for renewables.

Yet despite this uncertainty, the market continued to evolve in important ways, setting the stage for a return to economic viability and growth. This evolution took place along two broad dimensions.

• Technological diversity. The renewables sector is far more diversified today than it was in the early part of the 1980s, when renewable energy generation (other than from long-established hydro sources) was primarily reliant on biomass. Biomass — both wood and waste — accounted for more than 70 percent of renewable power generation installations through 2000. Although it was a convenient and economical source of power in areas like California and the northeastern United States, biomass demonstrated limited potential for either rapid technological improvements or large-scale capacity development. Wind and solar technologies, meanwhile, were in their embryonic stage.

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