Energy Transitions for the Economy: A Sustainable Future or a Sunk Cost Fallacy?
- Rishikesh Madhuvairy
- Oct 24, 2022
- 6 min read
Figure 1: Global Generation of Renewable Energy, Varied by Energy Source and Distribution, From 2005 to 2016
From coal, oil, and fossil fuels - labeled as the “backbone of aggregate demand” - to renewable energy, energy transitions, similar to technological/capital advancement, have been a central cause of productive improvements and development. Although this is part of a coordinated attempt by governments to mitigate the impacts of climate change on the global economy, the feasibility of these transitions from a multisectoral perspective is questionable. It is imperative to further analyze the current patterns of government investment in renewable energy resources, and, based on public expenditure/revenue variations, consider the true contributions of both the public and private sectors, to successfully “transitioning” towards green energy reserve consumption and manifesting the externalities it entails. This can reveal the influence of market forces over the cost, supply, utility, and replenishment of renewable energy resources. Such energy transitions are intended to be cost efficient and profitable, but can be harmful for consumers and supply chains, as we’ve already witnessed with the increase in gas prices worldwide.
However, these transitions are necessary to prevent the worsening of the current climate emergency and global energy crisis as a result of geopolitical tensions such as the Russian invasion of Ukraine. But the questions arise: How long can these explorations and usages of energy reserves be held to reduce our fossil fuel footprint on Earth, before the fruition of numerous negative prospects regarding where the global economy is headed, such as a permanent recession, significant trade deficits for many large global exporters of renewable energy, or sinking consumer costs and nullified profits? From a monetary perspective, how long can these initiatives be sustained, before the incentive to continue disappears, simply because it's hard to generate “off-grid” energy in selective scenarios, such as in underdeveloped nations, forcing us to inefficiently make yet again, another energy transition? The speculation arises that this scenario could be nothing but a sunk cost fallacy, where governments drastically and perpetually increase their public investments in the fossil fuel market, just because such a significant proportion of their public revenue has been spent on the resources they can leverage in the same market since the Industrial Revolution, and therefore, there is no solution but the continuation of the same. This sunk cost fallacy could be doomed to occur until climate change, once and for all, wipes us off the planet, but the outcomes of this energy transition are indeed, endless.
To analyze this in detail, we can compare government subsidies for coal, oil and gas in non Organization for Economic Co-operation and Development (OECD) countries, to show the affordability of the ongoing energy transition into the rising renewable market by the general public.
Figure 2: Graphical Comparison of OECD Governments’ Subsidies For Different Fuels
We can immediately observe the difference in supply-side incentives for the production and utility of non-renewables for economies such as Iran, Saudi Arabia, and Russia, in which non-renewables are readily available, valued at a mean of US$60 billion. Ideally, a reduction in these subsidies lowers supply and thus consumer surplus to an equilibrium at which the negative environmental externalities exceed consumer rewards from the mass production and subsidization of oil industries, simply because cost-inefficiency slowly becomes an issue for non-renewable production that is no longer subsidized. Consumers also forego the same cost while transitioning — which in itself, is a market force exerting its influence on the prices of renewables.
Worldwide legislative inefficiency has prevented the market for renewable energy from reaching its potential, which correlates to a lack of government spending on the renewable sector, considering the implementation of fiscal policy (as inflation and the inability to tackle it are vividly indicating to us at present.) A transition to a “green” market for electricity and heating is dormant in these contexts, simply due to government intervention aimed at balancing their international trade balance according to which form of energy is most profitable (often fossil fuels) – essentially implying that a transition induced by either Environmental Law or a reduction in subsidies is often deferred or half-heartedly developed, which is the likely case for these economies that have massive Gross Domestic Products from non-renewable exports. Off-grid energy, including solar power, photovoltaic cells (incredibly low in long-term development cost), hydrogen fuel cells, and to the most marginal of subsidy distributions, hydroelectric power, is simultaneously prevented from being implemented in many developing economies due to the investment expenditure required for offshore drilling, installation, geotechnical modifications, and construction of catchments and electric power stations to supply a constant level of voltage per district — thus also imposing an unnecessary burden on the local government. Vietnam is an ideal case for this economic issue, as despite their commitment to a national Electricity Law, production processes for heating using coal and natural gas are still subsidized at 16 percent of their original private costs. However, globally, as per developing Sustainability Acts to fix public investments onto achieving Sustainable Development Goal 13, aiming for affordable and clean energy, the transition is picking up some evident traction. Private markets for renewables are witnessing a decrease in costs never witnessed before, where developing economies contributed at least 33 percent of these investments in 2018. Private businesses that have structured risk-return models are increasing their use of renewable transport, industrial housing, and domestic utility, starting with hybrid fuels. This is strengthening the global supply of renewables for electricity from around 3.5-4 percent in 2014, to 23.5 percent of all resources for electrical power as of 2018, as shown below.
Figure 3: Percentage Distribution of the Global Generation of Renewable Energy (2018)
The rationale for the investment expenditure into the renewable sector also explains the drastic decrease in price, which questions long-term economic viability as these technologies are still developing.
Projects commissioned for geothermal and wind energy have also seen remarkable decreases in private costs due to the immediate implementation in developed nations,such as the Eurozone and Scandinavia, thus avoiding accumulating diseconomies of scale as the projects grow in size and monetary value. Figure 4 shows the lifetime costs (which are defined as on-site construction and maintenance of power plants, project development, and capital gains divided by the lifetime output in megaWatts-hour) for different renewable energy sources that have contributed to this boost in the market, and how their cost patterns can be tied to why some governments have decided to divert their share of public revenue to the same:
Figure 4
The stability of lifetime costs for wind and solar power incentivises their use, resulting in at least 15.7 percent of all power being generated by these two resources in the US, which is a rapidly increasing number. However, even under government policies such as subsidies, conflict arises. Subsidies in the US have failed to produce the same effect on emissions as corporation taxes , - they have led to an almost negligible reduction in the burning of fossil fuels. In fact, major metropolitan areas are witnessing a tremendous spike in carbon emissions, which once again makes us question how prominent, in terms of costs and expenditure, this energy transition truly is in the more developed economies, which seem to have more dynamic fossil-fuel trade and higher inflation levels.
An emerging contributor such as India’s investments in this transition are depicted below in Figure 5, according to variable sources of energy and its generation capacity, which once again documents the energy transition to economic growth correlation, as India rises to the forefront of mass domestic production of goods and services in the global economy. The nation has more recently introduced Small Hydropower initiated by private industries in large urban areas, and smart city Metropolitan Development Authorities to reconstruct their infrastructural frameworks via the usage of renewable resources, as shown by the supply curve:
Figure 5: Aggregate Supply Curve For Renewable Energy Sources in India, Categorized by Source Type
The debate continues, considering the challenges of implementing renewable energy programs made up of new, underdeveloped technologies, unlike fossil fuels which have been manufactured and dynamically operational for centuries. This introduces barriers to gas storage, endorsement, transport, and public facilitation of renewable energy. These have had a profound effect on government investment. Therefore, the value of Corporate Research and Development for this market substantially increases, as it is necessary to refine the aforementioned resources to reduce their lifetime cost. However implications on the economy from the primary macroeconomic perspectives of labor, trade, and inflation, are highly conflict prone, as proven earlier. Hereafter, the aforementioned possibility of a sunk cost fallacy will become more prevalent as long as governments reassess their capabilities of developing technologies which utilize renewable power, and act on the same in either direction. Right now, being unable to graduate to a modernized source of electrical and thermal power, due to the sheer quantity of investments that have already contributed to the fossil fuel market for decades, only reveals this possibility to a never-ending extent, hinting at a multitude of challenges that our global economy has yet to face.
References: Introduction to Project Finance in Renewable Energy Infrastructure: Including Public-Private Investments and Non-Mature Markets - Farid Mohamadi
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