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Highlights
  • The oil price spike of the early 1970s raised the alarm in OECD markets about the geopolitical risks of over-reliance on oil
  • Pricing reform in the oil markets brought about a decline in prices in 1986 and the renewable’s market was brought to its knees
  • Renewable power is now much more resilient due to oil’s weakening influence in the power sector
  • Renewables will have a strong grip on the power sector going forward and may actually start to influence oil market dynamics

 

Introduction

The oil price spike of the early 1970s raised the alarm in OECD markets about the geopolitical risks of over-reliance on oil, prompting a concerted effort to bring new, home-grown renewable technologies to commercial viability.

But when pricing reform in the oil markets brought about a decline in prices in 1986, the renewables market was brought to its knees. In the US, tax credits expired, and politicians embracing a new era of lower oil prices were not motivated to renew them. As the oil price depression continued into the late 1990s, Japan’s Sunshine Programme was dismantled, and the baton was passed to Europe where a few national governments introduced support regimes for renewable energy on the back of environmental concerns. However, it was not until the Renewable Energy Directive in 2008, when oil prices were peaking once more at $97/barrel, that the European Union put in bloc-wide targets to support the industry.

If history is to repeat itself, an industry collapse is certainly what should be happening now. In 2016, the prices of two key oil benchmarks, Brent and WTI, hit the $27/barrel mark, the lowest level since 2003. Brought on by a supply glut caused by the US shale oil boom and OPEC’s reluctance to rein in its own production and lose market share, along with lower-than-expected demand, the crash is one of the most acute in the industry’s history.

Just two years earlier, those same benchmarks were trading at over $100/barrel and thus the 2014–16 crash saw 75% of the value of a barrel of oil wiped out in less than 18 months. By comparison, the last oil price crash in the 1980s – coming after a sharp oil price spike in 1973 – saw oil prices fall by around 60% over six years.

History of Oil Prices
History of Oil Prices

Renewable resilience

So why has the industry proved so resilient this time round? The answer lies partly in oil’s weakening influence in the power sector. Whereas in 1973 oil made up 25% of the world’s power mix, now it represents just 5% which means that renewables and oil are no longer directly competing in the power markets. Therefore, any dip in oil price has less impact on the ability of wind and solar, for example, to compete.

However, while oil certainly has less of an impact on the power market than it did in its heyday, the wind and solar sectors would be unwise to underestimate the indirect influence of oil on electricity prices and therefore renewables’ ability to compete.

…but still exposed to Oil

Unlike oil, gas and coal do compete directly with wind and solar in the power mix, and depending on the market, the price of oil can certainly impact the price of both of these commodities.

This relationship is most evident in the case of gas. At the one end of the spectrum, large Asian power markets such as Japan, China and South Korea source liquefied natural gas (LNG) almost exclusively under oil-linked contracts. Here, the price of oil and gas are heavily correlated, which means that when oil crashes, gas is sure to follow. Indeed, Japanese LNG prices have fallen 69% since 2014, and the country’s utilities are under pressure to significantly cut electricity rates where they have not already.

In the middle is Europe, which buys some of its gas under oil-linked contracts from Russia, Norway and North African nations, and the rest is traded on liquid market hubs, sourced from domestic suppliers and from Qatar and the US.

Finally, in US there is almost no direct correlation between oil and natural gas prices, and plummeting natural gas prices have far more to do with overproduction of domestic shale gas than the international price of oil.

Cost reductions

Significantly, renewables investment has continued to grow in all three of these markets. This suggests that there is a second reason, other than the weakening oil-power link, for the resilience of renewables this time.

The answer lies in the significant cost reductions that have been achieved by wind and solar over the past few years, which means that these technologies are now able to compete with fossil fuels on a levelised cost of energy (LCOE) basis.

Global new investment in renewable energy by sector, 2015, and growth on 2014, $bn (image courtesy of UNEP).
Global new investment in renewable energy by sector, 2015, and growth on 2014, $bn (image courtesy of UNEP).

Onshore wind is, in many locations, at wholesale grid parity with an average cost of $45–70/MWh. Although this is heavily dependent on location, most studies conclude  that onshore wind is now cheaper to build than new-build gas plants ($65–120/MWh), coal ($80–120/MWh) and nuclear ($100/MWh).

Meanwhile the cost of solar PV, at $100–150/MWh, is at retail grid parity in many locations, making it highly competitive in the small-scale PV markets. And, in some locations, solar PV is even competitive at wholesale grid parity. Last year a 200 MW plant in Dubai was offered a power supply contract at just $58.50/MWh.

Opportunity

Furthermore, with oil and gas majors slashing capex and dividends in an effort to cut costs many investors are now looking to the renewable industry as a safe haven. But the question remains, what happens when oil prices start to rise significantly again?  I’d argue that by the time they do, renewables will have a strong grip on the power sector and may actually start to influence oil market dynamics – and the hunted could become the hunter.

Therefore, it is not so much a question of how lower oil prices impact renewables, but more of a question of will oil prices recover at some point and will that boost renewables even further? We’re likely to see that renewables supplement shale gas in putting a cap onto the oil price.

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References
  1. Renewable Energy Focus – Crude ambitions – Volume 17, Issue 4, July–August 2016, Pages 153–155
  2. https://energy.gov/sites/prod/files/timelines/Hero.jpg

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