The price is wrong: a book review
The premise of Brett Christophers’ book is that renewables are now cheaper than fossils, so we should be seeing huge investments in renewables, but we are not. The central idea of the book is that this situation is explained by the fact that investments are not determined by what things cost, but by how profitable they are, and that the market for renewables works in such a way as to make them insufficiently profitable. The problem is relying on markets.
I disagree with the premise. A useful way of looking at costs is to see power systems as consisting of different elements that perform different roles, and to ask what the cost-minimising system looks like. At today’s costs, in most countries, costs are minimised with a mix of renewables and fossils. That’s because of the familiar costs involved with transporting and storing renewable energy so that it is available to meet demand patterns.
Moreover, if you really want markets to deliver a renewables boom and displace fossils rapidly, then the cost comparison you are looking at is not that of comparing renewables against fossils for a potential greenfield investment, but whether building renewables will save money relative to continuing to operate incumbent fossil generators, where construction costs have long since been amortised and renewables are competing against fuel and maintenance costs.
Christophers understands all this, and a great deal of the book is spent explaining all the above, and the shortcomings of narrow cost metrics. But for some reason I cannot fathom, he does not recognise that all these arguments undermine his premise and imply there is no puzzle to explain: the costs of renewables are not yet low enough to sweep the board in a free market. [1]
Christophers also documents various investors complaining about the lack of profitability, especially the oil majors for whom the returns on investing in renewables compare very poorly to profits from their oil oligopoly. He correctly attributes this to the renewables market being very competitive. But for some reason he does not recognise that blaming this for slow renewables adoption amounts to arguing we don’t have enough investment in renewables because there are too many people willing to invest in renewables. As some else observed, this resembles Yogi Berra’s famous quip: “No-one ever goes there anymore — it’s too crowded.”[2]
One of the problems with renewables markets he describes is investor reluctance to take “merchant risk”, which involves selling power into a market where prices reflect supply and demand conditions on that day (as opposed to selling power at prices pre-defined by a contract). [3] Christophers points to price volatility, but to my mind it’s not so much volatility that is the problem (a variable can be volatile but also predictable over time) as it is the fear that power systems are already reaching the point where they have all the renewable power they can absorb, with the result that prices hit zero just at those times when you have renewable power to sell. This is a great example of where costs matter for what can be done profitably. If prices are low when renewables are generating and high when they are not, that means battery operators could turn a profit by charging when prices are low and discharging when prices are high. But only if the cost of batteries is low enough! [4]
Christophers demonstrates that government subsidies are still very important to the renewables industry and argues this supports his thesis. But if you accept that renewables are competitive in some places and for some purposes, but still more expensive than fossils in others, then the need for subsidies to tip that balance is obvious, and that includes subsidies in a form that makes it easier for developers to profit. Because nobody denies that private sector actors are motivated by profits.
In chapter 5, Christophers moves from description to explanation. He writes “Let us start with theory. The view that the relative prices of different sources of energy will determine [… what happens] is very much a view from within the economics mainstream” and he introduces readers to an alternative approach, “political economy”, which tell us the production of goods and services “is always initiated on the basic of prospective profit” and “even if they are confident about demand conditions, firms will be reluctant to invest if they think the return on investment is too low”. He continues, rather to my amazement, “this way of thinking brooks no space for orthodox economics.”
I wish critics would be slower to believe mainstream economists are blind to the bleeding obvious. Despite much economic modelling abstracting away from profits, the mainstream treatment of investment decisions very much does look at expected profitability. [5] Christophers goes on “the question nobody — not economists and not McKibben — ever ask is, why, unless externally forced would the electricity industry accept, let along embrace, a highly disruptive transition that lowered production costs but saw little, if any, of the resulting efficiency gains accruing to industry actors.” This is the sort of thing you can only write if you have not paid much attention to what questions economists ask. [6] One of the reasons why we might want market forces to be at work in energy systems it to create incentives for some actors to invest in cheaper generation technology and put other generators out of business.
Later, Christophers discusses the UK power market and describes how it “stacks” generators’ bids from least to most expensive and then dispatches power from the cheapest up until demand is met, with “the price set by the bid offered by the highest-bid generator amongst those dispatched”. He asks: “why does the most expensive generator set the prices received by all?” rather than everyone being paid what they bid, and writes that question elicited “much head scratching”. He then worries that “if bids reflect costs, then might not lower generating costs mean lower bids, lower wholesale prices and lower revenues?” thereby undermining profitability of cheaper generation technology. But that’s why the market is designed so the most expensive generator that sets the market price! That way, the cheaper generators make more money, so there is a greater incentive to be the cheapest than there would be if everyone was paid what they bid.
There is more to say — the book has various examples I would like to discuss. [7] But this is long enough already. Christophers concludes by suggesting state-owned utilities would do a better job of decarbonising power systems than markets. I work for a DFI that invests in private power generation and transmission, but I do not presume the private route is always better. Power markets with private actors (generators, traders, distributors) certainly have their problems and state-owned enterprises might be more effective. But state-run systems have their own problems, and often poor track records, which Christophers does not delve into. Which system generates the best results is a question that would benefit from some empirical answers. It was a shame the book did not attempt to show in the data whether greater “marketisation” is associated with slower renewables build-out.
The full title of the book is “The price is wrong: Why capitalism won’t save the planet”. It might be possible to envisage a market in which power companies are left to their own devices. I would certainly agree that capitalism won’t save us, if that’s what we mean by capitalism. But as Christophers points out, power markets designed by regulators are hardly “free markets.” My view is dull and conventional — we need government interventions in markets because of all the usual reasons (externalities and market failures), but that combined with tools such as subsidies and regulations, markets can be designed to create the right incentives to ride the wave of green technological progress and drive out fossil fuels. How fast that happens will depend on the force with which the state puts its thumb on the scales. I think it needs to push harder.
[1] Christophers also recognises “the legion bureaucratic barriers relating, for instance, to permitting and grid connection” that add to the costs of renewables, but again does not see these as undermining the premise that renewables are now cheaper.
[2] I got this from Ed Crooks on LinkedIn
[3] The problem of marginal cost pricing in the presence of fixed costs is very well-known — here is Geoffrey Heal writing about the general problem in 1980, and here he applies it to the Economics aspects of energy transition in 2020. I think Christophers is quite wrong about the relative costs of different technologies not being the underlying driver of what gets built, but the problems of designing power markets so that the various actors can do what we want them to, and turn a profit, are of course very real. Gallons of ink have been spilt by mainstream economists on the topic of how power market design should change to encourage decarbonisation — more than I could cite here — but for a taster here’s a summary page from Stanfords’ energy program. And countries, such as the UK, that want to use market mechanisms to decarbonise their power systems, also publish mountains of research on the topic.
[4] Once batteries are cheap enough to get built, and they start buying low and selling high, that will bid up prices when renewables are generating and reduce prices when they are not, thereby reducing price volatility until it is no longer profitable to add more batteries. People will then complain about how the battery business is not profitable.
[5] By abstracting away from profits, I mean reducing investment decisions to the marginal return on capital. Here is an example of a (imo, good) paper that derives demand for power investments but does not worry about whether power companies have a profitable business model. I am not sure what to cite to show that less simplified mainstream treatments of investment are based on expected profits. It comes up in hundreds of papers. Maybe this one from 1985 by Majd and Pindyck. First year students are taught how to calculate the net present value (a.k.a. profitability) of investments. I gave all my old economics textbooks to charity, this document has review questions from the relevant chapter of the micro textbook I had, asking, for example, whether it would be profitable to build a factory. There are whole subfields of corporate finance and industrial organisation that dig into the details of how investment decisions are taken and what explains profits.
[6] Again, I am not sure what is best to cite here. Perhaps Nordhaus “Schumpeterian profits in the American economy: theory and measurement or maybe Griffith and Van Reenen “Product market competition, creative destruction and innovation.” Those are about incentives for disruptive innovation in general — when it comes to electricity there are hundreds of a papers on power market design that study the incentives they create within the industry.
[7] For instance, he recounts research showing that steam power was adopted in England’s factories despite water power being cheaper, because the mobile nature of steam gave capitalists more bargaining power against labour and hence was more profitable. I don’t dispute that those dynamics influenced decisions, but that example does not overturn the idea that costs drive decisions. Products have different costs, they also have different attributes. A power source that you can only use if you have access to a suitable site is not the same thing as a power source that is more flexible. My belief that relative costs are ultimately what drives energy investments does not imply I’d choose a technology that generates electricity for $0.01, but only at midnight during a leap year, over one that costs $0.05 any time, any place.
