Commodity Cycles and Renewable Energy Costs

It's an article of faith for many that the costs of renewable energy sources will continue to decline, even while the costs of many other forms of energy increase. This view is supported by the impressive experience with both wind turbines and solar photovoltaic (PV) installations over the last couple of decades. The latest survey of US solar cost trends from the Lawrence Berkeley National Laboratory (LBNL) showed that between 1998 and 2009, the capacity-weighted average cost of PV installations fell by more than 30%, from $10.80/Watt to $7.50/W, with another drop of roughly $1/W occurring during 2010. However, it's important to think about what's behind these trends when assessing their future progression. Continued cost declines are subject to many uncertainties, not the least of which is the current rising tide of commodity prices as the global economy recovers.

The rationale for continued cost declines that I encounter most often is based on volume: If we install more wind and solar capacity, costs will fall in a virtuous cycle, making subsequent installations cheaper and prompting even more of them. The underlying logic behind this argument derives from empirically observed "experience curves", in which cost components such as manufacturing fall by a set percentage for each doubling of cumulative output. The problem with these curves is that they tend to flatten out fairly quickly, delivering their maximum effect in the early years of a technology, when doublings are frequent. Then they slow significantly as the technology gains scale and the interval between doublings grows. A look at global wind turbine capacity shows that it doubled four times between 1996 and 2008. At the currently expected pace of additions, the next twelve years could produce just two or three doublings. And as the experience curve effect slows, other factors including commodity costs can overwhelm it.

We saw that a few years ago, when the boom economy stoked by the inflating global financial bubble drove up commodity and construction costs to such a degree that wind project costs stopped falling and began to rise. These pressures eased after 2008, mainly because the recession and financial crisis reduced overall demand for construction and raw materials, while the rapid growth of renewable energy equipment manufacturing, especially in Asia, led to overcapacity and stronger price competition. That probably accounts for much of the effect that LBNL saw in its solar trends in the last two years, rather than the sort of scientific and engineering improvements that drive experience curve effects.

So what is likely to happen as the economy rebounds and the slack that developed is taken up? We're already seeing the early results in higher prices of raw materials such as steel. And higher prices for oil and coal, which are important inputs in the extraction and processing of many other raw materials, should intensify the pressure already being felt from the demand in developing Asia. For renewables, this could be further complicated by tightening supplies of critical materials such as rare earth metals, Tellurium, Lithium and other key ingredients of electric motors, thin-film solar modules, and electric vehicle batteries. Toyota and other makers of hybrid and electric vehicles are working on ways to circumvent these materials, but the results might not come fast enough to prevent a crunch.

The renewable energy industry is counting on a return to economic growth to boost demand for electricity. Together with government-mandated renewable energy targets, that should translate into increased demand for equipment like wind turbines and solar panels. However, if the underlying source of that demand increases their material and construction costs just as governments are coming under increasing pressure to reduce subsidies for the industry, the result might be that the end-users of these products could see their effective costs go up for the first time in several years. That would be a rude shock for those who believe that these costs must inevitably fall as installations grow.