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Impact of Declining Oil Prices on the Future of Solar Energy

AgMRC Renewable Fuels Monthly Report
February 2015

Don HofstrandDon Hofstrand
retired Iowa State University Extension agricultural economist
agmrc@iastate.edu

The recent sudden and precipitous drop in crude oil prices caught the energy industry and the world in general by surprise.  The price decline has resulted in a reevaluation of both short and long-range plans by the world’s oil industry.  Thousands of workers face being laid-off as oil companies adjust to the new environment. 

The ripple effect of the decline will impact the renewable energy industry.  The oil price decline may have long-term consequences for these emerging industries.  The collapse of oil prices in the 1980s led to the dismantling of most renewable energy programs, including solar.  Will this happen again?  This oil price collapse could impact renewable fuels like ethanol and biodiesel but also renewable energy sources like solar and wind.  While, the impact of declining crude oil prices on biofuels will be discussed in other articles in the Monthly Renewable Energy Report, the impact on solar energy will be discussed here.

Describing the Situation

As shown below, the price of regular gasoline price in the U.S. dropped from $3.50 to $4.00 last summer to $2.00 to $2.50 by the end of the year.  This reduction of about $1.50 per gallon occurred in just six months.

Figure 1.

Regular Gasoline Prices

However, gasoline is not expected to remain at these levels.  According to the Energy Information Administration (EIA), the short-term crude oil price is expected to gradually increase through 2015 and 2016 as shown below.  This rise will be accompanied by a similar increase in gasoline price during the same period.

Figure 2.

U.S. Gasoline and Crude Oil Prices

More specifically, as shown in the price summary below, by 2016 the crude oil price is expected to retrace about half of the decline and settle at about $20 to $25 per barrel below the 2014 average.  Similarly, gasoline is expected to retrace about half of the decline to average in 2016 about $.60 below the 2014 average.

Crude Oil and Gasoline Price Projections
    Projected
  2014 2015 2016
West Texas Intermediate Crude ($/barrel) $93.26 $55.02 $71.00
Brent Crude Oil ($/barrel) $99.02 $57.56 $75.00
Gasoline (avg. regular pump price) $3.36 $2.33 $2.73
Source: Short-term Energy Outlook, U.S. Energy Information Administration, http://www.eia.gov/


Renewable Energy Projections for the U.S.

During the short-term (2015 to 2016), renewable energy production in the U.S. is expected to continue its upward trend according to the EIA.  Liquid biofuels, woody biomass and hydropower are expected to remain relatively constant from 2014 to 2016.  Wind power is expected to increase and challenge hydropower and woody biomass as the largest producer of renewable energy.  Solar energy is also expected to continue to increase during this period. 

Figure 3.

U.S. Renewable Energy Supply

While still relatively small compared to the other sources, solar is the “wildcard” in the renewable energy mix over the next couple of years, both in the U.S. and across the world.  Below we will discuss some of the issues that make the future of solar energy production potentially explosive.   

Solar doesn’t Compete Directly with Oil

Crude oil is not used extensively to generate electricity.  Crude oil is converted into transportation fuels like gasoline and diesel fuel.  Conversely, renewable energy sources like solar and wind are used primarily for electricity production.  However, there is one exception where the decline in oil prices may directly impact solar. It is the use of solar to generate electricity for electrical vehicles (EV), which are in direct competition with gasoline powered vehicles. 

Many energy experts believe that, in its current stage of development, EVs have a large enough foothold to survive and expand during this period of low oil prices.  As shown below, EVs have close to a two percent market share of the U.S. car market.  It has a clientele that is not driven solely by cost but also a range of other issues including carbon emissions .  

Figure 4.

Plug-In Share of U.S. Car Sales

Source: Tom Randall. Data: Electric Drive Transportation Association, Ward’s Automotive Group, Bloomberg

On-going research and development have resulted in a large number of vehicles that run on electricity. The number of EVs currently being sold and in development by both major and small car companies indicates that the automobile industry sees a future for EVs.   Below are EVs that are either currently available to consumers or expect to enter the market in 2015.

Currently Available Electric Vehicles

  • Renault Twizy
  • Mitsubishi i
  • Smart Electric Drive
  • Chevy Spark EV
  • Nissan Leaf
  • Ford Focus Electric
  • Toyota Prius Plug-in
  • Ford C-Max Energi
  • Fiat 500e
  • Kia Soul EV
  • Chevy Volt
  • Ford Fusion Energi
  • Volkswagon e-Golf
  • Volkswagon e-Up
  • Honda Accord PHEV
  • Mercedes-Benz B-Class Electric
  • BMW i3
  • Tesla Model S
  • Cadillac ELR
  • Porsche Cayenne S E-Hybrid
  • Porsche Panamera S E-Hybrid
  • BMW i8

Coming in 2015

  • Tesla Model X
  • BMW X5 eDrive
  • Mitsubishi Outlander PHEV
  • Volvo XC90 T8
  • Audi A3 e-Tron
  • BMW 3 Series Plug-in
  • Volkswagon Passat GTE Plug-in

Apple has been quietly working on an electric car and may begin production of it as early as 2020.

Electricity Price Continues to Increase

Although low natural gas prices created by the emergence of the process of fracking to release shale gas has provided a low cost feedstock for electricity production, the retail price of electricity has continued to increase as shown below.  This is due to the cost of electricity transportation to get the electricity from the power plant to the place it is used.  This cost has increased substantially over recently years due to investments in the power grid. 

Figure 5.

Energy prices

Source: Deutsche Bank. Data: EIA, Thomson Reuters

The increasing cost of electricity has opened the door for solar production where the distance from production to usage is small.  Conventional fossil fuel power stations are centralized and require electricity to be transported over long distances to users.  However, solar systems such as roof-top solar and community solar are decentralized and located close to the users.  This is called “distributed energy resources” or DES.  Although DES installations are small, the cost savings from shorter grid connections are beginning to outweigh the economy of size advantage of conventional systems.

The Declining Cost of Solar

The cost of solar has dropped precipitously in recent years.  The cost of various energy sources is shown below.  It is called the “terrordome” by the author of the analysis.  The price of various electricity power sources (Henry Hub is natural gas, Brent is crude oil, LNG is liquid natural gas) since the late 1940’s is shown.  The outlier energy source that just recently appeared on the scene is solar.  Although very expensive when it first appeared, the cost of solar energy has dropped tremendously since that time.  

Figure 6.

Bernstein analysis

Source: Bernstein Research. Data: EIA, CIA, World Bank, Bernstein analysis

The decline in the cost of solar is expected to continue.  Below are projections of solar costs by Deutsche Bank. The projections indicate a cost reduction from $2.90 per watt in 2014 to $1.77 in 2017, or about a 40 percent decline.  The cost of solar panels is expected to continue to decline.  Some Chinese manufacturers were achieving sub 50 cents per watt already in 2014.  Inverter prices (an electronic device that changes direct current (DC) to alternating current (AC)) typically decline 10-15 per cent per year and are expected to continue into the future. Installation cost reductions will come from scale benefits and could fall 20 cents per watt over the next few years to 45 cents per watt.  Although solar installation jobs are likely to increase substantially to keep pace with demand, increases in efficiency are expected to more than offset possible wage increases.  Sales costs are expected to also decline as solar becomes mainstream and new methods are developed to reach customers.

Figure 7.

Cost reduction example

Assuming a 40 percent decline in the cost of solar by the end of 2017, some experts believe solar will reach “grid parity” to 80 percent of global markets within the next two years. 

Grid parity occurs when an alternative energy source can generate electricity at a levelized cost (LCoE) that is less than or equal to the price of purchasing power from the electricity grid. The term is most commonly used when discussing renewable energy sources, notably solar power and wind power. Reaching grid parity is considered to be the point at which an energy source becomes a contender for widespread development without subsidies or government support.

Source: Wikipedia

Levelized cost is the net cost to install a renewable energy system divided by its expected life-time energy output. For example, if a solar energy system costs $10,000 to install (after all rebates) and it provides 100,000 kWh of electricity over its life, then the Levelized Cost of the solar energy system is $10,000 / 100,000 kWh = $0.10 per kWh.

Source: Solar-Estimate


The Impact of Electricity Storage

The Achillies Heel of solar energy is storage.  Until electricity can be efficiently stored from the time it is generated until is it used, the expansion of solar will be impeded.  However, the investment bank Citigroup believes that the battery phenomenom will be even more profound than the solar revolution. It believes that battery storage costs will halve over the next 5, 6 or 7 years to around $230/KWh. That would make storage financially attractive enough to increase manufacturing and further accelerate the fall in battery storage system costs towards $150/KWh.

Storage will reduce the problem of “intermittent” energy production currently a problem for solar (electricity is not produced when the sun doesn’t shine).  With storage, solar can become a “firm” or less intermittent source of electricity.  So, solar can be used for “base load” generation of electricity.  Base load is the minimum amount of electric power delivered or required over a given period of time at a steady rate.  Base load generation is currently dominated by coal-fired power.

Today, natural gas is commonly used to fill the gaps in the intermittency of renewable energy sources.  So, as renewable energy generation grows, natural gas energy production also grows.  The development of electricity storage that makes renewable energy a firm source of electricity will eliminate the need for natural gas generation to fill the gaps. Also, in some instances, oil is still used in the power sector in a utility-scale peaking capacity.  Electricity storage may be used to reduce or eliminate the need for peaking power capacity. 

In addition, the development of electricity storage will make it similar to other types of storable energy (oil and gas) and transform electricity markets. 

The World Has Changed Since the 1980s

Renewable energy is more developed and cost competitive with oil than it was in the 1980s. The supply and cost of solar energy is based on technological developments that are only going to increase the supply and lower the costs of this energy source in the future.  Conversely, fossil fuels are basically mining operations that are dependent on supplies that are increasingly difficult and expensive to access. 

China is a major factor in the world economy and has made a commitment to renewable energy.    Currently China is the largest investor in renewable energy with a generating capacity of 378 GW (2014).  By comparison, the U.S. had a capacity of 172 GW in 2014.  China continues to invest in renewable energy even as oil prices have fallen.  This is because China’s renewable energy strategy is not based solely on the price of oil.  Air pollution in China’s cities is at a critical level.  An example is the smog-laden air in Beijing.  Another factor is China’s desire for energy security.  Reliance on imports of fossil fuels increases China’s exposure to geopolitical shifts in unstable parts of the world.  Renewable energy can be created at home from water, sun and wind.  Plus, because renewable energy is an emerging industry requiring new technology and manufacturing ability, China sees the production of renewable energy systems as an important segment of their future economic growth.

Greenhouse Gas Emissions

An important driver for the development of renewable energy (solar) is concern about global warming and the resulting impact on the world’s climate.  The need to reduce greenhouse gas emissions from fossil fuels is more urgent than it was in the 1980s.  The development of international and other agreements to reduce greenhouse gas emissions will have a huge impact on the future of renewable energy and solar.  The emission of greenhouse gases from energy production is a topic for discussion in itself and will be discussed in the future in the Monthly Renewable Energy Report.

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