The Economics of Change

When oil was first discovered in western Pennsylvania in the 1860s, it was virtually useless—far more expensive than coal and, prior to the development of the refinery or internal combustion engine, useless for transportation. Even as oil became widely used for lighting in the late nineteenth century, the idea that it would become a dominant energy source—let alone reshape the global economy—was inconceivable.

Building a Low-Carbon Economy

The history of economic transformation follows a familiar path. Dominant technologies and businesses are generally reliable and economical, and over time they develop a network of institutional and political support that effectively resists change. New technologies and businesses generally enter a niche of the broader market, offering a higher cost service that meets specialized needs. But over time the new competitor becomes more economical and widens its share of the market, eventually undercutting the cost of the dominant player and gradually remolding the institutional infrastructure to meet its own needs. The transition from one generation of technology to another is often gradual at first, but then speeds up as the economic advantage flips.

According to conventional wisdom, the energy sector is far from such a transformation. New renewable energy sources represent less than 2 percent of the total energy supply, and in 2007 total U.S. government support of renewable energy R&D came to little more than $600 million— about what the government spent in Iraq in a single day. What these figures fail to capture is the recent infusion of private- sector capital and technology and the fact that today's renewable energy pioneers are not limited to "energy technology" but rather draw on fields as diverse as semiconductor physics, biotechnology, aerodynamics, and computer engineer-

ing.28

Over the past five years, the manufacture of wind turbines has grown at 17 percent annually, and solar cells at a 46-percent annual rate. This rapid growth has turned these industries into lucrative businesses, with demand outrunning supply and profits soaring. Some $52 billion was invested in renewable energy in 2006, up 33 percent from 2005. (See Figure 6-3.) At that level, investment in renewable energy is already one quarter that of the oil industry—and gaining ground rapidly. Some of the world's leading corporations have made major investments in renewable energy, including Applied Materials (solar photovoltaics (PV)), BP (wind and solar PV), General Electric (wind), DuPont (biofuels), Goldman Sachs (wind, and central solar), Mitsubishi (wind), Royal Dutch Shell (wind, hydrogen, and solar PV), Sharp (solar PV), and Siemens (wind).29

Corporate R&D on clean energy technologies reached $9.1 billion in 2006. A single company, Vestas Wind Systems, spent $120 million on R&D in 2006, while the U.S. government spent less than $50 mil

Figure 6-3. Global Investment in Renewable Energy, 2000-06

Figure 6-3. Global Investment in Renewable Energy, 2000-06

Building a Low-Carbon Economy lion on wind R&D. Even these numbers understate private R&D, which is often embedded in commercial projects, and exclude R&D investments by privately held companies, many of them funded with venture capital and other forms of equity investment. Venture capital and private equity investment in clean energy totaled $8.6 billion in 2006, 69 percent above the 2005 level and 10 times the 2001 level. (See Chapter 13.) By early 2007, these investments had helped create 146 clean energy start-up companies with names such as Nanosolar, Celunol, SunPower, E3 Biofuels, and Miasole, most of them working to develop and commercialize new energy technologies.30

These tiny firms may be the real game changers in the new energy industries, following in the footsteps of companies like Microsoft and Google, which quickly came to dominate their more established competitors—bringing a level of innovation that larger firms are rarely capable of.

In Silicon Valley, clean energy is helping drive a post-dotcom revival. Although it is regrettable that serious investment in renewable energy did not begin earlier, the science and technology available today will allow the industry to achieve performance and cost goals that would not have been possible in the past.

One example is photovoltaics, where producers are pursuing a host of strategies for reducing materials requirements, raising efficiency, and lowering manufacturing costs of the crystalline cells that dominate the market. Other companies are developing new thin-film photovoltaic materials that hold the promise of dramatic cost reductions. With demand outrunning supplies of PV materials in the past two years, price trends have temporarily reversed their usual downward course. But the industry is planning to increase its manufacturing capacity as much as eightfold over the next three years, and dramatic price declines are likely, spurring the industry to develop new applications and markets that would not be feasible today.31

Beyond the advance in technology, the economics of renewable energy will further improve as the scale of production rises— the same phenomenon that has successively turned televisions, personal computers, and mobile phones from specialty products for high-income technology pioneers into massmarket consumer devices. An analysis of production costs in several manufacturing industries by the Boston Consulting Group found that each time cumulative production of a manufactured device doubles, production costs fall by 20-30 percent.32

The annual production of wind turbines is now doubling every three years—and wind is already competitive with natural gas-fired power in the United States. It would be competitive with coal-fired power plants if they had to pay the current European CO2 price of $32 per ton. Solar electricity is still twice as expensive as retail grid electricity in most markets, but annual production is doubling every two years—which should cut costs in half in the next four to six years.33

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