Low-Energy Fridays: What would the “energy transition” cost?

A news piece from Axios about a “‘pragmatic’ climate reset” caught my eye a while back. One line is particularly worthy of attention: “[T]he willingness to absorb the political and economic costs of a faster transition is waning.” (Emphasis added.) This is new. Until recently, a common refrain has been that a global transition to clean energy would have no net cost. In fact, many credible quantitative analyses have argued that fuel savings, clean energy jobs, and other benefits more than offset any burden from a forced uptake of clean energy. So—does it have a cost or not?

In thinking about the potential cost of a clean energy transition, it’s important to appreciate two key things:

• Clean energy cost estimates hinge upon long-term energy cost assumptions that may not be true.
• Analysts often estimate energy transition costs in isolation without considering competing uses of capital that determine whether the policy harms or helps the economy.

Let’s examine these in turn.

To the first point, a clean energy transition would have a considerable upfront cost. The International Energy Agency estimates an additional $32 trillion in capital for the next 10 years, while the International Renewable Energy Agency estimates $44 trillion. McKinsey estimates an additional $105 trillion in capital for the next 30 years ($3.5 trillion per year). But the argument to justify these high upfront costs is simply that clean energy saves more money in the long term. That may or may not be true, but it’s important to appreciate that analysts don’t know if it’s true, they’re assuming it’s true—a different thing entirely.

This is not a dig at analysts and their scenarios; one can’t analyze without making assumptions. But given enough time, these assumptions will almost certainly be wrong. Consider an alternative real-world example: The United States regularly implements vehicle fuel-efficiency regulation, which regulators estimate will save money based on what fuel costs might be in the future. But there have been times when regulators assumed fuel prices would increase when they actually decreased, seriously casting doubt on the promised benefits of their regulation.

It’s the same for clean energy transition scenarios—analysts make reasonable assumptions given the limited information available. But assertions about the magnitude of cost savings are made based on assumptions of both clean energy and fossil fuel costs far into the future, which are notoriously difficult to predict. Policymakers are wise to consider such analyses, but wiser to understand they may not pan out as expected.

The second point—that energy transition scenarios are often assessed in a vacuum—is perhaps even more important. Consider this hypothetical scenario: Suppose someone buys an energy-efficient appliance that costs $1,000 more than the energy-inefficient alternative but is projected to save $1,500 in energy costs over 30 years. While this might sound like a good investment, it’s actually a very bad one. That’s because the $1,500 in savings equates to a roughly 1.4 percent annual rate of return over those 30 years. It’s likely that other investments would net a much higher rate of return over the same period.

Similarly, one should be suspicious of claims about how much money is saved in a clean energy transition. If those savings don’t add up to more than an alternative use of that capital, then a policy forcing the action would be net harmful to the economy.

Returning to the Axios piece, the author’s observations reflect the fact that proponents of clean energy expansion often believe energy transition scenarios even though they are simply explanations of how a transition could occur rather than what would be most economical. Investors still heavily favor clean energy when it’s viewed as profitable; but to the above point, competing investment opportunities help explain why growth hasn’t risen to the level of a global clean energy transition.

Simply put, there are times when it is profitable to deploy more clean energy, which—as R Street has pointed out—the market has embraced. But clean energy transition scenarios overly simplify the economic tradeoffs investors consider and can mislead policymakers into false confidence in the value of policies that force clean energy uptake.

Ultimately, policymakers must appreciate the fact that, owing to the complexity and numerosity of assumptions involved, clean energy transition estimates are just as fallible as any other projection (if not more so). The Axios piece hints at this—the market is a better benchmark than transition scenarios to determine whether clean energy uptake aligns with climate goals. Policymakers should rethink their assumptions about the cost of policies that force clean energy uptake and whether they have adequately considered the economic trade-offs of such policies.