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The Economics of Renewable Energy Industry

Overview

As prices for fossil fuels continue on an upward curve, many analysts are now beginning to question whether investing in renewable energy makes economic sense. In the past, such projects were generally undertaken for environmental rather than economic reasons. However, governments and companies are much more likely to expect to recoup investment.

Building costs

One of the major problems for those interested in undertaking green energy projects is high building costs. In 2007, the construction and installation cost for a commercial scale wind farm was estimated to be between $1.2 and $1.6 million dollars per megawatt. Any project involving underwater or sea installation – hydroelectricity, offshore wind farms, tidal plants – will cost significantly more. At the same time, these projects tend to outstrip their non-renewable counterparts in terms of cost. Offshore water farms planned in the UK are expected to cost twice as much as coal or gas powered plants producing the same energy and may well need government subsidies for up to 20 years to overcome this problem.

Government Policies

In order to encourage private companies to embark on such projects, governments around the world offer a variety of subsidies. Without financial incentive, it is unlikely such projects would be completed. Feed-in tariffs are a widely used example of such tariffs. They offer guaranteed grid access, long-term contracts for energy produced and a purchase price based on the cost of generation to providers of renewable energy. They offer a guaranteed return for investors.
 
A number of countries currently offer such schemes including Algeria, Australia, Austria, Belgium, Brazil, Canada, China, Cyprus, the Czech Republic, Denmark, Estonia, France, Germany, Greece, Hungary, Iran, Republic of Ireland, Israel, Italy, Kenya, the Republic of Korea, Lithuania, Luxembourg, the Netherlands, Portugal, South Africa, Spain, Switzerland, Tanzania, Thailand, Turkey.

A European Commission study in 2008 concluded feed-ins were the most effective way to encourage renewable energy production. Alternatively, renewable energy certificates (RECs) are widely used in the United States. These are tradable, non-tangible commodities proving 1MWh of electricity has been generated.

Price of fuel

One of the major economic benefits for alternative energy is prices are much more predictable compared with fossil fuel. Since December 2005, the price of a barrel of crude oil has gone from $65 a barrel, up to $145 dollars and back down to $73 a barrel. It is often difficult to gauge future energy prices and for companies to make long-term economic plans. A major benefit to alternative energy is it can avoid fluctuations.

Economies of scale

Large projects tend to be more economically efficient than smaller ones because they are able to generate the volumes of power. Most government-funded projects in recent years have been designed to encourage large-scale production. Many have argued the output from solar panels would not produce an energy dividend for 10-20 years, given the amount of energy required to manufacture and install them. On the other hand, studies from the United States suggest homes with solar panels see an increase in value irrespective of energy output.

Financially unsuccessful companies

Many renewable energy firms have struggled in free market environments. Even with government intervention, return on investment in alternative energy is far from guaranteed. Analysts generally cite market pressures, along with slim profit margins, as reasons for failure. This appears to have been the case for both ASX-listed Solverdi Worldwide, which collapsed in 2010 with debts of US$4.3million, and Jackgreen energy, formerly Australia’s largest renewable energy company, which collapsed in 2009. Other reasons for failure include necessary high spend on research and development (R&D) which often hampers early stage development. Some argue company failure is not the same as technology failure and use the example of computer manufacturers in the 1970s. Many of these went bust and few survive to today. However, the technology itself continued to develop unabashed.

Areas of concern

There are still relatively few start-up companies for green tech worldwide. The high threshold often puts newcomers off entering into the markets. Many of the most successful alternative energy companies are established fuel companies.

Conclusion

The economics of alternative energy still present a challenge to all investors. However, renewable energy presents an opportunity for those brave enough to take such projects on and will undoubtedly become more significant in the future.

Visit our Alternative Energy section for more articles about renewable energy sources.

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