Clean Energy Competitiveness in a Global Economy

Concerns about the future of the US clean energy sector were heightened last week when John Rudolf ran a New York Times article describing plans for a 600-megawatt $1.5 billion wind farm in West Texas. With construction set to begin in March 2010, the wind farm will use 240 2.5MW turbines manufactured by A-Power Energy Generation Systems in Shenyang, China, and the capital cost is mostly financed by Chinese banks. Though pitched as a “joint venture” among a consortium of Chinese and American companies, the US contribution is mostly limited to federal loan guarantees and cash subsidies from stimulus funds for about one-third of the total cost. The utility-scale wind farm will be operated by a Texan company, Cielo Wind Power, and the financing was arranged, in part, by the U.S. Renewable Energy Group, an American private equity company.

Clean energy has been pushed as a “win-win” solution to reduce greenhouse gas emissions while simultaneously stimulating a high-growth technology-based sector with a broad range of employment opportunities. Yet while the proposed wind farm will generate plenty of clean power, it is expected to create only about 300 temporary and 30 permanent jobs. Reaction to the proposal has been harsh, judging by the comments mentioned in a follow up piece. One captured the mood saying: “Why are U.S. stimulus funds being used to subsidize manufacturing jobs in China?”

It’s important to disentangle the issues here, as government subsidies have at least three goals: short term demand stimulus, emissions reductions, and longer-term creation of a competitive clean energy cluster. As a short term Keynsian economic stimulus for the US economy, this is clearly not a good use of funds, considering how much of the spending is “leaking” internationally. On the other hand, US firms are in line to benefit from stimulus spending in other countries, so we need to be wary of protectionist “Buy American” constraints to stimulus spending. As a mechanism for reducing carbon emissions, wind farms are a relatively effective way to spend money, in terms of cost per ton of carbon, certainly more so than the “cash for clunkers” program, which has been estimated to cost more than $200 per ton. If we take a view as global citizens concerned about the climate, then the location of jobs does not matter. Indeed, finding the lowest cost source for blades ensures the maximum carbon reduction per dollar expenditure.  

The creation of a competitive clean energy cluster in the US is an important longer-term policy goal. Clusters such as life-sciences in the Boston area and electronics/software in the San Jose/Silicon Valley region provide high-income employment opportunities and a strong tax-base. Clusters, by their nature, are enduring and “sticky” – businesses are willing to locate in high-cost regions to be close to customers, suppliers, specialized services, competitors, skilled labor, university research centers, and sector specific sources of capital. Clusters become self-sustaining economic ecosystems that stimulate innovation and enhance specialized skills and corporate capabilities. They are geographically bound not so much by the physical flows of components but by the dense human networks that enable rich information flows.

Once technologies stabilize to some degree, manufacturing becomes less “sticky” and easier to relocate to low-cost offshore sites in Asia (I did my PhD thesis on this topic, you can download my articles on international sourcing here and here). In the computer industry, the US has retained plenty of high-paying jobs in product management, design, software, finance, and marketing. In clean energy, however, production is moving astonishingly quickly to China even while there is still rapid technological evolution. This week, Evergreen Solar of Massachusetts announced that it would shift panel assembly to China, with the loss of about half of the 800 jobs at a new factory opened last year with $58 million of state aid. Of even more concern, the technological center of gravity might also be shifting. First Solar’s deal last month to build a 2 GW solar farm in Inner Mongolia is reported to include the construction of a manufacturing plant in China and the transfer of expertise, including First Solar’s unique cadmium/tellurium technology. China is perhaps intent on replicating in clean energy Japan’s earlier success in consumer electronics, which was built on the transfer of Western technologies during the 1960s and 1970s.

Intense price competition is part of the reason for the rapid move offshore. Product cycles are speeding up for clean energy, as for other sectors, resulting in a rapid commoditization and falling prices. This trend is reinforced by the recession and overcapacity. But China is also putting into place massive subsidies, in the form of feed-in tariffs for renewable power combined with grants and cheap finance for construction of projects and factories. In a reversal of tradition, the path for foreign companies is being smoothed with the elimination of bureaucratic red tape.

In this context, a new report from Deutsche Bank published October 2009 and reported in the Wall Street Journal makes for interesting reading. The report assesses country-level risk from the perspective of clean energy investors. The key conclusion is that:

Investors want TLC— transparency, longevity, and certainty –  in government energy policies. Countries that offer that—Australia, Brazil, China, France, Germany, and Japan—will attract capital. Countries that don’t—including the U.S. and the U.K.—will struggle….Investors will become increasingly concerned about regulatory risk and thus countries that deploy a transparent, long-lived, comprehensive and consistent set of policies will attract global capital.

The report analyzes more than 270 climate policies in more than 100 countries, and provides an aggregate risk rating of countries based on the strength of policies. The implication is that investors are looking to commit capital in countries with a strong commitment to addressing climate change. Echoing my own sentiments (see: Carbon Markets to Serve the Planet), the report favors clear mandates over weak and volatile price signals:

While emissions targets express an intention and carbon markets might deliver a price signal in the long-term, governments must strengthen underlying mandates and incentives immediately if capital is to be deployed to cover the gap, creating more investment and jobs.

Specifically, the report suggests that, to be effective, policies must:

• Be Transparent, Long-term and exhibit Certainty through consistent, secure and predictable, payment mechanisms

• Introduce incentives that decrease over time as technologies move towards market competitiveness;

• Eliminate non-economic barriers (grid access, administrative obstacles, lack of information, social acceptance)

• Provide fair and open access to distribution channels (e.g. transmission grid);

• Be enforceable.

The Deutsche Bank report’s focus on mandates and subsidies misses other important aspects of competitiveness suggested by the cluster approach, such as labor force skills, infrastructure, and research and development activity. Not surprisingly, the US, UK and Canada do not fare well on the report’s risk rating, but have nevertheless attracted significant clean energy capital. The report attributes this to the large size of their capital and energy markets overall, and the existence of state level incentives in the US and Canada. To this list should be added the high technological sophistication of these countries in clean energy and related sectors, both in the university and corporate sectors.

It’s ironic that the Deutsche Bank report recommends stronger climate policies to attract investment capital at the same time as some are raising concerns that putting a price on carbon in the US will drive jobs overseas (see this recent WRI report). Yet building a dynamic regional clean energy cluster requires more than subsidizing power generation or putting a price on carbon. Denmark was able to build a wind industry by being a first-mover in creating large scale demand that stimulated the emergence of a local industry with strong research, design and production capabilities. But countries that only subsidize demand, now that clean energy is more mature and global, might find that the money only sucks in imports and perhaps some final assembly from firms headquartered elsewhere.