Follow the money and note who benefits from creating an artificial demand for renewable energy.
By Joshua Rauh and Mels de Zeeuw Wall Stree Journal, Nov. 11, 2021
At the COP26 U.N. climate change conference, a group of 450 financial firms pledged $130 trillion in capital to finance the transition to net-zero emissions. Government mandates have already driven large private capital flows into expanding renewable energy, and now financial firms are eager to kick the phaseout of fossil fuels into high gear.
The finance industry’s palpable excitement is electrifying to climate activists and the politicians who cater to them. Wall Street is now squarely on their side. Yet the enthusiasm of asset managers and banks is hardly surprising. Any government mandate that a large amount of capital must be swiftly retired and replaced creates a tremendous opportunity for financiers, no matter the underlying reason.
Suppose a government announces that all machines of a certain color, say brown, must be destroyed and replaced with machines of a different color, say green. Owners of the brown machines aren’t happy, but those who can finance the new green machines will profit handsomely. This artificial demand distorts the efficient allocation of capital and comes at a great cost to economic prosperity.
This thought experiment isn’t so different from current developments in the energy industry. Government mandates and incentives are artificially driving demand for renewable energy. The political desire to cater to climate concerns is increasingly benefiting large financial companies, which have been quick to lend their support. Institutional investors have been preparing by reducing their fossil-fuels exposure.
To be sure, private capital is better suited to fund energy investments than overstretched government budgets. Public investment is highly susceptible to inefficiencies such as project delays, cost overruns and politically-driven investment decisions. (Remember Solyndra?)
But it isn’t true, though it’s asserted often, that the benefits of energy transition investments make their ultimate net costs minimal or zero. The boosters of the energy transition are ignoring the opportunity costs of replacing existing energy production with renewables.
Government mandates and incentives steer existing capital, including natural gas and nuclear plants, to retirement for being “dirty,” rather than for age or obsolescence. These still-productive assets must then be replaced. This is on par with trying to get wealthier by breaking one’s own windows—the classic fallacy that holds that the necessary repairs would help the economy, not recognizing that the funds that must be spent on repairs now can’t be spent on efficient production.
The crowd-out will be substantial. The $130 trillion in private capital pledged to support the energy transition, more than 135% of the world’s gross domestic product in 2021, is $130 trillion that can no longer be invested in other productive activities. No economy has infinite productive or financing capacity.
The opportunity costs will be the investments that aren’t made, the products and services not invented or scaled up, the jobs not created in other industries, and the productivity gains and prosperity that don’t materialize.
The accelerated transition to renewables also imposes direct costs on Main Street. The huge increase in demand for financing and factors of production raises the cost of capital and labor inputs. Further, U.S. households and businesses will face higher utility prices because of electricity grids’ greater reliance on expensive battery storage technology.
This is particularly troubling when many households already face an inflationary pinch, with rising bills forcing them to make tough choices. Additional costs may arise from power outages, as the power grid becomes less stable and baseload capacity is reduced.
The transition to an energy industry that emits less carbon is a positive development and an important tool to combat climate change. But policy makers and commentators ought to be realistic about the costs, include nuclear energy as part of the solution, and accept that a more gradual replacement can alleviate some of the potential costs and problems.
President Eisenhower famously cautioned about the “military-industrial complex.” Today, an emerging coalition of governments and environmental activists singularly focused on net zero are empowering a “finance-industrial complex” eager to affirm the activists’ goals—and get rich doing so.
Mr. Rauh is a senior fellow at the Hoover Institution and a professor of finance at the Stanford Graduate School of Business. Mr. de Zeeuw is a senior research analyst at Hoover.