What is the impact of increasing commodity and energy prices on solar PV, wind and biofuels?

Prices for many industrial materials, and freight costs, have been on an increasing trajectory since Q1 2021, pushing up wind turbine and solar PV costs. Since the beginning of 2020 the price of PV-grade polysilicon has more than quadrupled, steel has increased by 50%, copper by 60% and aluminium by 80%. In addition, freight fees have increased almost sixfold, resulting in additional costs for the geographically dispersed supply chain of renewables. The reversal of the long-term trend of decreasing costs is already visible in the prices of wind turbines and PV modules, which have increased by 10-25% depending on country and region, erasing two to three years of cost reductions since 2018 from technology improvements. The exception, however, is in People’s Republic of China (hereafter ‘China’) where wind turbine costs have continued to decrease in 2021, as demand declined following the 2020 deployment boom driven by the planned phase-out of subsidies.

In addition to increased raw material, commodity and freight prices due to the economic recovery after the Covid-19 crisis, rising energy prices are also putting upward price pressure on renewables as manufacturers of materials critical for renewable energy equipment have curtailed production in Asia and Europe to avoid higher fuel and electricity costs. This situation further exacerbates an already strained material supply chain, leading to additional increases and volatility in prices for commodities such as aluminium, copper and steel.

In addition, trade measures due to concerns over the origin of equipment bring additional price increases to solar PV modules and wind turbines in key markets such as the United States, India and the European Union. Both supply-side constraints and trade measures have a short- and medium-term impact on markets, increasing costs and affecting project profitability, especially for those projects that won auction bids prior to price increases, and also delaying investment. 

The rapid economic recovery from Covid-19 and higher commodity prices compared to pre-pandemic levels have contributed to rising inflation in many countries (IMF, 2021a). The OECD and the IMF expect inflation rate increases to peak at the end of this year before moderating in 2022; however, both organisations warn that uncertainties associated with the pace of the Covid-19 economic recovery may prolong inflation beyond their current forecasts (IMF, 2021a; OECD, 2021b).

In the event of inflation remaining above target levels, central banks may consider increasing interest rates. Higher rates translate into higher borrowing costs, affecting the total generation costs of renewable energy projects. Although the European Central Bank and the US Federal Reserve currently do not plan to raise their main interest rates in the short term, uncertainty over possible hikes presents a longer-term risk. Coupled with prolonged cost increases for equipment, this could have a material effect on investment in renewables, leading to increased costs for developers and governments and affecting the pace of deployment.

Rising natural gas and coal prices have led average wholesale electricity prices to increase worldwide. In countries such as Germany, the United Kingdom and Spain, average wholesale electricity prices from January to October 2021 more than doubled compared with values observed in 2019 and 2020. Higher natural gas and coal prices have improved the competitiveness of wind and solar PV, despite historic equipment price increases due to high commodity and energy prices. For corporations, fixed-price renewable energy contracts have served as a hedge against higher spot market prices, increasing the value of such bilateral agreements. For governments, higher electricity prices are not translated into higher subsidies for wind and solar PV, as almost 90% of all wind and PV projects have long-term fixed-price PPAs either through FITs or CfDs. 

The long-term implications of price increases

Although it is too early to assess the medium- and long-term implications of commodity price increases on the deployment of wind and solar PV, so far higher prices have had limited impact on demand for new capacity. Governments have made no major changes in their policies or cancelled auctions, both of which are crucial to ensure the continued deployment of renewables. In addition, corporate buying is on pace to break another year-on-year record, demonstrating the cost-competitiveness of renewable resources, even with a slight increase in prices in some markets. Should commodity and freight prices moderate in the near future, the cost reduction trend of wind and solar PV would continue, and the long-term impact on the demand for solar PV and wind may be minimal. However, there is a risk of a prolonged period of high commodity prices, inflation and rising interest rates increasing the cost of clean energy transitions and slowing the pace of wind and solar PV capacity expansion.

Biofuels

Feedstock costs have been driving up biofuel prices, causing an estimated 3% decline in global demand in 2021. A number of factors are causing this price increase, including growth in demand for soybeans and corn in China, weather impacts, climbing shipping costs and, to a lesser extent, biofuel demand itself. In response, governments have lowered blending mandates in Argentina, Colombia, Indonesia and Brazil, reducing biofuel demand. These impacts are likely to be short-lived should prices decline in the coming years. The significant planned expansion of renewable diesel projects, for instance, remains on track and governments seem willing to reinstate mandates if prices come down. However, the prospect of high feedstock and biofuel costs does present a risk to supportive policies under discussion in the United States, Europe, India, China and Indonesia.

• Short-term impacts

In mid-July Argentina passed a law to reduce the biodiesel blend rate from the original 10% to 5% because of high crop costs. The law also authorises the government to reduce the biodiesel blend rate to 3%, and to halve the ethanol volume entering the fuel sector from corn ethanol if necessary.

The Colombian government reduced its ethanol blending mandate from 10% to 4% from April 2021, with the aim of returning blending to 10% in September 2021. However, in August, Colombia extended the 10% blending mandate to January 2022. The reduction was in part because of a sugar cane shortage due to excessive rains, as well as high US ethanol import costs.

Indonesia has continued to delay increasing its biodiesel mandate from 30% to 40% as initially planned. High palm oil and biodiesel costs are part of the reason for the delay.

In response to high costs, Brazil’s mines and energy ministry reduced its biodiesel blending mandate to 10% from 13% for July and August. It then increased the mandate to 12%, but is considering reducing it again to 10%. High costs are also part of the reason for reduced sales of hydrous ethanol in Brazil, as consumers have switched from buying ethanol to gasoline.

In the United States high feedstock prices are contributing to climbing Renewable Identification Number (RIN) trade prices. The US Environmental Protection Agency (EPA) uses RINs to track the production and use of qualifying renewable fuels under the Renewable Fuel Standard (RFS). RINs are tradeable and fuel providers with a deficit can purchase credits from those with a surplus. RIN prices are at an all-time high, having nearly tripled since 2019 for biodiesel and reaching seven times higher for ethanol as of October 2021, according to IHS Markit data. These increases are primarily a result of higher feedstock prices according to the US Environmental Information Administration. However, uncertainty around renewable fuel obligations, ongoing discussions on waivers for small refineries and lower ethanol production following Covid-19 impacts on fuel demand are also contributing. The impact these prices will have on biofuel production and demand is unclear. If the RIN market acts as intended, then higher RIN prices should create an incentive to produce more biofuels since biofuel producers will receive higher prices for their products. However, since biofuels are blended with gasoline and diesel, higher biofuel prices can also increase consumer fuel prices, which can reduce overall fuel demand. The EPA has also yet to set renewable fuel obligations for 2020/21 and will be starting the process for RFS obligations post 2022 later this year. Fuel costs will no doubt feature prominently in those discussions.

• What is driving price increases?

Weather impacts on biofuel crops, growing corn and soybean demand in China and certain other markets, and higher shipping costs are all contributing to higher biofuel prices. They have increased by between 70% and 150% from the 2019 average, and more than prices for crude oil in most cases, increasing the spread between biofuel and fossil fuel costs. 

Chinese demand for soybeans and corn to help rebuild its pig herd after swine fever decimated its pig populations, combined with tight supplies, is one of the main drivers of cost increases for these feedstocks according to the US Department of Agriculture. Biofuel producers use soybeans to make biodiesel and renewable diesel, and corn to produce ethanol. To help keep costs in check, China has increased imports of both soybeans and corn. China’s corn imports more than tripled in 2021 relative to 2020, for example, to satisfy this demand (USDA, 2021). In the United States increased renewable diesel demand for soybeans has also contributed to cost increases by limiting the soybean harvest available for export.

In the case of sugar, used to produce ethanol, high costs are in part driven by a poor harvest in Brazil; sugar production in 2021 is down by 7% compared to 2020. In Europe, high shipping costs – up nearly 700% from 2019 levels for a shipment from China – have contributed to higher used cooking oil costs. Nearly 70% of used cooking oil for biodiesel production in Europe is imported according to IHS Markit estimates.

• The impact of cost increases on the prospects for renewable diesel and biojet

Production of renewable diesel and biojet is set to expand by 9 billion litres over the next two years in the main case, at a time of high feedstock costs. Despite the combination of high feedstock costs and growing demand for those feedstocks, renewable diesel and biojet facilities in the advanced stages of development remain on track. To date only one advanced project, CVR’s Wynnewood facility, has delayed start-up, citing high feedstock costs. To mitigate cost increases, producers are building facilities that can process multiple feedstocks, buying agricultural supply chains and investing in non-crop feedstocks.

Refiners can produce renewable diesel from plant oils, used cooking oil and animal fats. One way to mitigate costs is to build renewable diesel facilities that can use a variety of feedstocks. This flexibility allows producers to purchase whichever feedstocks are the least costly at the time.

Owning feedstock supply chains also helps ensure supplies and keep costs in check. Some renewable diesel and biojet producers are pursuing this strategy by purchasing seed oil production and used cooking oil collection companies. For instance, Neste, a renewable diesel producer, purchased used cooking oil collection and refining companies in the United States and the Netherlands to improve the used cooking oil supplies it uses to produce renewable diesel.

Some investment continues as well in technologies to process wastes and residues that would avoid competition with food demand or for limited supplies of used cooking oil. Wood and agricultural wastes, for instance, can be processed into biofuels and have other benefits such as meeting sustainability requirements in regulations such as Europe’s Renewable Energy Directive. These investments remain limited, however, with most new plants planning to use oil crops and used cooking oil.

• What are the long-term implications?

The long-term implications depend primarily on whether feedstock and biofuel prices stay high or not. Feedstock demand and weather impacts, mostly unrelated to biofuel demand, are driving high prices. There is little indication of changes in project plans for renewable diesel and biojet production, and governments seem willing to reinstate mandates should prices decline.

High prices are nevertheless a clear reminder of the links between feedstocks, biofuel costs and government and consumer exposure to them. This comes at a time when the United States, Europe, India, China and Indonesia are all discussing new policies or working to implement existing plans that could increase global biofuel demand by 30% by 2026. The greatest risk of high costs may therefore be how they affect these policy discussions. Current high prices draw attention to important questions. Where will the feedstocks come from? How sustainable are they from an economic, environmental and social perspective? Will costs drive investment into new feedstocks? And what will be the cost impacts not just on fuels, but on agricultural products?