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Renewable Energy

Energy that is extracted by renewable resources, such as sunlight, wind, and waves

What is Renewable Energy?

Renewable energy is the energy that is extracted by renewable resources – such as sunlight, wind, waves, heat, etc. In contrast, non-renewable energy would be sources such as coal, nuclear, oil, and natural gas, as they are available in limited supplies and take a long time to be replenished.

 

Renewable Energy

 

Main Types of Renewable Energy

 

1. Wind energy

Wind turbines capture the wind’s power and convert it into electricity. When the wind blows, it will spin the blades of the turbines clockwise, which will capture the energy. The energy from the turbines will be captured and sent to the generator, which converts it to electricity.

 

2. Solar energy

When the sun shines, particles of sunlight reach the Earth, which fuels our planet. Solar power can convert the energy using photovoltaics or solar thermal collectors. Photovoltaics are more common for smaller-scale electricity projects, such as residential solar panels, whereas solar thermal collectors are used for electricity production on a massive scale.

 

Drivers of the Development of Renewables

As of 2019, renewable energy beat coal by providing 23% of power generation in the U.S. It was a huge step up, considering the historically dominant sources of energy used to be coal, oil, and gas. The cheaper the renewable sources get, the more widespread they will become.

In terms of where we are at, there are a lot of incentives to invest and produce renewable energy given United States government tax credits. The tax credits incentivize developers to continue investing in such assets and to hopefully make it cheaper.

There are two types of tax credits – mainly for wind and solar renewables – called the investment tax credit (ITC) and the production tax credit (PTC). In a more macro-level theme, the drive towards renewables includes government and country climate change goals, such as Europe’s Green Deal.

 

Merits of Investing in Renewable Assets

Before diving in, there are different stages of renewable assets. Greenfield assets are those that are in their early stage of development and come with the highest level of risk. Brownfield assets are more mature assets that already provide a contracted stream of cash flows and are on the operational stage. We will specifically look at the merits of investing in brownfield assets.

 

1. Stable and steady cash flows

When there is a brownfield renewable asset, most of the time, it will be associated with a Power Purchase Agreement (PPA). The PPAs are usually long-term, locked-in contracts that create steady and predictable cash flows. It is usually one of the most attractive features of investing in renewable assets, which also makes it very convenient to value with a Discounted Cash Flow model.

 

2. Non-cyclical

Renewable assets such as wind or solar plants are usually classified as a sub-sector of the power and utility industry. The power and utility industry is well known for being non-cyclical and very defensive against economic downturns. The reason is that people will always use and need energy, as it is one of the fundamental necessities of life. Therefore, the constant need for energy makes renewable assets non-cyclical.

 

3. Low variable costs

If you worked at a cellphone manufacturing store and a customer wanted a new phone, you would need to spend direct variable costs to buy the parts for the new phone. However, renewable assets are known to incur extremely small marginal costs per use, which is almost completely negligible. For example, for a wind plant to power one more household, there will be very little incremental costs.

 

Risks of Renewable Energy

 

1. Intermittent

A risk of renewable energy is that you cannot control when the generation happens. It leads to intermittent risk, as renewables are not yet able to cover every hour of the day consistency, especially the peak hours.

For example, one period of peak energy-usage is during dinner when people come back from work, start cooking, turn on the TV, etc. However, it is usually the same time that the sun goes down and the wind is the weakest, which means that renewable energy alone may face difficulty producing enough energy to last through peak hours.

To mitigate such a risk, the development of an affordable, long-lasting battery is needed to store the energy generated throughout the day to support peak hour usage.

 

2. Weather

With wind and solar plants farming energy from renewable sources, it also exposes the assets to weather and nature-related risks. For example, solar panels exploded into pieces after they were hit by the Northern California wildfire in late 2017. As extreme weather events continue to occur, it may warrant a risk for renewable assets unless further develops are made.

 

Conclusion

As society continues moving towards a sustainable future, renewable energy will start to play a larger part in our energy production. Understanding what renewables are and the merits and risks of investing in it is a first step towards investing in the future.

 

Related Readings

CFI is the official provider of the global Certified Banking & Credit Analyst (CBCA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional CFI resources below will be useful:

  • Energy Return on Investment (EROI)
  • Carbon Credit
  • Environmental, Social, and Governance (ESG)
  • Kyoto Protocol

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