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In this episode, we discuss how economic rents from different renewable energy sources may be valued and how these change with technology, market conditions, and policies.
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Roumeen Islam: This is the World Bank’s Infrastructure podcast. In today's episode, we discuss a new initiative to count renewable energy assets as part of a country's wealth.
There are many countries around the world that have large deposits of fossil fuels which are counted as part of that country’s wealth. There are also countries endowed with large mineral wealth and this is in addition to the human and physical capital that countries are endowed with. Countries and people use income generated from their wealth to finance their consumption and their investment expenses. But the sustainability of this expenditure, for example, fiscal expenditures depend on the size of a country's wealth. Well, there's a proposal to formally include in this estimate, the value of energy derived from renewable energy sources, such as water, wind, solar, or geothermal sources. As technology is changing and rendering it economically feasible to produce economic rents from these sources such an idea is attracting increasing attention, but how would this be done and what are the implications? Let's find out.
Good morning and welcome. I am Roumeen Islam host of Tell Me How, and my guest today is Grzegorz Peszko, one of our lead economists covering environmental and energy issues. He will be speaking today about how to value a country's renewable energy assets and whether these should be considered part of national wealth. Welcome Grzegorz.
Grzegorz Peszko: Thank you, Roumeen. Very nice to be here.
Roumeen Islam: It's very nice to have you, so let me start by asking you, why is it important to know the wealth of nations? And normally we talk about national income, not wealth, what a country produces every year and the corresponding income that people make. So, why is the country's wealth important, could you explain?
Grzegorz Peszko: Yes, because we need to know the annual flows of income of production, of economic output, as well as we need to know what is the basis that generates this income? So, wealth or the sum of assets that we as a country have, it's the basis that underlies, the generation of annual income.
So, the understanding of the stocks that generate income, is important to understand how sustainable the future income will be. It's like, you know if you are trying to enjoy your annual income as a person, by selling your possessions, your houseware, little by little, a car, and so forth, it is on so long as you can enjoy this flow of income.
By the same token, every company has income statements as well as a balance sheet. So are their countries, they have balance sheets incorporating the value of all assets that the nation has to generate the future income, how sustainable it will be. And it so happens that these national balance sheets usually underestimate and undervalue renewable capital.
Roumeen Islam: So, basically you don't just want to eat up all your wealth. You want to have consumption that is sustainable, both from a country and an individual perspective. Now, fossil fuels have traditionally been explicitly considered in assessments of a country's wealth. Oil and gas deposits, for example, and you are proposing to bring estimates of renewable energy wealth to the discussion of a country’s overall position. Now, why is this important?
Grzegorz Peszko: So, going beyond the traditional assets, like fossil fuels into the renewable nature of capital. In this case, in particular, renewable energy, is very important for policymakers. Especially now when we are facing the disruptive changes due to climate change and the low-carbon transition, the over reliance on fossil fuels can be short-lived.
That's why many policymakers tend to over-invest and overestimate the value of fossil fuels and underestimate hence, under invest in other assets, such as human capital and such as renewable natural capital, including renewable energy.
Roumeen Islam: So, it's clear that it's important to understand the value of all your assets, but then why hasn't it been done before this, has it something to do with how we actually do national accounting and how we define assets? Do we have to have a different definition?
Grzegorz Peszko: I think there have been a few reasons for that. First of all, I think the main reason why renewable energy has not been perceived as a big chunk of national wealth so far is that they are relatively nascent and recent and new electricity generation technology, except for hydro and geothermal energy. Solar and wind power, in particular, is the fastest growing electricity generation technology currently, but it has been growing from barely zero, for about 15 years only. So, until recently, the value of renewable energy has been small and economically unviable so that the governments have not seen much of the value for the balance sheets and it's not until recently, when governments started leasing the rights to use renewable energy resources and the factor they started recognizing them as balanced street ready economic assets.
Roumeen Islam: I wanted to know if there were other issues.
Grzegorz Peszko: Yes, according to the system of national accounts, natural resources can only be counted as assets when someone has ownership rights over them and when they deliver the economic benefits to their owners. So, it implies that if you cannot establish ownership, it cannot be an asset. It's a very anthropocentric perspective. Ownership, however, does not have to be private. It can be collective, it can be social, so for instance, in US the owner of the land owns everything that is beneath that land surface, but in all other countries, the resources that are under the surface of the earth are owned by society that are represented by the government.
And as long as these resources are generating the flow of economic benefits that can be extracted by the government, for instance, through the lease of rights to use these resources, then, it meets the definition of an asset in the SNA.
Roumeen Islam: All right. But then we go back to how feasible it is to own sunlight and wind right? They are freely available to all. So how do you get around this?
Grzegorz Peszko: You don't need to own the resource itself. You need to be able to exclude others from using that resource. And in this way, you exercise your property rights. So, by the same token, the SNA recognizes the radio spectrum as an economic asset just by the fact that the government started selling the rights to use radio spectrum in the form of licenses. So, in this way, the government, on behalf of society, extracts the economic rent from that resource that in principle is not owned by anything. By the same token, you know, renewable energy, nobody owns the sun, but the sunlight that reaches the earth’s surface can generate value to these persons that can control the use of that resource for economic benefits.
Roumeen Islam: That's a very good analogy. Now, if natural resources such as oil are discovered, but there's no exploration. Are these assets counted as wealth then?
Grzegorz Peszko: Yeah, this is a very important question because indeed, you know the resources of all gas and coal just by the very fact that they are discovered does not qualify as assets that can be introduced in the government's balance sheets, because they cannot be extracted. They cannot generate economic benefits to the owner.
So, by the same token, renewable energy can be treated as economic asset only when they are generating the flow of economic rent under current markets and physical conditions. So, for instance, a remote river with no hydro-power generation facilities on it it's not an asset, it's not a renewable energy asset.
Also, the air current, the winds, which does not hit the wind turbine that generates electricity it's not an asset or the rate of sun that reaches the earth’s surface and does not fall on an existing solar panel or a panel under construction is still not an economic asset.
Roumeen Islam: So, in this environmental accounting system, I suppose the value of renewable energy is included in the value of the land. Right? Is that as it is for oil and gas because once you've started exploring when you try to buy that land, you're buying the oil and gas as well. So, the value of the land should reflect that, but does this work for solar and wind energy?
Grzegorz Peszko: Correct. So, systems of national accounts do not say anything about the valuation of the renewable energy. We are indeed systems of environmental economic accounting seem to suggest that the value of renewable energy if it exists, it is already captured in the value of the land that is used to generate this renewable electricity. This is the limiting factor is not sufficiently captured in the value of the land and has a distinct component that it’s go over and be above, uh, the value of land.
Roumeen Islam: Why is that?
Grzegorz Peszko: Yeah, because several renewable energy installations are not located on the land. Yeah. Look at the offshore wind farms. Look at the floating solar power plants, they are installed either on the water or on the seabed. Which, doesn't have any value of the land, but at the same token, even if you have installations that are located on the land, this land is often a desert, like for many solar power plants or marginal lands or, drylands that have zero to none alternative uses. That's why the opportunity cost and the value of this land is close to zero. So if you are installing the renewable energy power plant there, the total value generated by this power plant is attributed to the renewable energy, not to the land that is under.
Roumeen Islam: That explains it now.
So, you are proposing a new approach to value certain types of renewable energy assets. And this approach has actually been piloted in 15 countries or so, and I think it'd be really useful to understand this approach. So, could we talk about that?
Grzegorz Peszko: We have indeed developed a methodology to capture the value of renewable energy with the same approach that is used as a standard to capture the value of fossil fuels and other minerals located on the surface of the Earth.
So, the valuation is based on the concept of natural resource rent. That's why we proposed the same valuation method, which is the residual value method, where the resource rent is estimated as the difference between the annual revenues that is earned from the sale of the useful energy, renewable energy and the annual cost of its production, as well as the appreciation of this capital.
Roumeen Islam: So, you've taken into account all the fixed costs, the recurring costs, which I presume are very small and you subtract that to get the profit in every year the rent in every year, and then you do want?
Grzegorz Peszko: Well, actually the fixed costs for renewable energy are quite significant. That's why it is a big part of the costs that have to be deducted from the value and it includes the rate of return on this capital. And then we use it to calculate the annual rent that renewable energy generation plant creates as an asset. Now, we need to move from the annual rent calculation to the calculation of the value of wealth. And that is done by calculating the net present value of the expected resource rents, under the expected market and natural conditions.
Roumeen Islam: Now, I'd like you to speak a little bit about the difference between economic rents and the profits that companies might make in investing in a particular renewable energy source? For example, if I were to invest in a given country, for a solar project, what is the difference between the profit that that investor makes and the economic rents that you would calculate?
Grzegorz Peszko: If this is a crucial difference between the return to nature and the return to investments in power plants or transmission lines. The key difference between the company profits and the resource rent are subsidies and the cost of capital. So, subsidies to renewable energy production, by the same token for subsidies to coal extraction or oil and gas extraction, they increase the profits of the companies that are involved in harnessing fossil fuel or energy, but are not increasing the economic rent because from the point of view of society, they are transfers.
Roumeen Islam: So, at market prices, given existing technology, it may not be profitable to extract them. So, governments give subsidies, or they guarantee off-take prices for these above-market prices. So, the company may make a profit, even though there is no economic rent accruing to the country from this exercise.
Grzegorz Peszko: Yes, there's a place not only to renewable energy, but it also applies to fossil fuels that are also heavily subsidized in different ways. For instance, producers subsidies and so forth, but also, one important difference is that many fossil fuel resources, they generate economic rents only under the condition that external costs related to the damages created by the combustion of fossil fuels is not included in the calculation of rents. Once you include these social costs of environmental and climate change damage created by fossil fuels in the calculation of rents, many of the existing fossil fuel resources, not all of them, but many of them would not create economic rents under these conditions.
Roumeen Islam: That is clear and of course all of these things, these values depend very much on what we assume about the cost to society, the costs of technology in the future, etc. Now, could we talk a bit about the numbers that you found because you piloted this in 15 countries and you're planning to expand this methodology to several more? So, how important are these, numbers and can you do, and have you done international comparisons with these numbers?
Grzegorz Peszko: We chosen 15 countries as pilots, as stress testing of the methodology for calculating resource rents for renewable energy.
Roumeen Islam: And sorry, just to interrupt. There are many different types of countries, right? Or are they small or large countries? How did you choose them?
Grzegorz Peszko: We have chosen rather bigger countries with an established track record of renewable energy generation, because it makes no sense to calculate resource rents in the countries that don't generate renewable electricity, or they have done it only recently.
So, we've picked up the 15 countries that accounted for more than 70% of global installed hydroelectric capacity more than almost 90% of the solar electricity capacity, both photovoltaic and concentrated solar power plants, and almost 90% of the global wind capacity. So, we picked up all the largest electricity renewable energy producers.
And what we've found is that in most cases, the hydroelectricity have generated very volatile, but positive resource rents. In countries like Brazil or Canada, actually a hydro-power often has generated higher rents than fossil fuels. However, for wind and solar power despite the fact that most of these generation plants have been profitable under the favorable policies to support them. Nonetheless safe for a few examples, they have not yet generated economic rents at least until 2017. Which is the last year for which we have calculated/
Roumeen Islam: Is there any difference between wind power and solar base power?
Grzegorz Peszko: What we found out for wind farms is that a few countries have been able to generate positive economic rents from wind farms because of their electricity market design. When wind farm operators were able to benefit from high electricity prices without using the guaranteed off-take prices for feeding tariffs or similar, then they were able to make profits as well as economic rents to the country.
However, the moment that the countries are introducing very favorable support systems for renewable energy. They're increasing the profits, they increasing the generation rates, but sometimes that means that we have to subtract the subsidies from economy rents and the economic rents become negative, although company profits become higher.
Roumeen Islam: Now let's move on to hydroelectric energy assets because we've been building dams forever for hydroelectricity. How about the value of these assets? What do you find?
Grzegorz Peszko: The two key findings were that first of all, the value of the asset is major, is large. So, what we found out that in the last few years, in these 15 countries, the value of hydro-power wealth ranges between one and $4 trillion, on annual basis. And second, what do we found out by the size of this range that's these values have been quite volatile.
Roumeen Islam: But first of all, that's a very high value.
Grzegorz Peszko: It is. And as I said in at least two out of these 15 countries in Brazil and Canada, the value of hydro-power has been often higher than the value of fossil fuels, which for Canada, which is a major fossil fuel producer is a big thing. But Canada has recognized it because probably Canada was the first country that really introduce the very rigorous accounts of both fossil fuels and increasingly renewable energy into the balance sheet.
Roumeen Islam: You said the value was also very volatile for hydroelectric assets.
Grzegorz Peszko: Yes. And this volatility is significant and is very policy-relevant we thought at the beginning that maybe there is some flaws of the methodology that we apply or some noise in the data.
But then when we started to assign this volatility to certain external events or to certain markets changes, it all became very well explained by the drivers we would expect that they would change the value of rents and the work. So for instance, external events such as drought, such as El Niño events have been significantly changing the value of hydropower assets in many different countries. Often during the drought times, the value of hydro-power assets have been declining
Roumeen Islam: Because revenues fall dramatically?
Grzegorz Peszko: Correct generation and revenues fall dramatically. Other generation assets stepped in, and this was the case for instance, in Turkey in the last few years. But for instance, the example of Brazil in 2014 is very interesting because we saw a skyrocketing, spike in the value of hydro-power wealth in 2014 alone.
Despite the fact that it was a year of significant, serious drought in Brazil. But what happened is the combination of the external physical shock of drought and internal market shock of demand because it was also a year of the World Cup in Brazil and the World Cup draws millions of people to Brazil, increasing energy demand, electricity demand, given the lower generation and lower supply pushed prices to a very high level. So, overall rent in this year, despite lower generations has increased because of this spike in revenue due to the higher prices.
Roumeen Islam: So, I guess we can think similarly about, you know, the fossil fuel market, which is also being suffering from volatility in terms of demand or supply shocks, and their asset values would also be affected by this.
Grzegorz Peszko: Correct. But the drivers of the asset value of renewable energy are different than the drivers of the asset value of fossil fuel. For renewable energy, the physical impacts of climate change are very critical. For fossil fuels the critical factor is not so much the physical risk of climate change, but the low carbon transition risk and the climate policies that can undermine the value of fossil fuels as well.
And we did the simulations of the future value of fossil fuel worth as well under the different scenarios of future climate and energy policies.
Roumeen Islam: Grzegorz, I guess one other important factor that I want to bring up is that fossil fuels are tradable across vast distances and renewable energy much less so. You take fossil fuels in tankers to countries far away. Whereas if you want to trade renewable energy, you have to build transmission lines. You can't really carry them on tankers. So, they're more restricted to, I guess, relatively more local demand conditions. Is that right?
Grzegorz Peszko: Yes, it is. Although going forward with the development of green hydrogen that is produced with renewable energy, we can see that renewable electricity stored in the form of hydrogen can become internationally tradable commodity.
Roumeen Islam: That's a very good point. Now let's just talk quickly a bit more about how you derived the asset values in terms of the different scenarios, because, I'm assuming you model different scenarios with assumptions, for technology, for demand, all of these things, which we've just discussed affect asset values. Do you want to say a couple of words about this?
Grzegorz Peszko: The 15 countries that we have covered in our pilot estimates of the renewable electricity asset values, where the countries, where we have looked at the historical development of economic rents generated by renewable electricity from solar, wind, hydro and geothermal energy. We stopped in 2017. We started in 1995, but for 2017, the value of renewable energy wealth was, net present value of the expected rents that we have seen in 2017. But certainly, we knew that extrapolating of the past trends, especially given the impact of climate change and the impact of low carbon transition can mislead about the expected rents in the future. So, for that purpose for renewable energy, we simulated what would be the impact of certain energy and climate policies on the value of renewable energy into countries. South Africa has a lot of wind and solar resources, no hydro. Angola has a lot of hydro, a lot of sun but no wind resources available.
So, what we did, we looked at a number of policies that can determine the future value of renewable energy. One of them being the way in which the existing thermal power plants are protected from the competition of renewable newcomers, renewable new entrants to the electricity pool. We found out that protecting of existing thermal power plant operators by giving them guaranteed off-takes at specific prices under the long-term power purchase agreements, has an important impact on quenching the demand and hence the ability of the even cost-competitive, renewable power plants to generate economic rents for the countries.
So, the removal of the protection as part of the electricity market reform that increases cost competition has had a dramatic impact of the future value of renewable energy in both countries pushing the value of renewable energy in South Africa very quickly above the value of the coal assets of that country. And in Angola the same, pushing the value of hydro and solar energy, about the value of country's gas, not oil.
Roumeen Islam: Sorry. This is over the long term, right?
Grzegorz Peszko: No, it's not a long term. We found the major differences even in 2020 their calculations were done in 2000 with the data as of 2019. So even 2020 and 2030, we saw immediate effects of this cost competition of electricity markets.
And especially if that. Electricity market reform is combined with a carbon pricing, which addresses the level playing fields for the social cost of renewable energy and fossil fuels.
Roumeen Islam: Grzegorz, what sort of carbon tax did you use for your simulations?
Grzegorz Peszko: We introduced a carbon price gradually in 2025 from zero, and we increased it linearly to a value of $100 per ton of CO2 in 2040.
Roumeen Islam: Okay. Very good. So let me end here because you've given us a lot of food for thought. We're going to need some time to chew through at all. Thank you very much. That's been very informative. Thank you.
Grzegorz Peszko: Thank you very much.
Roumeen Islam: Well listeners, what did we learn today. Firstly, in order to make assessments about the sustainability of a country's income stream, it's important to understand the country's asset base, it’s human, physical and natural assets or capital. so far renewable energy sources have not been considered an asset class.
Secondly, country’s endowments of any assets, fossil fuels, minerals, or solar, hydro, and wind power is valued as wealth to the extent that it earns economic rents in markets at existing technologies and policies. In this regard, hydroelectric assets already account for considerable wealth in a number of countries.
Thirdly, renewable energy companies may make profits under favorable policies, but not necessarily generate economic rents for the country as a whole. Finally, energy market reforms, such as having competitive electricity markets and a carbon tax to reflect the externality related to fossil fuel consumption, are both policy measures that increase the value of wealth in renewable energy assets.
Thank you and bye for now.