A Change Will do Us Good

Energy diversification & economic growth

Energy and economies are inextricably intertwined. The Industrial Revolution that made human productivity skyrocket was made possible by the exploitation of fossil fuels and the spread of electrification. Countries blessed with abundant energy resources have become wealthy, providing for all domestic needs and exporting surplus resources around the globe. As developing nations modernize their economies, they power the transformation with more energy use. With climate change a threat everywhere and lowering greenhouse gas emissions a common goal, the question is how energy diversification affects economies.

Short-Term Losses

Like most investments, diversifying with renewable energy sources takes time to pay off. Researchers studying the economic impact of energy diversification found that in both high- and low-income countries, “economies underperform in the short run with energy diversification,” Giray Gozgor and Sudharshan Reddy Paramati wrote in Energy Economics.

It takes time and investment to build up renewable infrastructure, connect those sources to the grid, and encourage widespread adoption. Change is hard, especially on a large scale. People and governments are reticent to slow down an economic machine that is seemingly humming along nicely. And in the short term, any gains made by renewable energy might be directly replacing lost output powered by fossil fuels.

Once energy diversification in an economy reaches a tipping point, however, the balance shifts dramatically. Renewable energy prices go way down as technologies mature and grids become better suited to new technologies rather than legacy ones.

“It is important to note that countries may experience a slowdown in their economic growth in the short run but will see the positive benefits of energy diversification in the long run,” the scholars wrote.

Don’t Be Shocked

The benefits of diversification are manifold, but a major one is that it prevents countries from putting all their eggs in one basket. Relying heavily on one source of energy, especially if it’s imported, leaves economies vulnerable to shocks and disruptions. For example, Russia’s invasion of Ukraine triggered what the IEA labeled the “first truly global energy crisis.” The UK, European Union, and even the U.S. drastically reduced their oil imports as part of sanctions. Energy prices hit record highs, as countries scrambled to replace what had been a key part of their energy mix.

The long-term effect, though, might be that the war hastened the “end of the fossil fuel era,” the IEA said, with demand projections for fossil fuels set to peak this decade then recede. Diversifying under such circumstances was not ideal, but the countries that turn to more renewables as a result of the war will be set to better absorb such a shock in the future.

Over the last quarter-century, fossil fuel energy prices have been highly volatile, leading to periods of uncertainty for both importers and exporters. Within a few months in 2008, oil prices went from $147 per barrel, a record at the time, to $34 at the onset of the Great Financial Crisis. When the first wave of Covid shut down the world economy, Brent crude futures actually went below $0.

Recognizing their vulnerability, petrostates in the Persian/Arabian Gulf area have been diversifying their economies. Countries such as the UAE and Saudi Arabia have built robust tourism industries, shifting away from oil exports and emphasizing renewables.

“Up to 2040, 40 petrostates could see oil and gas revenues fall from an expected $17 trillion to just $9 trillion,” Carbon Tracker reported.

Secure Future

The reason, then, for petrostates and others to diversify their energy mixes is security. That can mean economic security directly, as is the case with switching from an economy based on oil exports to one based on tourism. But it can also mean political and societal security, which in turn can prevent economic disasters.

“Particularly, the concept of energy mix concentration instead of energy diversification is considered an early warning indicator of vulnerability,” Gozgor and Paramati wrote. “Energy diversification can mitigate the spillover impact of energy prices on food prices and decrease domestic conflicts and violence due to price spikes and volatility.”

In short, if major swathes of a country’s people are rioting in the streets, they’re not at work driving economic gains.

In contrast, the researchers point out, that raising the level of investment in renewables will slow the negative impacts of climate change brought on by GHG emissions and yield sustainable economic growth.

The authors of a paper in Frontiers in Energy Research entitled “Energy Diversification and Economic Development in Emergent Countries” concur. Calling renewable energy “a driver of economic growth,” they wrote, “efforts to diversify the energy mix with renewables will accelerate economic productivity.”

Energy security through diversification provides the economic conditions necessary for entrepreneurship and innovation.

“We demonstrate that wealth creation can be achieved through energy diversification rather than relying solely on conventional energy sources,” the authors wrote.

That’s reason enough to make the effort to mix things up.