Home Finance Economics Why Corporations Embrace Renewable – It All Comes Down To Marginal Costs

Why Corporations Embrace Renewable – It All Comes Down To Marginal Costs

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Historically, government policies imposing lower emissions have had little effect on companies to become greener. Since the first industrial revolution, fossil fuels have provided the majority of the energy needed for industrial use. Profit interests have delayed restrictions on fossil fuel energy because until recently, sourcing renewable energy was too expensive and countries lack the infrastructure needed to support renewable energy alternatives. This made renewable energy an unlikely source for industrial use. Though the Paris Agreement is a symbolic commitment among nations and companies to reduce CO2 emission by 2040, only the private sector can make this commitment a reality, and it will.

In an ironic twist of economic fate, the same industries that polluted our air and water for the sake of making a profit may be the key to getting us out of it. Recent strides in renewable energy technology have improved the cost of renewable energy. Companies are taking notice and are beginning to change their tune. Masked under the call for social responsibility, companies are seeing the economic benefits of switching to renewable energy. Today, the leverage of renewable energy is being evaluated in the same manner as the leverage of technology and automation was viewed just 10 years ago. Nanotechnology is being used to leverage the efficiency of renewable energy resources. For example, research within the last decade has shown that the thermal efficiency in solar collectors can increase by up to 88% and over 200% at higher temperatures if the water fluid used in solar collectors is replaced with nanofluid (Robin Wylie, EniDay.com). As nanotechnology improves, so does the case use for renewable energy. In terms of manufacturing, this all boils down to marginal costs.

What is Marginal Cost?

Marginal cost is the difference in cost per unit in relation to each additional unit produced and sold. The higher the marginal cost, the lower the profitability of products manufactured and sold. It is important to understand that marginal cost fluctuates up and down depending on the number of units produced and sold. To best understand how marginal cost (MC) is calculated, we have to know a few other terms:

1) the price (P) of the item sold, 2) the quantity (Q) of items sold, 3) the fixed cost (FC), which does not change regardless of quantity, 4) the variable cost (VC) that does change depending on quantity, 5) the total cost (TC) which is the sum of fixed and variable costs, 6) the total revenue (TR) which is the total sales multiplied by total quantities sold, and 7) the marginal revenue (MR) which is the change in total revenue over the change in quantities sold. See insert:

Companies rely on the relationship between marginal cost and marginal revenue to determine the marginal profit (MP), a number that also fluctuates depending on the relationship between the change in revenue over the change in quantities sold. Companies will increase quantities of units produced until they reach maximum profit (the point when MR and MC intersect, MR=MC). This is the point in which a company has reached the maximum number of units it can produce before they no longer have a marginal profit.

It is also referred to as the point of maximum production. Producing and selling any additional units above this point will yield either no profit or will result in losses for each of those additional units. See insert:

 

The challenge for businesses is in creating processes so that marginal costs decrease with increased quantities, resulting in economies of scale (EOS). The alternatives to this are constant returns to scale (CRS) when there is no change in margin costs with increasing quantities and diseconomies of scale (DOS) when the marginal costs increase with increasing quantities. See insert:

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Energy and Marginal Cost

The introduction of robotics and artificial intelligence has significantly reduced the cost of process labor, but not creative labor. You can write software and integrate robotic to replicate processes but this requires energy. A great deal of energy is required to power today’s computer processors which we use for cloud services, websites and even crypto-currency. Cloud companies spend billions each year to keep data centers running 24 hours a day around the world. The search for cheap energy is so much a concern for mega-tech companies that they strategically place their data centers. Take Iceland for instance. It has become the main site for crypto-currency miners looking for cheap energy to power their mining equipment 24 hours a day. More companies requiring a vast amount of energy to operate are looking to move to countries where renewable energy is not only inexpensive but also offer an endless supply. Iceland has become popular among tourists in recent years for its beautiful, natural landscapes. It has also become popular with technology companies that require enormous amounts of energy to power new zettabyte data center. Iceland offers a unique opportunity in that Iceland is powered mostly by naturally occurring energy from hydro and geothermal sources, which is cheap, abundant and won’t fluctuate in price because of shortage or demand. Here is an example of how marginal costs are reduced when companies switch to renewable energy in places where renewable energy is readily available and plentiful.

You run a data center 24-hours a day. Your fixed cost is the rent and insurance you pay to occupy the data center. Your variable costs include the cost of the number of servers you operate, the payroll for your IT workforce which monitors and manage the servers, the cost to maintain and repair your servers, and the amount of energy your data center consumes. The energy is used to power the servers and to keep the temperature in the server rooms cool (your utility bill). Your revenue structure is set up to charge your clients monthly based on the number of hours and the number of terabytes your clients use per month. As technology improves, you require less space and fewer servers to produce the same amount of processing power and storage. However, as the processors become more powerful, they consume more energy and require more energy to cool. As such, the amount of space you require and the number of people you need to manage, monitor and maintain the servers will go down, but your energy bill goes up. Also, since you now have more space and technology is cheaper to acquire, you can have more servers in the same amount of space, thus increasing customer capacity. This results in even more energy consumption and cost. Hence, though your fixed costs and other variable costs go down, your energy costs go way up. Add to this the fluctuating price of energy in kilowatt-hours based on demand, your energy costs increase significantly, forcing you to limit most of your operations to off-peak hours when demand is lower and the average cost per kilowatt-hours is cheapest. For you to run servers 24-hours a day and leverage cheaper off-peak energy, you are forced to set up various data centers around the globe that would operate using time zone differences to maintain 24-hour uninterrupted service, limited to off-peak hours to contain your energy costs. Instead, you decide to set up all of your data centers in Iceland where thermal energy is naturally occurring, inexpensive, and abundant all day, year round. In choosing to consolidate all of your data centers to one location like Iceland, where energy is cheap and readily available, you reduce the costs associated with having to operate multiple facilities that can only operate during off-peak hours to hedge against energy costs. In addition, you can upgrade your data center with more powerful processors and greater storage capacity, to serve a larger population with zero marginal costs. This is because energy costs do not increase with increased energy use. This is true scalability in that this creates economies of scale because your marginal costs do not increase with increases in the quantity of output in services.

Renewable energy is fast becoming more affordable than conventional fossil fuel energy. As demonstrated in the hypothetical example above, renewable energy is a key component in creating perfect markets and the byproduct is a cleaner planet, and as companies strategize leveraging the cost of energy, countries that are preparing for low-cost renewable energy are partnering with companies to build modern infrastructure to provide house renewable energy sources. Cities and private companies share the cost of building new renewable energy sources, saving both taxpayers and private company stakeholders money, while preparing for strategic positioning in a global market.

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How affordable is renewable energy compared to fossil fuel energy? A few years ago solar cells were more expensive, required more surface area and needed more time in sunlight to extract energy. Today, solar cells are cheaper and require less sunlight and surface space to collect sufficient energy for commercial use. The average annual cost of electricity derived from fossil fuel, according to the US Energy Information Administration in the US, in 2018, was about 10.58¢ per kilowatt-hour. The same amount of renewable energy from solar power now matches the cost of conventional energy and wind power is already cheaper.

Globally, onshore wind schemes are now costing an average of $0.06 per kilowatt hour (kWh), although some schemes are coming in at $0.04 per kWh, while the cost of solar PV is down to $0.10 per kWh. In comparison, the cost of electricity generation based on fossil fuels typically falls in a range of $0.05 to $0.17 per kWh.”—Dominic Dudley, Forbes 2018

The cost of natural gas power is tethered to the commodity price of natural gas, which is inherently volatile. The price of controllable, storable renewable energy is tethered only to technology costs, which are going down, down, down. Recent forecasts suggest that it may be cheaper to build new renewables+storage than to continue operating existing natural gas plants by 2035.”—David Roberts,Vox 2018

Related Fossil Fuel Costs

Companies must contend with shipping costs, most of which are related to fossil fuel consumption. The marginal freight costs measure the change in cost per unit with each additional unit shipped. Logistics companies ensure low-cost, efficient, accurate, on-time delivery of shipped products. They must calculate the marginal freight costs, determining the minimum and maximum quantity of units per container required before a container can ship to cover the cost of shipping. A quantity that is too low cannot cover the cost of dispatching a container and a quantity that is too high may cost prohibitive because if a load is too heavy, the amount of fuel consumed may not make the shipment feasible without affecting COGS (total cost of goods sold).

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Then there are the marginal social costs which account for the byproducts of corporate operations often referred to as carbon footprints. This is the cost paid by society to deal with the repercussions stemming from air, land and water pollution, waste management, damage to ecosystems, and property and person damages from natural disasters caused by global warming. Health-related expenses from long-term exposure to toxic pollutants and effects on quality of life are also included in marginal social costs, all of which require millions of dollars to mitigate. Industries that leave carbon footprints may pay taxes to offset these costs, but the taxpayer covers the costs from the long-term effects.

What Companies Are Doing Today to Move Toward Renewable Energy

At least 22 Fortune 500 companies including Apple, Walmart, Microsoft, Google, and AT&T have pledged to reach a goal of 100% renewable energy power to match their annual energy consumption.

Realizing there would be no government incentives to move towards carbon neutrality after the Trump administration pulled the US out of the Paris Agreement, companies have opted to move forward in adopting renewable energy as a cost-cutting measure. Companies also see this as a way to demonstrate corporate responsibility, thus killing two birds with one stone. Companies vowed to honor the Paris deal from which the US government withdrew. The New York Times states:

“Dozens of Fortune 500 companies, from tech giants like Apple and Google to Walmart and General Motors, are voluntarily investing billions of dollars in new wind and solar projects to power their operations or offset their conventional energy use, becoming a major driver of renewable electricity growth in the United States.”—Brad Plumer, NYT, January 2018

Mass Adoption

As more companies move towards renewable energy, more money will be invested into renewable energy technology and total sustainability. This will improve renewable energy effectiveness, reduce costs associated with renewable energy and thus reduce the barrier to entry for more businesses to leverage renewable energy. Much the way improvements in industrial computer technology improved, leading to the invention of the personal computer, widespread industrial creation and use of renewable energy sources will lead to further improvements in the technology surrounding renewable energy. This will motivate companies to work together with governments at all levels using private money to fund projects to create the infrastructure to support renewable energy sources. As technology becomes cheaper and more efficient, entire populations around the globe will largely adopt renewable energy as the main source of energy.

Though our recently elected federal government officials have taken a step backward in combating climate change, companies know all too well that the “holy grail” of zero marginal costs lies heavily on continued investment in renewable energy technology. Regardless of government support, companies are making the switch to renewable energy. Reducing margin costs is the primary incentive for companies to advance renewable energy technology. Thus, the answer to solving the problem of global warming and fossil fuel dependency will ultimately not be solved through government-imposed policies, but rather by accounting for the marginal costs that result from not solving the problem. Corporations know that adopting renewable energy is the solution to achieving zero marginal costs. Though marginal costs may be the cause of corporate responsibility, the cause is irrelevant because everyone wins in the end.

2 COMMENTS

  1. Thankyou for a really interesting article that I could understand-even with my limited costing background!
    The future generations will enjoy a better everything if we all contribute towards educating the ‘foot-dragging’ industries,, thrown in with a few more kicks administered to their rears!
    Financial incentives can work to help speed up the greater acceptance of all things categorized as renewable energy. Implementation time is running out!!

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