Renewable energy is surrounded today by conflicting signals: it is hailed by politicians as essential to sustainable growth and energy sovereignty, yet its subsidies are being questioned and its profits are being capped by some governments.
The majority of low carbon energy investments have been directed at intermittent technologies such as wind and solar , built far from the main consumption areas, with electricity storage and network adaptation lagging behind – a trend which could continue given the sheer volume of future investments already planned. .
As a result, the opportunity to invest in renewable energy comes with new questions: is the risk profile of renewable investment going to evolve in a world where there are always more renewables but not (yet) enough storage? How can investors manage their portfolio in this changing environment? Do mature technologies still need the incentives that have supported the market growth to date?
These questions are addressed in a recent paper authored by Laurence Monnier in collaboration with Frederic Blanc-Brude and EDHECInfra. This report uses the example of the UK, a market with a long history of deregulation, abundant wind resources and historically limited interconnection to other neighbouring markets, to draw out the following key points.
- The growing share of intermittent renewable in the power system brings new risks for investors. These includes volume and price volatility (as the intermittency of renewables’production also amplifies the gas price volatility), as well as the risk of curtailment due to market imbalance and grid congestion. Increasing competition between renewable energy producers can also depress revenues. Meanwhile, the option value of gas generation, which is needed to balance the system, is rising. As mature renewable technologies become more cost competitive, regulation is evolving and incentives are being removed. This brings potential risks as well as new opportunities, such as the ability to earn revenues on the balancing market by reducing production.
- The emerging risks have yet to be reflected in returns requirements. Investors have historically benefitted from yield compression. Yet their voracious appetite for investments that bring both financial and environmental returns has kept the risk premium in check. This makes it all the more important to manage risks effectively. To do this, investors can hedge revenues, buy self-insurance (e.g. through energy storage) or build diversified portfolios. Diversifying investments by country and technology reduces portfolio risk significantly. While studies have shown a strong correlation of weather pattern over western Europe, access to different power markets and regulations translates into real financial diversification benefits.
- For revenue hedging, a regulation offering the option to fix the price of electricity – for example through contracts for difference (CfDs) – remains critical to support investments in greenfield projects. The private market for corporate power purchase agreements is growing rapidly but remains insufficient to support the vast volumes of investments needed. Public CfDs, where the price is fixed through auctions are fundamentally different from subsidies. They offer price stabilisation which not only encourages investment, but also benefits consumers. For instance, the price of electricity sourced from CfDs awarded to UK wind generators appears quite low in today’s market.
- The current energy crisis has highlighted that deregulation is no guarantee for low prices – with the link between gas and power price and the rising market volatility hurting consumers. Emergency windfall tax measures put in place to protect consumers will likely raise investors’ perception of political risk, at a time when the market risk is also set to rise. By contrast, regulatory reforms that maintain or expand price stabilisation options can ensure that investors continue to direct the vast capital flow needed at competitive cost to the renewable sector, while ensuring that customers can also share the benefits of low-cost renewable generation.
LAURENCE MONNIER- 1PlanetInfra. Research Associate and member of the EDHECinfra Advisory Board
For the full report, please read