Switch renewable energy remains firmly on

Real Assets Research team
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28 July 2017
  • Significant renewable energy investment needed to meet global climate change targets
  • Companies such as Google and Facebook are driving demand for energy from renewable sources
  • Renewable energy costs are falling and some projects do not need government subsidies, reducing potential risks for investors

Regardless of President Trump announcing that the “United States will cease all implementation of the non-binding Paris Accord”,1 agreed at COP21 (Conference of Parties) in 2015, the switch to renewable energy should continue. Simply put, burning fossil fuels at current rates is incompatible with a target to “limit global warming to well below 2°C.”2

Across Europe, there has been progress in moving away from polluting fossil fuels, with renewable energy sources accounting for a fastgrowing share of electricity generation. After representing less than 5% of new generation capacity in 2000, renewables increased their share of additions to more than 80% in 2016, according to WindEurope, as shown in Figure 1.

Because of this sharp increase in capacity additions from renewables, across Europe, wind now ranks second to gas as the largest source of electricity generation capacity (157.4GW, compared to 155.4GW).3 The surge in renewables has been at the expense of both coal and nuclear power, with both fuel sources seeing their share fall dramatically. Coal, for example, accounted for 25% of European capacity in 2005, compared with just 17% in 2016. Nuclear power accounted for 19% of capacity in 2005, falling to 13% in 2016, according to WindEurope figures. Against this backdrop, the  recent push for additional coal output in the US appears at odds with the European direction of travel. However, according to Bloomberg New Energy Finance, global coal fired generation is expected to peak in 2026, with demand growth until then dominated by Asia.

European commitment to renewable energy

This aside, drivers of the move towards renewable energy sources in Europe look set in stone, with the European Union’s (EU’s) Renewable Energy Directive setting a binding target of 20% final energy consumption from renewable sources by 2020.4 To achieve this, EU countries have committed to reaching their own national renewables targets, ranging from 10% in Malta to 49% in Sweden. While this may appear ambitious, Germany, which was initially slow to ramp up its investment in renewables, is now leading other nations in the switch. It introduced its Energiewende legislation in late 2010, which includes a Green House Gas reduction target of 80–95% by 2050 (relative to 1990) and a renewable energy target of 60% by 2050.5 Already, Italy, Finland, Sweden and Norway have broken through their respective targets, after significant investment.6 Despite these individual achievements, for the rest of Europe to meet its targets, large-scale investment, estimated at around EUR1 trillion between 2015 and 2030, is required, according to research undertaken by Bloomberg New Energy Finance.

In order to encourage development of renewable energy sources and spur private sector investment, many governments have introduced a range of incentive mechanisms. These include:

  • „„Feed-in tariffs (FITs), where asset owners receive a pre-determined tariff (price per unit of production) for “feeding-in” electricity to the grid. FITs are fixed at either a nominal or a real level at inception. Often, FITs cover all or nearly the entire revenue stream „„
  • Contracts-for-difference (CfDs) are a mechanism where asset owners receive prevailing market price for electricity and a top-up payment from the government if the market price is below a stated benchmark (usually with a symmetrical repayment if the market price is above the benchmark)
  • „„Renewable energy certificates (RECs) are a system where asset owners receive a REC and the market wholesale power price (typically known as merchant pricing) for each unit of production. There are various mechanisms for the pricing of certificates, with some markets using fixed pricing (UK) and some using merchant pricing (Norway and Sweden) that are subject to supply and demand
  • „„Alternatively, some governments will use a variety of tax incentives in order to encourage investment.

Renewable energy asset owners often collaborate with financial investors, who can monetise the tax breaks. This approach is rare in Europe but relatively common in the US.

Global companies at the forefront of renewable energy use

Governments are not the only driving force behind the move to use electricity generated from renewable sources. Many corporations are setting ambitions targets as they seek to lead the way in sustainable business practices. Google, which is the single largest buyer of renewable energy in the world, is on track to reach its target to use 100% renewable energy in 2017 across its global operations — including both data centers and offices. Google was one of the first corporations to create large-scale, long-term contracts to buy renewable energy directly, signing its first agreement to purchase all their required electricity from a 114-megawatt wind farm in Iowa, in 2010. Today, Google’s commitments reach 2.6 gigawatts (2,600 megawatts) of wind and solar energy.7

Where Google leads, others follow. Facebook has committed to powering its business with 100% clean and renewable energy, although no formal date to achieve this target has been set. During 2015, Facebook exceeded its goal of reaching 25% clean and renewable energy across its data center electricity supply mix. Since then, it has doubled its target and expanded its scope, with an aim to achieve at least 50% clean and renewable energy across its companywide energy mix in 2018.8 Objectives of this kind are not only good for the environment, but can also help improve energy security and consistency of supply.

Non-subsidised renewable energy is already a reality

Government support, allied to operator excellence, project scale, fast-developing technology and cheaper finance have combined to reduce the cost of renewable developments. Figure 2 shows the base case assumptions used to reach Final Investment Decision (FID) revolved around a LCOE (levelised cost of electricity) of EUR115/MWh* in 2010. Thanks to the positive changes listed above, the potential LCOE for future developments could fall to EUR37/MWh, a reduction of 68% compared to 2010 levels.9

Importantly, while absolute margins could fall from EUR16 to EUR6/MWh over time, in percentage terms, there is likely to be an increase – from 14% to 16%. This falling LCOE and the range of factors influencing the drop are exemplified by DONG Energy, which recently secured two offshore German wind projects without government subsidy.10 While this (non-subsidised) outcome is unlikely to become the default position immediately, there were a number of factors supporting DONG Energy’s recent bids:

  • „„Larger turbines (13-15MW, compared to the 8-9MW turbines currently in use).
  • „„No new grid connection required.
  • „„Probable synergies, as the new projects are located adjacent to existing DONG wind farms and so they can be treated as expansions to existing projects „„A longer life-span than the usual 25 years.

Wide range of options for investors

Given the lack of geographic constraints, offshore wind projects are generally utility-scale and significantly larger than onshore. There are also a limited number of developers, so from an investment perspective, competition for assets can be tough and dominated by the largest operators in the infrastructure investment sector. That is not to say opportunities are limited, and investing in consortia represents a potential way to secure exposure to this part of the market. Onshore wind investment benefits from a broader and deeper pool of assets, operators and investors. Co-investment in a consortium or individual transactions won at auction are methods of gaining exposure to the sector, but potentially high abortive costs can be enough to make some investors think twice. Partnering with an aggregator in an attempt to build an investment platform is an option, as this allows investors to build a portfolio of assets over a clearly defined period, set to pre-defined investment objectives.

Clearly, investors are now firmly switched on to renewable energy. While many questioned the viability and validity of renewable energy generation, technology has developed to such an extent, and costs have reduced by so much, that renewables are no longer a government-led pipe dream, they are a reality. Moreover, as technology improves further and reaches scale, a future of renewable energy without subsidy looks a realistic option. Further investment is required and the private sector has an important role to play in the delivery of renewable energy projects, as the world transitions away from  carbon intensive fossil fuels.


1 https://www.whitehouse.gov/the-press-office/2017/06/01/ statement-president-trump-paris-climate-accord
2 https://ec.europa.eu/clima/policies/international/negotiations/paris_en
3 Source: WindEurope
4 https://ec.europa.eu/energy/en/topics/renewable-energy/renewable-energy-directive
5 https://www.bundesregierung.de/Content/DE/StatischeSeiten/Breg/Energiekonzept/0-Buehne/ma%C3%9Fnahmen-im-ueberblick.html
6 http://ec.europa.eu/eurostat/statistics-explained/index.php/Energy_from_renewable_sources
7 https://blog.google/topics/environment/100-percent-renewable-energy/
8 https://sustainability.fb.com/clean-and-renewable-energy/*MWh – Megawatt Hour
9 http://www.mckinsey.com/business-functions/sustainability-and-resource-productivity/our-insights/winds-of-change-why-offshore-wind-might-be-the-next-big-thing
10 http://www.dongenergy.com/en/media/newsroom/company-announcementsdetails?omxid=1557851

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