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Finance

Macro volatility rocks renewables rollout

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Decades of low rates and falling cost-curves were key to making renewables competitive, helping channel billions of dollars into green energy projects. Amid soaring inflation and the most rapid interest rate rise in history, concern is growing that economic turmoil could sap momentum from the energy transition, writes Steven Gilmore.

Renewables’ far larger up-front capex requirements mean a sharp rise in rates has long been seen as the industry’s achilles heel. Weighted average cost of capital can account for up to half the cost of electricity from utility-scale solar PV projects, according to the International Energy Agency.

Rampant inflation creates a pernicious cocktail. Not only are projects having to pay more to borrow, but much of this capex goes on raw materials that have soared in price over the last year or so.

“We have seen a surge in prices for key materials like steel, transportation, PV panels and wind turbines,” says David Swindin, chief executive officer of Cubico Sustainable Investments, one of the world's largest privately-owned renewable energy companies. “The costs of building renewables have significantly increased because of inflation and there is a real risk that without the right response this could derail the global energy transition.”

Some of the most capex intensive renewables projects are already struggling. In October, Commonwealth Wind said that a proposed 1,200 megawatt (MW) offshore wind project in Massachusetts was “no longer viable” under the terms of a contract signed in May.

“Global commodity price increases, in part due to ongoing war in Ukraine, sharp and sudden increases in interest rates, prolonged supply chain constraints, and persistent inflation have significantly increased the expected cost of constructing the project,” the developer said.

Green funding booms

Capex requirements on renewable projects had been falling steadily and predictably for years as learning effects improved efficiency. Economic turmoil has thrown this trend into reverse, but energy analysts think renewables – at least in Europe and the US – will weather the volatility.

“It may be that with marginal projects, particularly those that are especially capital intensive, it can be the difference between go and no go,” says Oliver Kerr, head of US for Aurora Energy Research. “But there's a huge amount of capital out there that’s seeking renewable projects, there’s no shortage of funding available.”

Investment funds with established power practices are finding it increasingly challenging to justify financing fossil fuel projects. The funding pool dedicated to green investments, meanwhile, continues to surge. PwC expects global ESG-related assets under management to hit $33.9tn by 2026, up from $18.4trn in 2021.

Kerr at Aurora says some US projects have been delayed by supply chain constraints, which make it hard to source key components like solar panels and battery packs. Several renewable projects in Texas that were expected to close this year now look likely to do so in 2023 or 2024.

But the projects are not in jeopardy. In Europe, inflation and rising rates have stalled only a small number of projects, according to Gabriel Umana Gomez, customer success manager Europe for LevelTen Energy. The firm operates an energy marketplace that delivers access to more than 4,500 PPA price offers in 25 countries across North America and Europe.

Many of the PPAs agreed on its marketplace are for projects yet to be built, and in some cases the shifting economic backdrop has prompted a temporary pause in negotiations. “But we also see demand [for PPAs] growing,” he says. “Many, many deals are going through. Inflation isn’t stopping deals, it's making developers and off-takers to be a little bit more innovative in contract structure.”

[The impact of inflation and rising rates] might be hitting a bit further down the line...things are developing extremely fast
Jan-Lukas Bunsen, Aurora Energy Research
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Renewable projects are paying more on their capex and their inputs. But, crucially, they are also being paid more for their electricity. A significant chunk of global inflation is down to higher gas prices, and the structure of electricity markets – where gas sets the marginal wholesale price – has meant higher profits for all producers.

In Europe, soaring gas prices have driven up the price renewables can receive for electricity on the open market by between five to 10 times, says Jan-Lukas Bunsen, who covers Europe for Aurora.

Many renewables agree to sell much of their power through longer term PPAs. But here too demand is far in excess of supply. Companies on both continents are turning en masse to renewable PPAs to lower their exposure to surging power prices and to meet increasingly stringent decarbonisation targets.

LevelTen’s most recent European PPA index for Q3 this year showed solar annual PPA prices were up 15.4% and wind prices up 8% - significantly faster than EU annual inflation at 10.7%. LevelTen’s index for the US tells a similar story, with solar PPA prices up 7.5% and wind up 11.4%.

Political backing

None of this argues in favour of a relaxed approach. The impact of inflation and rising rates “might be hitting a bit further down the line”, says Bunsen, “things are developing extremely fast.” But political and regulatory support for renewable power is getting stronger on both continents.

In Europe, fossil fuel generators face a carbon tax while most renewables still enjoy supportive subsidies that provide a price floor. In the UK, a contract for difference scheme means renewable generators have to pay back excess profit. But in other European countries – including Germany and the Netherlands – there is a price floor but no ceiling.

Russia’s war against Ukraine and its impact on gas prices has strengthened European resolve to decarbonise its power sector. The continent’s REPowerEU Plan announced in May is designed to end the EU's dependence on Russian fossil fuels and tackle the climate crisis. The new plan will see renewables provide almost 70% of power sector electricity by 2030, mostly through expanding wind and solar.

In the US, the Inflation Reduction Act passed earlier this year provides huge tax credit incentives for renewable resources. Like most of Europe, there is no cap on the profits US renewable generators can receive on the open market.

The regulatory hill facing fossil fuels, on the other hand, is only growing steeper. California and 11 other states have carbon pricing that is expected to ramp-up over time. New federal regulations around local air pollution will alter the economics of fossil fuel plants.

All this is good news, because it remains unclear whether the cost of developing renewable projects will fall back to pre-pandemic levels.

“Inflation will probably return to a new normal over the next few years,” says Swindin. “However, with demand for renewables expected to spike in future years, I cannot see the cost of developing wind or solar projects returning to where they were two years ago.”