Merchant Renewables: A Viable Investment Or A Bubble Fit To Burst?
Like many other nations, Spain has incentives to encourage investment in renewable energy production. After several years with a ‘moratorium' on incentives and no new build, the need for incentives has disappeared almost overnight as renewable energy sources have reduced costs and have now achieved “grid parity”, meaning that they can be developed without government subsidies. Whilst this has encouraged an increase in renewable energy projects, it could be harmful to profits and have serious economic risks for investors. ÅF Pöyry Management Consulting's Javier Revuelta considers the potential risks of taking a long-lasting grid parity in Spain for granted, how to mitigate these problems, and why it's relevant to us all.
Anyone who believes we are in the midst of a climate crisis will celebrate the recent increase in renewable energy projects, but policies must also ensure a secure energy supply and competitive end-user prices. In order to contribute to the new ambitious EU targets for 2030, the Spanish government has committed to more than doubling the current wind capacity, and multiply by eight times the solar PV capacity; it considers the use of new auctions to find bidders, as a complement to subsidy-free developments. These auctions are expected to include guaranteed prices which shield investors from future changes in market prices, for example if they fall due to the increasing number of renewable projects already planned and promised to the EU. Unfortunately, this means that the market is likely to reduce revenues as a consequence of a high cannibalisation effect; whilst some cannibalisation can be digested by current projects and still make them sufficiently profitable, it might be too high if all grid connection requests that have deposited guarantees and have been accepted by the grid operator effectively go forward.
Government auctions mitigate investment risks, but there are considerable economic risks for those who believe that the current ‘apparent' or ‘initial' grid parity will remain over the life of the project, and that future market prices will support the case for independent investments outside of probable future government auctions. Those risks only increase when you consider other challenges that would contribute to reduce the cannibalisation of market prices, such as: the development of interconnections; the rise of currently unprofitable storage; electric vehicles; and the many necessary regulatory changes which are likely to take years to develop.
If the Spanish government strives to achieve its commitments with the EU through the development of auctions, those who have already invested and expect the wholesale electricity market to remain at current levels are likely to encounter serious economic problems. Should the wholesale electricity market price drop, they should not expect the government to bail them out, stop the annual auctions for new entrants, or change the market model so that it suits their needs. The government will not rescue investors, nor will the EU change the market model it has just ratified, at least in the foreseeable future. These investors should also not rely on a sector ‘collusion' to bid-up in hours of RES surpluses and otherwise depressed prices, not only because it is illegal, but also because it is materially impossible to orchestrate and is counterproductive given its negative effect on renewable exports to the rest of Europe.
Investors must seek robust analysis and advice to decide where to put their money. At present, despite much higher revenues than new projects' LCOEs (the average remuneration that a project requires over its lifetime), it is difficult to guarantee whether investments in merchant renewables in Spain will indeed reach attractive returns over the investment lifetime, or whether very high additional capacities supported by auctions will trespass the bursting point of today's investors. Potential return on investment will depend on several factors, including: the international price of gas and carbon emissions; the development of electric interconnections; the penetration of electric vehicles and storage; and the government's ability to meet its commitments to reduce greenhouse gas emissions.
The future of the renewable energy landscape is unclear as we do not know how many renewable megawatts will be installed. At present, administrative inefficiencies and market price signals are the sole moderators of investors' appetites. In this new environment of subsidy-free developments, nobody controls and anticipates the volume of annual connections, and no authority is responsible for warning investors about the potential economic risks set out above.
A message for investors in renewables - regardless of where they are investing - is that it is not a responsibility for grid operators, governments or regional governments to show them the economic risks of their investments. Specialists must provide good analysis and advice to investors in order to help them understand the opportunities and the many risks. Investors should take care to understand this environment, or to otherwise entrust themselves to the wholesale electricity market.
At this point it's hard to say if subsidy-free investments in the renewable energy market in Spain will provide a good return on investment despite the very attractive initial returns of this 30 years investment journey. Hence investors must be aware of the potential risks. European governments can monitor the upcoming volumes of investments under the two main investment options (subsidy-free with volatile market revenues, or under auctions with guaranteed revenues), and we shall soon see whether they can learn from the Spanish energy market how to do things, or how not to do them. Business or bubble? Let's talk in 2030.