Green energies are booming but are they also profitable?
This has been the main concern for investors in the past. Green technologies have been known to be expensive and with slower return rates than their traditional energy counterparts, but is that still the case?
Despite the so-called energy transition being a currently ongoing process in active development, the results are already shaping finance and investment trends of the global energy sector. Investors have started to adjust their preferences and the behavior trends have shifted in favour of renewable energy technology.
A recent study by the renowned Oxford Institute for Energy Studies showcases that major investors are already showing decreased interest in conventional energy resources in comparison with renewable ones mainly due to the high risks and uncertainties, affecting the return on investment.
In the study published back in January, the researchers added that “Investors are demanding a much higher hurdle rate in order to invest in long cycle oil and coal projects” This finding is based on a survey with institutional investors including asset managers, hedge funds and private equity investors in the US and Europe. It has concluded a clear differentiation among various energy resources and the expectations of returns connected to them. The investors were asked to specify the minimal Internal Rates of Return (IRR), or hurdle rate, that they require to invest in different energy projects. Investors are expecting higher risks in oil and gas projects in comparison to solar and wind projects, thus asking for a higher return on investment rates in the former categories. (Results are in Figure 1).
When the researches compared these numbers with older ones, it was noticed that solar, wind and liquefied natural gas (LNG) projects had rather stable hurdle rates. On the other hand, fossil fuel projects, specifically the deep-water oil, long cycle mega oil projects, and new coal faced major increase in the minimal required level of return. This is a clear evidence of the change in risk perception in the energy industry.
Figure 1: Comparison of the hurdle rate of return for different energy projects in the survey. Source: Oxford Institute for Energy Studies
The foreseen risks originate from different factors such as technological advancements and policy alterations. One such example of a technological risk for oil producers is electrical cars outperforming internal combustion cars. Policy risks have even more devastating effect on conventional energy sources. This can be clearly observed in cases where governments completely banned the usage of a specific energy resources.
An example is the case of coal in Germany where all coal-fired power plants will be phase out by 2038. Another market-related risk is the decreasing prices of substitutes as the recent fall in PV systems and batteries prices. In general, renewable energy is shielded from these risks through state support schemes and continuously decreasing costs. LNG is also perceived positively by investors. This energy source has a low carbon content and can play an important role in the future energy mix complementing the intermittent renewables.
This unwillingness to peruse long term oil projects and the concentration within short term upstream ones will amount to fewer attempts to explore and appraise oil. In the long run, this will lower the supply of traditional energy resources such as oil and gas and subsequently increase their prices. In turn, a boost in the energy transition process is expected to lead towards more affordable renewable energies.
Renewable energy continued to dominate the power generation sector at nearly USD 300 billion in 2017. This value accounted for two-thirds of the total investment in the energy segment. PV sector specifically is booming. This technology reached a record number in terms of investments and installations representing 8% of the total energy investment worldwide. Wind technology was also performing well with robust offshore installations in Europe reaching 4 GW in 2017 alone.
This increase in RE share is critical to offset the halt and closure of many nuclear and coal-powered plants worldwide. Another promising trend, the increasing investment in electricity networks and battery storage is beneficial to the increased flexibility of power systems. This flexibility is crucial in overcoming the current intermittency problems and to increase the overall share of renewables.
Figure 2: Global power sector investment for the year 2017. Source:IEA
Geographically, China is leading the global distention for renewable energy projects and investments accounting for 45% of the total worldwide installations in 2017. The global trend is showing a shift in investments from developed to developing countries. In 2017, the former has only accounted for 37% in comparison to 63% among the latter.
Cost reduction was a decisive factor in this investment growth. The cost of PV projects fell by nearly 15% in 2017 alone, mainly due to lower module prices and deployment of projects in favorite solar radiation conditions. This cost is expected to continue to decrease with technological advancements such as bi-facial modules. The economy of scale was also in favor of renewable energy reducing the costs. The size of awarded PV projects during auctions in emerging economies rose by four and a half times from 2013 to 2017. Moreover, the size of onshore wind projects rose by half in the same period. Europe has not followed this trend with such intensity, however, the end cost of produced electricity has decreased nonetheless.
Privatization of power sector has opened the door for alternative mechanisms for renewable energy projects. Advanced markets such as in Europe allow the direct interaction between power producers and large consumers including utilities, corporates and even spot markets. Corporate PPAs, or merchant PPAs, are flourishing reaching 19 globally GW by the end of 2017 with skyrocket increase rate. One noticeable example is the deal of aluminum producer Norsk Hydro’s to purchase electricity from the 650MW Markbygden Ett wind farm in Sweden. This market is gaining huge momentum and many deals of this kind have been sealed in the past year. In Spain, Cox Energy Solar S.A. has signed a long-term PPA with energy trader Audax Energia S.A. covering capacity of 660 MWP
Figure 3: Global volume of corporate PPAs signed by region from 2008-2017, GW. APAC: Asia-Pacific, EMEA: Europe Middle East and Africa, AMER: Americas.
Source: Bloomberg New Energy Finance
Renewable energy technologies are being perceived differently
In regard to financing and funding, renewable energy technologies are now identified as low-risk mature opportunities by investors and lenders with expansion in off-balance project finance. The cost of capital has been exceptionally low in recent years causing an immense competition for shares between various investment funds and developers. Development Finance Institutes (DFIs) are paving the way in developing countries by providing cheap finance below the market rate and promoting the adoption of best practices. In Europe, better finance conditions allowed for lowering the generation cost of new offshore wind by nearly 15% in the past five years. Renewable energy projects are predominantly owned by private entities while government-backed entities are still playing the main role in the electrical grid spending.
Green bonds play a leading role to bridge the gap between investors and development projects as a debt instrument that allows fighting climate change and promote innovative technologies. Since the initiation of this concept 10 years ago, renewable energy projects were the preferred option to get this type of finance due to its established credibility as an effective green technology that mitigates climate change. In 2017, green bonds issued for energy efficiency the first time exceeded the value of those for renewables. The historically underestimated sector of energy efficiency is finally gaining momentum.
Areas of improvement
Despite this impressive performance in power generation sector, clean energy is still lagging behind other energy resources in the transportation sector. Investments in the electrification of this sector and energy storage are vital for the acceleration of the energy transition. There have been recently notable investments in mining and battery manufacture, especially for the leading lithium-ion technology. Nevertheless, bottlenecks and defects in the supply chain are still hindering wide implementation of EVs. There are other newly developed technologies, hydrogen being one of them, that have started to receive the attention of investors and developers, however, the high production costs are harming their ability to be widely implemented.
R&D activities in renewable energy are increasing and sat a record high in 2017, rising 6% to $9.9 billion where the corporate sector mirrors the volume of governmental investments. The governmental investments, therefore, act as an endorsement and guarantor for lower risk. Back in 2015, during the Paris climate talks, 22 global powers, including the US and China committed to double their clean energy R&D by 2025. The execution of this promise has not been carried out in full yet, however, the political commitment alone and slight improvements are showing a trend in the right direction.