The decline in growth of the renewables empire

January 2024  |  SPECIAL REPORT: ENERGY & UTILITIES

Financier Worldwide Magazine

January 2024 Issue

Gibbon’s ‘The Decline and Fall of the Roman Empire’ is a monumental six-volume work that explores the history of the Roman Empire from its peak in the second century BC to the fall of Constantinople in 1453. Having seen the stratospheric rise of the renewables industry over the past 25 or so years, one of the questions that has emerged recently is whether, like for the Roman Empire, there are some systemic limitations to renewables that are beginning to curb the ambitions or even turn the tide against it.

The renewable energy sector is still growing and still lucrative. However, it seems some of the big-name players are shifting their priorities. For example, oil & gas companies such as Shell and BP are shifting away from renewable energy generation due to lower profits compared to their fossil fuel divisions. Even the bastion of the sector, Equinor, reported a $91m net operating loss in its renewables division due to lower prices and higher project costs. The world’s biggest offshore wind developer, Ørsted, recently reported heavy losses and then abandoned two offshore wind projects in the US at a reported cost of more than £3bn, citing “a challenging and volatile business environment” which includes rising interest rates, supply chain disruptions and regulatory uncertainty, and lost its chief financial officer (CFO) and chief operating officer (COO) shorty after. Vattenfall’s Boreas, a mega-project off the Norfolk Coast, has run into difficulty despite success in winning a UK government-backed contract for difference guaranteeing its bid price of £37.35 per megawatt hour (MWh).

The problems extend beyond developers to the supply chain, with the German government extending around €15bn of guarantees recently to shore up Siemens Energy, which produces a significant proportion of the equipment installed in new renewables projects.

In this article we explore the drivers for renewables. While the renewables empire is still growing, the pace of growth seems to have slowed and the number of negative news stories has increased, giving investors and financiers some cause to pause and consider the reasons behind the slowdown.

The need to accelerate

The ‘energy transition’ broadly refers to the sector’s shift from fossil fuel dependency to decarbonisation. Measures such as net zero targets and incentives, frameworks for investment in renewable energy projects, legislation to reduce carbon emissions and initiatives to shore up energy security have all accelerated the transition.

With growing importance being placed on the energy transition, it is no surprise that both private and public investors are increasingly investing in renewable energy projects. In fact, the International Energy Agency (IEA) reported that renewable energy investment globally hit a record $358bn in the first six months of 2023. It has also estimated that low-emissions power will account for almost 90 percent of total investment in electricity generation this year.

In line with this, investment in clean energy is exceeding that in fossil fuels. This has been caused by a number of factors including decreasing technology costs, volatile fossil fuel prices and increased governmental support through legislative instruments such as the Inflation Reduction Act (IRA) 2022 and the European Green Deal. However, is such additional investment sufficient to support what is required for the energy transition?

The answer seems to be ‘no’. The IEA has noted that investment must significantly increase to meet announced climate pledges and net-zero targets. This is further supported by the International Renewable Energy Agency’s (IRENA’s) findings in 2020 that, to meet agreed global climate goals, renewables will need to provide two-thirds of the world’s energy supply. In comparison, according to REN21, in 2020 only 29 percent of global electricity generation came from renewable energy sources.

In terms of funds that may be required, in that same year the IRENA estimated that government plans at the time called for investing at least $95 trillion globally in energy systems over the next three decades. As private and public entities are increasingly showing interest and commitment to the energy transition, investment will therefore likely continue growing. However, it is unclear if it will reach the levels necessary to accomplish climate ambitions.

Importantly, for the energy transition to be effective the amount of investment in the energy sector must not only grow, it must also be appropriately channelled into the right technologies. Just because renewables is growing does not mean that its share of the energy sector is growing. As the Energy Institute’s 2023 ‘Statistical Review of World Energy’ reported, oil production grew by 3.8 million barrels per day (BPD) in 2022 and global energy-related emissions grew by 0.8 percent to reach 39.3 billion tonnes of CO2 equivalent. This seems like we are getting further away from an energy transition despite the investments.

In 2020, the IRENA estimated that nearly $9.6 trillion of cumulative investments would be needed to scale up renewable power generation capacity through 2030. In annual terms, this would imply doubling investments in renewable power generation capacity to $676bn per year until 2030, compared to $289bn invested in 2018. Furthermore, it noted that $10 trillion would need to be redirected from fossil fuels to low-carbon technologies by 2030.

Government interventions

Notwithstanding the above uncertainty, there is cause for hope for the renewables sector. It seems clear that investment in renewable energy will continue growing, and perhaps the trajectory will gather pace to become exponential at some point.

National and federal governments and institutions have recognised the need to accelerate renewables investments and seem to be constantly intervening in the sector. Some have implemented incentives which encourage participation in the energy transition. Others have imposed tighter restrictions on those that are not directly transitioning, rendering it more difficult to avoid the consequences. Examples of the first are the IRA in the US and the European Green Deal in the European Union (EU). The IRA includes $216bn in tax credits for corporations investing in clean energy and aids the provision of up to $250bn in loans benefitting energy infrastructure. The Green Deal, through its Green Deal Industrial Plan, aims to provide €1 trillion in funding, by also releasing private capital.

An example of tightening restrictions is the EU’s Carbon Border Adjustment Mechanism (CBAM). From 2034, this will require producers of applicable carbon-intensive products to purchase CBAM certificates to account for their emissions. This aims to incentivise the decarbonisation of processes but will likely also increase the price of materials used for renewable energy projects in the EU. Additionally, as CBAM will also apply to electricity imported into the EU, it may cause importers to be ‘priced out’ of the EU energy market. This may therefore disincentivise investment into such projects.

Causes of the slowdown in growth

Increased interest rates. Higher interest rates have impacted the cost of borrowing and, consequently, the cost of financing renewable energy projects. For example, in 2020 the IEA estimated that a 5 percent rise in interest rates could increase the levelised cost of electricity from wind and solar power by a third. A further example is Berenschot Group BV’s estimation that interest rate rises in May 2023 likely caused an increase of €163bn in the cost of certain technologies compared to 2021 and earlier. It is not clear how much policy effort is being directed at securing a return to cheaper debt in the sector. The current strategy seems largely to focus on progressing only those projects that are still commercially viable, or throwing additional money at selected others which need a higher revenue stream to achieve a commercial return.

Supply chain issues. The coronavirus (COVID-19) pandemic, the war in Ukraine and growing demand for raw materials have negatively impacted supply chains globally. This has consequently affected the supply and prices of such materials, thereby causing market volatility. For example, more than 79 percent of the world’s supply of polysilicon used for solar projects is produced in China. Due to COVID-19 lockdowns, floods and factory accidents, it is estimated that, between 2020 and 2022, its price rose by 350 percent. In that same time, due to the increased price of this and other materials, the price of photovoltaic (PV) modules rose by 25 percent and that of wind turbines outside China rose by up to 20 percent. This therefore likely further exacerbated the effect of interest rate rises.

As the number of renewable energy projects continues to grow, so will the demand for the raw materials and rare earth metals needed to build and maintain these. Additionally, as it is estimated that recycling of these will only meet 10 percent of demand, shortages will likely be experienced. It is therefore important that adequate investment be made to strengthen supply chains and increase manufacturing capacity. Furthermore, price hedging and long-term agreements can be used to limit the effects of price increases.

Regulatory uncertainty. Regulatory uncertainty can also impact renewable energy projects. For example, in May 2022 the US was suffering from uncertainty over wind and photovoltaics incentives. It had also implemented new trade policies banning imports of certain materials from China. This caused the IEA to revise its 2022 and 2023 renewable capacity forecast for the US downward by 8.5 percent.

A further well-publicised example is of the UK government recently relaxing some of its climate-related policies. Although it is still unclear the extent to which this will impact renewable energy projects, this may indicate that the government is willing to amend other targets as well. Additionally, this may reduce investor confidence, as it may suggest that its commitment to a multi-decade energy transition is susceptible to short term political and economic drivers.

Lacking or outdated infrastructure. The war in Ukraine highlighted the need, especially in Europe, for greater energy security. This, to the surprise of some, increased policies designed to accelerate renewable energy deployment and, therefore, enhanced interest and investment in renewable energy projects. However, in many countries, network infrastructure remains insufficient to absorb the scale of power from the increasing number of projects. Without this, renewable energy projects cannot progress as they need certainty on their connection and system use arrangements.

Projects across Europe are facing connection offers that are sometimes 15 years or more in the future. Across Europe and the US some 1500 GW of wind and solar projects are estimated to be in gridlock due to these and similar issues. The reasons for this are not only grid capacity but also extend to administrative complexity in some countries where consents and approvals can be mired in arcane requirements.

Investment in countries’ electricity grids is needed to speed up and modernise this process. As an example of the level of investment required, the European Commission estimated that €584bn needs to be invested into Europe’s grid alone by 2030. This is a significant issue for renewable energy projects. While several system operators have geared up, whether governments will have the stomach for the escalating funding to carry out these necessary upgrades remains to be seen.

In conclusion, investment in new renewable energy project opportunities is still growing, interest in the sector is still booming and policy frameworks continue to support a shift toward a decarbonised energy sector. However, deal activity appears to have slowed markedly in the past 12 months, reflecting investor reticence in a volatile environment. The sector will likely continue to grow in the coming decades. However, for it to fulfil the ambitions of the energy transition, it needs not only to be growing but to achieve escape velocity, an exponential increase that can help to substitute other forms of primary energy such as coal, oil and gas. This means increasing the scale of projects. With increasing scale, the amounts of investment and risk are rising for developers. For now, price factors including the cost of materials and funding, and important non-price factors which cannot be tackled solely through increased funding, remain a growing concern for the sector.

 

Munir Hassan is a partner and Lisa Franco is a trainee solicitor at CMS Cameron McKenna Nabarro Olswang LLP. Mr Hassan can be contacted on +44 (0)20 7367 2046 or by email: munir.hassan@cms-cmno.com. Ms Franco can be contacted by email: lisa.franco@cms-cmno.com.

© Financier Worldwide

BY

Munir Hassan and Lisa Franco

CMS Cameron McKenna Nabarro Olswang LLP

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