A troubled generation

Renewable energy subsidies are under attack. But investors have what it takes to weather the storm

When Jeffrey Altman climbed on stage at Infrastructure Investor’s Renewable Energy Forum last week, he promised a punchy introduction to the day.

The seasoned energy specialist didn’t miss his target. European power utilities were ‘struggling for survival’, he said, largely because financial support for renewable projects had ‘destroyed the free market.’ Fresh and deep regulatory interference would be needed to safeguard the continent’s generating capacity, he went on, piling more uncertainty on an already troubled market. His conclusion: the industry had to change.

His audience certainly seemed electrified. The ensuing panels swapped the polished tone that usually prevails at industry conferences for occasional bouts of verbal sparring, while speakers used forceful language to describe Europe’s alleged energy policy flaws. But not everybody had such a dim view of the industry’s immediate future. And following the initial shock delivered by Altman’s address, some started to wonder what they should conclude.

There’s no questioning the diagnosis. Europe’s largest power companies are going through an unprecedented crisis: in Germany alone, Altman says they’ve been forced to retire 10,350 megawatts (MW) in conventional power capacity in recent years and will likely withdraw another 20,000MW over the next decade. Figures from Thomson Reuters show that European utilities have lost nearly half a trillion euros in market capitalisation since the heyday of 2008.

The rise of renewables has played a large part in this, even if another factor is overinvestment in fossil fuel generation in the 2000s and plummeting demand in the aftermath of the Crisis. Accounting for an ever-growing share of power production, renewables are pushing wholesale prices down. The excess capacity they generate puts strains on national grids, forcing old-fashioned plants to adjust by cutting production. Both are squeezing utilities’ revenues and margins and challenging their business models.

But what matters more to investors is how these developments may loop back to the renewables industry – in the form of regulatory changes. The rapid withdrawal of conventional power capacity is a worry to governments, who fear they might end up depending on less reliable electricity sources. This will likely push them to adopt capacity payments mechanisms to keep plants online – as well as roll back existing renewables subsidy regimes, so as to restore a level playing field between energy sources and mitigate the impact to the taxpayer. A revamp of Europe’s withering carbon trading scheme (ETS), as well as a probable consumer backlash in the face of rising energy bills, could add to regulatory uncertainty.

Some of this is already happening – as industry insiders know all too well. But rather than a fundamental threat to their business, optimistic investors rightly see the current crisis as a source of fresh opportunities. Troubled utilities are putting assets on the block to shore up their balance sheets, some of which make attractive acquisition targets. They’re also looking for private partners to help fund redeployment in greener areas, creating opportunities for partnerships. Meanwhile a flurry of smaller assets is coming to market, looking for fresh capital to scale up.

The prospect of the European renewables industry being tested by normal market principles understandably raises questions. But it’s worth noting that this is already happening across a number of Latin American and African countries, where it competes on an equal footing with fossil fuel generation. And tellingly, while investment is down in parts of Western Europe, deal flow remains strong in other markets – younger and established ones alike. Data from Infrastructure Investor Research & Analytics shows that transactions nearly trebled in value in both the UK and Central and Eastern Europe between 2011 and 2013.

Altman is right to say that investors shouldn’t be complacent. But as the industry matures, it’s only natural that subsidies should be phased out. And the sooner the renewables industry can generate profits on its own merits, the more compelling the case for investing in renewables will be.