Renewables: a game of musical chairs?

Record low renewable power bids in countries like Portugal are again putting the spotlight on the risks investors might be exposed to.

Portugal’s recent solar power auction – where bids hit a low of €14.76 per MWh – set a new world record. Somewhat predictably (and like many a world record) it also set tongues wagging.

Depending on where you were coming from, the auction either offered incontrovertible proof that all new energy capacity should henceforth be renewable or it highlighted the kind of unsustainable lows developers are willing to sink to in the name of clinching new business.

For readers of this publication, though, the more interesting questions are: what risks are being assumed when you put in that kind of record-low bid, and are they ‘infrastructure’ risks? Those questions are especially important as renewables transition from a sector “which was fuelled for 20 years by subsidies, into unsubsidised projects,” as SUSI Partners chief investment officer Marco van Daele recently told us.

The folks at Greentech Media put out a handy article tackling the first question and concluded that the kind of record-low bids that surfaced in Portugal (but are certainly not unique to it) are not predicated on PPA revenues alone. They are also based on rosy merchant revenue assumptions.

“We believe that bidders are planning to sell into the wholesale power market at the end of the 15-year contracts on offer, and as such they’re making a bet on merchant pricing from years 16 to 30 of the asset’s lifetime,” Tom Heggarty, a senior analyst at Wood Mackenzie Power & Renewables, told the publication.

The problem, as Heggarty also pointed out, is that “such bets represent a significant risk”. That’s because, well, no one really knows where power prices will be in 30 years’ time.

We explored power-price forecasts at length in an October 2017 article entitled “Are renewables really low risk?” And while opinions varied, those on the pessimistic end of the spectrum echoed the view of Giles Clark, an advisor at AlSi Consulting: “I suspect forecasters are systematically overestimating the underlying cost of generating electricity in the long term.”

That’s especially important because, as Bloomberg New Energy Finance’s head of solar analysis, Jenny Chase, told Greentech Media, negative net present value PPA bids have been prevalent since renewable auctions started becoming the norm. This means that, somewhere down the line, “equity investors […] will not get quite what they were looking for,” according to Chase, who added: “But if they end up getting 4 percent instead of 6 percent, it’s probably not the end of the world.”

At this point, we get into our second question about the nature of the risks being built into certain renewables projects. Perhaps the better way to put the question is to ask whether they are the types of infrastructure risks that investors are expecting from renewables. We explored that theme recently and concluded there is a mismatch between the subsidy expectations of yesteryear and the merchant-power realities of today.

As investors get comfortable with the latter, though, it’s important to keep in mind, as one power-market veteran highlighted, that there is a lot of aggressive money out there; that no one has a clear view on how much distributed capacity is coming online, with oversupply a likely scenario; that PPAs have relatively short tenors; and that most bids are not pricing in a change to the macro picture, whether that’s a rise in interest rates or another global financial crisis.

Of course, you could counter that we’re irrevocably on the path towards a low-carbon world, with electric vehicles, smart cities and massive data-storage requirements likely to increase clean-energy demand exponentially. A recent McKinsey podcast predicts electricity demand to double, powered by renewables, even if peak energy will be reached in 2030-40.

That doesn’t change the fact that there’s significant uncertainty on the medium-to-long-term terminal value of some of today’s renewables investments. If you’re a long-term investor, the last thing you want is to find yourself standing in a game of musical chairs.

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