Quinbrook on the great US renewables story

This article is sponsored by Quinbrook

What are the most attractive parts of the North American renewables landscape?

We saw attractive opportunities in onshore wind between 2017 and 2019 and we did quite a bit of large-scale investing in that sector over that period. But returns have now deteriorated. It feels as though wind is starting to enter a period of consolidation and is no longer as attractive as it once was. We are now more focused on large, utility-scale solar development in the high desert and western US. I certainly think development and construction are more interesting than M&A.

At the smaller end of the market, meanwhile, I think there are attractive opportunities within distributed solar. These are all areas that offer the longest-term contracted revenues, which is a key requirement for our investment strategy.

How do renewables stack up against natural gas in North America today?

Gas is still setting the clearing price for wholesale electricity in many US power markets. That said, there is no real competition anymore between renewables and gas or coal for new capacity. Renewable power sources can be built at a fraction of the cost of new fossil fuel plants – even with relatively cheap gas. So, while gas still sets the marginal price, over time it will become less relevant to the overall story.

What are going to be the most important drivers of the US renewables market over the next couple of years?

In the very near term, I think it will be a combination of politics, with the upcoming US election having important implications for the tax equity market, together with the level of corporate procurement we see for offtakes. There is an abundance of projects. In fact, a significant emerging risk in certain US regional power markets is over-build. The issue, therefore, will be ensuring your projects have competitive advantages in terms of features and pricing so that you can secure favourable offtake agreements. There is no shortage of projects but there is, potentially, a shortage of demand at reasonable pricing.

What role are storage solutions playing?

Storage is going to have a huge impact but we are still at a very early stage. There has been a lot of noise around batteries, but outside of California, there has been very little actually getting done. Nonetheless, if you take a five- to 10-year view, then batteries are probably going to be as significant to the power market as solar has been over the past decade. In fact, I think the market is generally underestimating the impact that the pairing of solar and battery storage will have on the wholesale market as well as the pricing of electricity.

How much competition are you seeing for renewables assets?

“Renewable power sources can be built at a fraction of the cost of new fossil fuel plants – even with relatively cheap gas”

We are certainly seeing more participants in the greenfield development sector. There are more new entrants coming into that market than we have ever seen before. It was previously an underpopulated space – but now we are seeing Asian utilities and the big European majors, even more than we are US utilities. Those players are far more active in the market than the incumbents.

But one of the things that we like most about the US market is that it is so big and so fragmented. You can always find opportunities to pursue if you think hard enough. As long as you are flexible in your strategy you can pivot from one area to another. We think of it as a series of opening and closing doors. As one door closes another one opens, and that is an endearing feature of the US.

Meanwhile, although there is more competition in earlier stage construction, some of the heat appears to be going out of the M&A market, which is no longer as crushingly competitive as it once was. I think a lot of players have now established their positions and so we are now awaiting some new entrants. We are already starting to see that happen, with announcements in recent weeks from Korean investors.

What are the biggest challenges associated with the US renewables market?

There are plenty of challenges. I think selling the offtake on reasonable terms is one of the biggest challenges, as I said. Buyers are spoilt for choice. Then there is the fact that US renewables are so heavily influenced by tax equity, which can significantly distort the market. At the moment, with the expiry of some of the investment tax credit and production tax credit windows, we are seeing an absolute proliferation of projects. So, it is a great time to be a scale buyer of renewable energy but more challenging if you are a developer.

“It is still possible to strike interesting contracts if your projects have unique features but there is nevertheless more supply than demand”

It is still possible to strike interesting contracts if your projects have unique features but there is nevertheless more supply than demand. What happens, as a consequence, is that other risks emerge. One of the bigger themes out there is what is known in the industry as basis risk and congestion risk. That has bitten some people pretty hard.

It becomes like trying to shove too much down a pipe. There are going to be consequences. Either the power will trade at a very low price or there will be a price disconnect between the node and the hub and that risk is usually borne by the project. These are risks that are emerging in certain parts of the US market and that have not necessarily been reflected in the returns being targeted. There are just too many developers and investors prepared to take ambitious punts with their money.

You mentioned the presidential election. To what extent might the result impact renewables opportunities?

There are two areas where whoever is in the White House can exert significant influence on power markets and therefore on opportunities for renewables investment. One is tax policy, because tax equity is such a significant component of the financing of wind and solar projects, in particular. The government of the day’s policy response to either a contraction or expansion of the tax equity market will directly impact both the supply and demand of projects and the pricing of those projects and therefore the returns you can generate. That is the most direct way in which the federal government can impact renewables. And, if anything, the Trump administration has actually been fairly supportive.

The second area where the federal government can influence power markets is through the Federal Energy Regulatory Commission. That body makes the rules on how utilities that trade across state borders can operate, so it has significant reach when it comes to things such as how costs are passed on to consumers, or the decommissioning of coal plants or old nuclear capacity. The FERC can also force utilities to either procure solar, or not.

All of these things can influence the market opportunity for renewables and while, on the one hand, the Trump administration has been relatively supportive from a tax stance, we have also seen pro-coal and pro-gas policy from the FERC. That hasn’t severely impacted the market but it has created some distortions, particularly when it comes to legacy fossil and nuclear assets.

What makes you excited about the US renewables opportunity in the years to come?

At a macro level, it is all about renewables. There is no other story like it out there and that is fantastically exciting. Electric vehicles are going to revolutionise transportation, creating new areas of demand. Data centres are driving huge demand growth as well. All of these areas create an enduring story for renewables but, of course, you have to pick your markets, your structure and your technology. It is not a market for the faint-hearted. Nonetheless, there is no doubt that renewables will represent an incredible infrastructure opportunity for the foreseeable future.

What impact has covid-19 had on the US renewables story?

I think there have been three areas of impact. First, there has been a softening of power pricing in the short term. As a rule of thumb, prices have come down by around 10 percent. And while some markets have recovered quickly, it remains to be seen how long others will take to pick up. It is very much correlated to GDP and so it will all depend on when people get back into their old routines.

The second area where we have seen impact has been on the construction side. This has been minimal. In most cases, construction activity hasn’t missed a beat as a result of covid-19. Delays have been limited, although there have been some staffing issues around the interconnecting utilities.

Where we are seeing the greatest impact, however, is on the balance sheets of the companies that typically write the tax equity financing. Of course, the less profits they make, the less tax equity appetite they have. It is one of the real perversities of US renewables that the market is dependent on less than 20 or so organisations. And if they are not making as much money as they have done historically, that means a shrinking pool of tax equity.

This is currently the subject of legislation being introduced to the House by the Democrats. They want to recreate what we had in the financial crisis that effectively ameliorates the reliance on those top 20 players by creating cash-out schemes. If there is a Democratic president and the Democrats win control of the Senate, we may, therefore, see changes to tax policy that soften that impact from covid-19. If that doesn’t happen, covid-19 will continue to affect the tax equity market for at least the next two to three years.