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EMEA subsidy-free renewable energy projects gaining momentum

Publication Date: 25 Oct 2018 - By ReachX Team By ReachX T.

Environmental, Social & Governance Equity Fundamental Macro Commodity Multi Asset Equity Middle East UK EU Energy


Capital costs of renewable energy projects have dropped “significantly” in the past several years, making subsidy-free schemes a viable option in the 2020s in Europe, according to fresh research.

In a note to clients, Fitch Ratings said: “Technological improvements have helped reduce capital and installation costs of renewable energy. This has improved the economics of renewable projects, making new projects potentially feasible without government support.” 

In 2016-17, winners of several capacity auctions in Germany, the Netherlands and Spain were able to propose building renewable projects fully relying on market power pricing only. 

“We expect a considerable number of new renewable projects to continue to rely on subsidies, although the share of those without subsides is likely to gradually increase. Subsidy-free projects will be concentrated in developed countries that benefit from established power markets and stable regulatory frameworks, where investors require a lower internal rate of return on their investments,” the agency added. 

Transition to subsidy-free renewables is positive overall, as the burden on governments and, ultimately, consumers to support the sector is set to lower over time. Still, a higher prevalence of renewable energy causes additional system costs, Fitch said. 

These include the need to upgrade grid networks to allow flexibility to accommodate intermittent renewable generation, costs of "curtailment" of renewable energy generation in case of excess production and costs of back-up capacity (i.e. thermal power) being available on a stand-by basis. 

Merchant renewable energy projects are riskier due to power price volatility, the agency said. Many factors can influence power prices and price patterns can be very region-specific. For example, in markets with high exposure to hydro generation, market prices will increase during droughts. 

Markets with a significant portion of fossil fuels in the generation mix have recently experienced power price increases because of rising prices for CO2 certificates or commodities, but power prices could retreat when prices for CO2 certificates and commodities decline.

Growing merchant renewable capacity also increases "capture" price risk. Solar and wind generation is variable and, during particularly sunny and windy periods, power prices can be depressed or even negative due to increased generation. Energy storage could mitigate this risk. However, so far there is limited proven technology to provide sufficient storage capacity at economic prices. 

Under Fitch’s Renewable Energy Project Rating Criteria, a merchant project that fully relies on market pricing could still achieve investment-grade ratings, albeit with higher thresholds compared with subsidised projects, due to the lower visibility on future revenue. 

“For instance, all else being equal, a wind project fully reliant on market prices will need to demonstrate an average debt-service coverage ratio of 1.7x to achieve a 'BBB-' rating, while a fully contracted project will need to demonstrate a 1.3x coverage ratio. If a transaction has a blend between incentives and merchant power, then the ratios to achieve a certain rating will be a weighted blend,” the agency said.

Exposure to market prices is one of the reasons for the increasing popularity of power purchase agreements (PPAs) signed between generators and corporations. Fixing the power price for a certain period, generally between five to 10 years, would help financeability of a renewable project.

Consequently, some subsidy-free projects may rely on PPAs but they can be structured in many different ways and these would need to be assessed on a case-by-case basis. The credit quality of the PPA counterparty is likely to cap the rating of the project-financed transaction, unless credit enhancement is provided, Fitch concluded.


I have no positions in any of the securities referenced in the contribution

I do not use any non-public, material information in this contribution

To the best of my knowledge, the views expressed in this contribution comply with UK law

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This contribution is for informational purpose and does not constitute investment advice nor is it an offer to sell or buy, nor is it a recommendation for any security.

ReachX T.


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