Declining Subsidies and the Future of Renewable Energy Projects in Europe

Subsidies for renewable energy production gave the much-needed impetus for Europe to embrace renewable energy. Europe’s focus on renewable energy established the foundation for a global energy transition, reduction in project costs and improvements in technology. The share of energy from renewable sources in the European Union grew from 8.5% in 2004 to 17% in 2016; it was well placed on the way to reach the target of 27% by 2030.

However, as Europe phases out subsidies by replacing feed-in-tariffs that were available to all producers of renewable power to an auction process open to all green energy operators competing equally for government funds, merchant risk has become a key driver in investments in the energy sector. According to Bloomberg New Energy Finance(BNEF), the new investment in clean energy projects in Europe fell from $137 billion in 2011 to $57 billion in 2017. Part of this can be attributed to falling costs, however, there is no denying that it was guaranteed returns through subsidies that made renewable energy projects attractive investments in the first place. As subsidies get replaced by competitive bidding, there is more pressure to keep contract prices down in order to win the bids. As far as investors are concerned, the profits are diminishing, and the risks are increasing.

What is the future of renewable energy projects in Europe? We asked experts from our speaker panel about the impact of declining subsidies on renewable power generation and investments in renewable energy projects.

Sebastian Burgers, Project Finance Director – ABB

“After the introduction of the power generation subsidies via the “Erneuerbare Energien Gezetz (EEG)” at the beginning of this century in Germany, the investments in renewable energy increased enormously. Companies and private persons appreciated the stable, consistent and reliable policy of the German government and welcomed the security of revenues by fixed feed-in tariffs. The European Economic Recovery Program of the European Union was a broad initiative but also an additional stimulation for investments in renewable power generation and strive for independence from non-European energy. Besides increased investments in renewable energy projects, the subsidy programs have led to decreasing power prices throughout Europe and a budgetary “challenge” for the German government (for that reason the EEG had to be revised in 2014). Based on the experiences from the past, the current and future (possible) declines in subsidies for renewables could lead to an increase in power prices and a shift towards non-sustainable power generation.

During the past 20 years, the renewable energy sector has developed from an experimental, marginal sector to a mature international business. Therefore, it is logical and acceptable that subsidies with a start-up character are decreasing. In order to further stimulate the energy transition from traditional forms to renewable forms of energy, Europe should focus on further international cooperation and integration of the network infrastructure: a requirement for new investments with new investment stimulation programs. Examples given: facilitation of distribution of solar-based power from countries in southern Europe (and North Africa) to central Europe, and Hydro based power from Scandinavia to central Europe, and further strengthening of the grid infrastructure on land in order to cope with offshore wind-generated at the North Sea. Besides stimulating the use of renewable energy throughout Europe, cross border connections of national grids increase reliability and stability of power supply throughout Europe and reduce the dependency of traditional forms of energy generated outside Europe. “

Louis Strydom, Director- Market & Project Development: Middle East, Wartsila

“Subsidies have created economies of scale; this has helped scale the top-line for developers, EPCs and suppliers. Declining subsidies will move focus to the bottom line – this requires more efficient development and will result in severe competition for any supplier (including finance) to the development value chain. The ability to deploy new, efficient technology ahead of the curve will be essential to maintain a competitive advantage.

As projects incur further bottom-line pressure, investments are likely to take two directions. First, consolidation – investors will be looking at larger aggregated investment classes and pools of assets – favouring larger developers and operators. Second, technology – the need to enhance yield will drive the search for technologies that can be developed and implemented in projects that will improve returns.”

Louis Strydom will speak on how to optimise IPPs and design-build contracts for the utilities of the future at the Project Finance & Infrastructure Investment in Energy Sector 2020.

Zaira Dupont, Equity & Infrastructure Finance Manager, BP

“According to many different sources, wind and solar technologies can now compete against other conventional power technologies without additional public support. They have reached cost competitiveness in many parts of the world. For technologies that have achieved full commercialisation, such as onshore wind and solar, the slowdown will be smaller and subsidy reductions arguably justified.  At the same time, the cost of renewable power is likely to continue to decline, which may lead to increasingly more competitive power auctions. This could lead renewable energy producers to accelerate their pursuit of new routes to market for power.

Over time, renewable power is likely to become more exposed to merchant power risk, and therefore, investments in renewables could see a more integrated approach to capturing the upside in the power value-chain. In general, carbon pricing across all technologies remains the most adequate policy tool which would boost renewables growth and achieve the transition to a cleaner energy mix.”

Zaira Dupont will speak on risk management in project finance at the Project Finance & Infrastructure Investment in Energy Sector 2020.

Martijn Maandag, Director Due Diligence, DNV GL

“By 2050, generation from solar photovoltaic (PV) and wind will be 36,000 terawatt-hours per year, more than 20 times today’s output. One of the biggest impacts in the decline of renewable subsidies is the decline of predictable income. Renewables by their very nature are not dispatchable, and anything which is not dispatchable is more exposed to market risk. This will vary across countries but ultimately merchant risk will become a deal driver. The investment community must capitalize on significant opportunities to continue supporting the growth of renewables. The number of projects that will be installed, and their diverse locations, will require ever-more efficient transaction processes. Power producers will have a growing and changing portfolios of assets that will need to operate with increasing volumes of variable generation.

As renewables transitions to a subsidy-free phase, developers will need a greater understanding of electricity market opportunities and risks. They will also need to assess alternative approaches to maximize the value of their developments – such as incorporating storage into projects – and, to have a greater awareness of potential cannibalization. This term describes the depressive influence on the wholesale electricity price at times of high output from intermittent, weather-driven generation such as solar, onshore and offshore wind. High volumes of simultaneously generated electricity combined with lower demand will lead to a greater number of hours in which there is potential for oversupply. The outcome is low, zero or even negative electricity prices that could erode the business case of renewable generation.”

Tobias Heyen, Senior Originator, Engie

“Due to more decentralized assets, we have a high demand for digital change in our industry. The utilities are having a huge need to aggregate the different types or renewables sources within an efficient and reliable virtual power plant. The decline in subsidies is supporting the need for it. Besides the investment costs, the process costs are forced to be at a minimum in order to reach the target return on invests by covering higher risk profiles on the decentralized production structure.

I do not except significantly fewer investments due to declining subsidies. It will take place and will be more market-driven. The next step in market integration will take place. It is good that respective generation costs are decreasing and the developments on R&D are driven by the market evolution.”

At the Project Finance & Infrastructure Investment in Energy Sector 2020, Tobias Heyen will share his insights on the role of Power Purchase Agreements (PPA) in the way to green energy in Europe.

Caroline Lytton, Head of Power & Renewables, SMBC

“Declining subsidies in the renewable energy sector are leading to a greater diversity in the structure of transactions – the length, nature and pricing of any PPAs, the quantum of merchant risk, credit support that may be provided – which will in turn lead to more bespoke finance structures, carefully examining risk sharing between project parties on a case by case basis. This may prove challenging for some, but on the other hand a move away from subsidies does bring new potential for upside which doesn’t tend to be present under full subsidy.”