Wind investors will need to get more comfortable with merchant risk

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Ilaria Valtimora
September 29, 2017
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Wind investors will need to get more comfortable with merchant risk

We all know that wind energy is getting cheaper.

In the latest round of the UK’s Contracts for Difference auction this month, Dong Energy’s 1.4GW Hornsea 2 and EDPR and Engie’s 950MW Moray East offshore wind farms secured contracts at strike prices of £57.50/MWh. This is down from £119/MWh in 2015.

This follows Germany’s first offshore wind auction in April, in which EnBW won the rights to build its 900MW He Dreiht with no subsidy, as did Dong for two schemes totalling 480MW.

And the same is happening onshore. In May and July, Spain gave backing for around 4GW of wind capacity subsidy-free; and, in August, Germany held its second onshore wind auction, where it awarded support for 67 projects totalling 1GW at strike prices averaging €42.80/MWh.

We have seen these remarkable results all within six months, but what do these numbers really mean? Sure, that developers say they can build with little or no government support, but this makes them and their investors more reliant on market prices to get their returns. Will the removal of subsidies affect investors’ appetites to take on these projects now?

Removing subsidies is an crucial step in the industry’s maturation. While this support has historically provided guaranteed long-term revenues that made investors feel comfortable, they could not last forever. However, the main consequence of a greater reliance on market prices is that investors have to deal with long-term returns becoming less predictable.

In practice, this means investors will have to look far harder at long-term predictions of open market prices to estimate how long would take them to recover the cost of capital and make some revenues. This is a new source of uncertainty when deciding how to invest.

These predictions will not be easy. Power prices are affected by many variables, including changes in government and regulations, and a wind farm is a long-term investment. To predict how market prices would change over a long timeframe is near impossible, but it is a skill with which project owners must become acquainted.

Moreover, as a greater market exposure makes the investment potentially riskier, investors would need to price in that extra risk, increasing the cost of capital and the interest rates that developers need to pay. There will be a knock-on impact on developers.

But this additional risk should open new opportunities for the wind sector in Europe: power purchase agreements (PPAs) with large corporates, which have been a feature of the wind market in North America for the last five years but haven’t taken off in the same way in Europe. We will cover this more in Wind Watch on Monday.

These PPAs represent a long-term hedge against the risk of fluctuating energy prices, and a long-term PPA could be a win-win solution for both developers and investors. The developer would sell the power generated directly to a firm, protecting it from the volatility of selling its power on the merchant market, where it would be more exposed to prices fluctuations. For the investor this would mean being able to get long-term stability over his revenues, at least for a part of the lifespan of the investment.

PPAs would provide developers with the certainty they need in terms of the revenues they receive from projects, helping them to attract backers and financial investors.

Of course, that relies on the corporate having a strong covenant that gives the investor certainty that the energy user will be around for the duration of that PPA – and able to pay their electricity bills. That can be as tough as predicting long-term power prices.

We all know that wind energy is getting cheaper.

In the latest round of the UK’s Contracts for Difference auction this month, Dong Energy’s 1.4GW Hornsea 2 and EDPR and Engie’s 950MW Moray East offshore wind farms secured contracts at strike prices of £57.50/MWh. This is down from £119/MWh in 2015.

This follows Germany’s first offshore wind auction in April, in which EnBW won the rights to build its 900MW He Dreiht with no subsidy, as did Dong for two schemes totalling 480MW.

And the same is happening onshore. In May and July, Spain gave backing for around 4GW of wind capacity subsidy-free; and, in August, Germany held its second onshore wind auction, where it awarded support for 67 projects totalling 1GW at strike prices averaging €42.80/MWh.

We have seen these remarkable results all within six months, but what do these numbers really mean? Sure, that developers say they can build with little or no government support, but this makes them and their investors more reliant on market prices to get their returns. Will the removal of subsidies affect investors’ appetites to take on these projects now?

Removing subsidies is an crucial step in the industry’s maturation. While this support has historically provided guaranteed long-term revenues that made investors feel comfortable, they could not last forever. However, the main consequence of a greater reliance on market prices is that investors have to deal with long-term returns becoming less predictable.

In practice, this means investors will have to look far harder at long-term predictions of open market prices to estimate how long would take them to recover the cost of capital and make some revenues. This is a new source of uncertainty when deciding how to invest.

These predictions will not be easy. Power prices are affected by many variables, including changes in government and regulations, and a wind farm is a long-term investment. To predict how market prices would change over a long timeframe is near impossible, but it is a skill with which project owners must become acquainted.

Moreover, as a greater market exposure makes the investment potentially riskier, investors would need to price in that extra risk, increasing the cost of capital and the interest rates that developers need to pay. There will be a knock-on impact on developers.

But this additional risk should open new opportunities for the wind sector in Europe: power purchase agreements (PPAs) with large corporates, which have been a feature of the wind market in North America for the last five years but haven’t taken off in the same way in Europe. We will cover this more in Wind Watch on Monday.

These PPAs represent a long-term hedge against the risk of fluctuating energy prices, and a long-term PPA could be a win-win solution for both developers and investors. The developer would sell the power generated directly to a firm, protecting it from the volatility of selling its power on the merchant market, where it would be more exposed to prices fluctuations. For the investor this would mean being able to get long-term stability over his revenues, at least for a part of the lifespan of the investment.

PPAs would provide developers with the certainty they need in terms of the revenues they receive from projects, helping them to attract backers and financial investors.

Of course, that relies on the corporate having a strong covenant that gives the investor certainty that the energy user will be around for the duration of that PPA – and able to pay their electricity bills. That can be as tough as predicting long-term power prices.

We all know that wind energy is getting cheaper.

In the latest round of the UK’s Contracts for Difference auction this month, Dong Energy’s 1.4GW Hornsea 2 and EDPR and Engie’s 950MW Moray East offshore wind farms secured contracts at strike prices of £57.50/MWh. This is down from £119/MWh in 2015.

This follows Germany’s first offshore wind auction in April, in which EnBW won the rights to build its 900MW He Dreiht with no subsidy, as did Dong for two schemes totalling 480MW.

And the same is happening onshore. In May and July, Spain gave backing for around 4GW of wind capacity subsidy-free; and, in August, Germany held its second onshore wind auction, where it awarded support for 67 projects totalling 1GW at strike prices averaging €42.80/MWh.

We have seen these remarkable results all within six months, but what do these numbers really mean? Sure, that developers say they can build with little or no government support, but this makes them and their investors more reliant on market prices to get their returns. Will the removal of subsidies affect investors’ appetites to take on these projects now?

Removing subsidies is an crucial step in the industry’s maturation. While this support has historically provided guaranteed long-term revenues that made investors feel comfortable, they could not last forever. However, the main consequence of a greater reliance on market prices is that investors have to deal with long-term returns becoming less predictable.

In practice, this means investors will have to look far harder at long-term predictions of open market prices to estimate how long would take them to recover the cost of capital and make some revenues. This is a new source of uncertainty when deciding how to invest.

These predictions will not be easy. Power prices are affected by many variables, including changes in government and regulations, and a wind farm is a long-term investment. To predict how market prices would change over a long timeframe is near impossible, but it is a skill with which project owners must become acquainted.

Moreover, as a greater market exposure makes the investment potentially riskier, investors would need to price in that extra risk, increasing the cost of capital and the interest rates that developers need to pay. There will be a knock-on impact on developers.

But this additional risk should open new opportunities for the wind sector in Europe: power purchase agreements (PPAs) with large corporates, which have been a feature of the wind market in North America for the last five years but haven’t taken off in the same way in Europe. We will cover this more in Wind Watch on Monday.

These PPAs represent a long-term hedge against the risk of fluctuating energy prices, and a long-term PPA could be a win-win solution for both developers and investors. The developer would sell the power generated directly to a firm, protecting it from the volatility of selling its power on the merchant market, where it would be more exposed to prices fluctuations. For the investor this would mean being able to get long-term stability over his revenues, at least for a part of the lifespan of the investment.

PPAs would provide developers with the certainty they need in terms of the revenues they receive from projects, helping them to attract backers and financial investors.

Of course, that relies on the corporate having a strong covenant that gives the investor certainty that the energy user will be around for the duration of that PPA – and able to pay their electricity bills. That can be as tough as predicting long-term power prices.

We all know that wind energy is getting cheaper.

In the latest round of the UK’s Contracts for Difference auction this month, Dong Energy’s 1.4GW Hornsea 2 and EDPR and Engie’s 950MW Moray East offshore wind farms secured contracts at strike prices of £57.50/MWh. This is down from £119/MWh in 2015.

This follows Germany’s first offshore wind auction in April, in which EnBW won the rights to build its 900MW He Dreiht with no subsidy, as did Dong for two schemes totalling 480MW.

And the same is happening onshore. In May and July, Spain gave backing for around 4GW of wind capacity subsidy-free; and, in August, Germany held its second onshore wind auction, where it awarded support for 67 projects totalling 1GW at strike prices averaging €42.80/MWh.

We have seen these remarkable results all within six months, but what do these numbers really mean? Sure, that developers say they can build with little or no government support, but this makes them and their investors more reliant on market prices to get their returns. Will the removal of subsidies affect investors’ appetites to take on these projects now?

Removing subsidies is an crucial step in the industry’s maturation. While this support has historically provided guaranteed long-term revenues that made investors feel comfortable, they could not last forever. However, the main consequence of a greater reliance on market prices is that investors have to deal with long-term returns becoming less predictable.

In practice, this means investors will have to look far harder at long-term predictions of open market prices to estimate how long would take them to recover the cost of capital and make some revenues. This is a new source of uncertainty when deciding how to invest.

These predictions will not be easy. Power prices are affected by many variables, including changes in government and regulations, and a wind farm is a long-term investment. To predict how market prices would change over a long timeframe is near impossible, but it is a skill with which project owners must become acquainted.

Moreover, as a greater market exposure makes the investment potentially riskier, investors would need to price in that extra risk, increasing the cost of capital and the interest rates that developers need to pay. There will be a knock-on impact on developers.

But this additional risk should open new opportunities for the wind sector in Europe: power purchase agreements (PPAs) with large corporates, which have been a feature of the wind market in North America for the last five years but haven’t taken off in the same way in Europe. We will cover this more in Wind Watch on Monday.

These PPAs represent a long-term hedge against the risk of fluctuating energy prices, and a long-term PPA could be a win-win solution for both developers and investors. The developer would sell the power generated directly to a firm, protecting it from the volatility of selling its power on the merchant market, where it would be more exposed to prices fluctuations. For the investor this would mean being able to get long-term stability over his revenues, at least for a part of the lifespan of the investment.

PPAs would provide developers with the certainty they need in terms of the revenues they receive from projects, helping them to attract backers and financial investors.

Of course, that relies on the corporate having a strong covenant that gives the investor certainty that the energy user will be around for the duration of that PPA – and able to pay their electricity bills. That can be as tough as predicting long-term power prices.

We all know that wind energy is getting cheaper.

In the latest round of the UK’s Contracts for Difference auction this month, Dong Energy’s 1.4GW Hornsea 2 and EDPR and Engie’s 950MW Moray East offshore wind farms secured contracts at strike prices of £57.50/MWh. This is down from £119/MWh in 2015.

This follows Germany’s first offshore wind auction in April, in which EnBW won the rights to build its 900MW He Dreiht with no subsidy, as did Dong for two schemes totalling 480MW.

And the same is happening onshore. In May and July, Spain gave backing for around 4GW of wind capacity subsidy-free; and, in August, Germany held its second onshore wind auction, where it awarded support for 67 projects totalling 1GW at strike prices averaging €42.80/MWh.

We have seen these remarkable results all within six months, but what do these numbers really mean? Sure, that developers say they can build with little or no government support, but this makes them and their investors more reliant on market prices to get their returns. Will the removal of subsidies affect investors’ appetites to take on these projects now?

Removing subsidies is an crucial step in the industry’s maturation. While this support has historically provided guaranteed long-term revenues that made investors feel comfortable, they could not last forever. However, the main consequence of a greater reliance on market prices is that investors have to deal with long-term returns becoming less predictable.

In practice, this means investors will have to look far harder at long-term predictions of open market prices to estimate how long would take them to recover the cost of capital and make some revenues. This is a new source of uncertainty when deciding how to invest.

These predictions will not be easy. Power prices are affected by many variables, including changes in government and regulations, and a wind farm is a long-term investment. To predict how market prices would change over a long timeframe is near impossible, but it is a skill with which project owners must become acquainted.

Moreover, as a greater market exposure makes the investment potentially riskier, investors would need to price in that extra risk, increasing the cost of capital and the interest rates that developers need to pay. There will be a knock-on impact on developers.

But this additional risk should open new opportunities for the wind sector in Europe: power purchase agreements (PPAs) with large corporates, which have been a feature of the wind market in North America for the last five years but haven’t taken off in the same way in Europe. We will cover this more in Wind Watch on Monday.

These PPAs represent a long-term hedge against the risk of fluctuating energy prices, and a long-term PPA could be a win-win solution for both developers and investors. The developer would sell the power generated directly to a firm, protecting it from the volatility of selling its power on the merchant market, where it would be more exposed to prices fluctuations. For the investor this would mean being able to get long-term stability over his revenues, at least for a part of the lifespan of the investment.

PPAs would provide developers with the certainty they need in terms of the revenues they receive from projects, helping them to attract backers and financial investors.

Of course, that relies on the corporate having a strong covenant that gives the investor certainty that the energy user will be around for the duration of that PPA – and able to pay their electricity bills. That can be as tough as predicting long-term power prices.

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Not a member yet?

Become a member of the 6,500-strong A Word About Wind community today, and gain access to our premium content, exclusive lead generation and investment opportunities.