Renewable energy investment risks are dynamic
by Florian Egli (ETH Zurich)
Florence is a Mecca for foodies. When I enter a restaurant in Florence, I can be sure they offer some of my favourite Italian dishes. Moreover, they may also feature less known specialities, such as the Panzanella — a Tuscan bread salad. The choice I make, my well-known favourite or a surprising speciality, reveals something about my risk preferences. As a risk taker, I may go for the surprise, potentially offering a higher reward too; as a risk-averse person, I may stick to my favourite.
Investors weigh options similarly. The literature has established a strong correlation between risk and return (i.e., reward). For riskier investments, investors seek compensation in higher expected returns. Consequently, public policies that lower risks are particularly successful in attracting investment (cf. this review paper) because they lower the financing cost of a project. This finding is particularly important in the case of renewable energies because private markets may not deliver deployment levels that the society would demand to avoid dangerous levels of climate change.
In an upcoming paper, I investigate the dynamic changes in risks for renewable energy investments over time (slides here). Strikingly, the research community knows a lot about investment risks in different contexts and for different technologies, but we know very little about how and why risks change. I use interviews with leading onshore wind and solar PV investors in Germany, Italy and the UK to show that there are five major investment risks. Of those five, technology risk and price risk changed most between 2009 and 2017.
Technology risk, i.e. the risk due to the technology’s novelty and unpredictability, used to be the most important risk in 2009 before its importance declined rapidly until 2017. Why did this happen? Investors were able to use their experience. They had access to performance data, they could rely on trusted partners (from developers to law firms) and, with time, they were able to build the in-house expertise required to evaluate those projects (especially as the technologies were new to most large investors).
Price risk, on the other hand, i.e. the exposure to revenue volatility, was one of the least considered risks in 2009 only to become the most important one in 2017. This change is mainly due to European policymakers discussing the phase-out of fixed renewable energy remuneration schemes (e.g., Germany or the UK), which in turn means that investors have to factor in (uncertain) electricity prices over the next 20–30 years. Predictions of these prices hinge on assumptions about grid expansions, the use of electric vehicles and many more developments that are uncertain.
Besides these changes in risk types, overall investment risks in onshore wind and solar PV declined drastically. This is reflected in very low debt margins (i.e., the technology-specific premium a bank requires) in the range of 100 to 110 basis points for solar PV and onshore wind respectively. In fact, in a recent study on the German market, we find that debt margins decrease along an ‘experience path’ similar to technology learning (e.g., approx. 11% reduction for every doubling of cumulative global investment).
If investment risks are dynamic, reflect experience levels and respond to policy, more work is needed to understand why and by how much investors change their risk perception. To come back to the start, if I lived in Florence for a while, getting to know the local kitchen, I could learn from my experience and judge the menu better — potentially leading to less risk aversion. Whether and to what extent this happens in energy finance and hence allows for policy support to decline without hampering the deployment of renewable energies, today remains unknown. Improving this understanding is crucial to judge the potential effects of phasing out renewable energy support policies.
Lights on Innovation is the new blog series by the Energy Innovation area of the Florence School of Regulation (FSR)
