Why the risk profile of European renewables is likely to change

17 May 2018

Europe’s renewable sector has been growing strongly in recent years, due in part to efficiency gains and deliberate government policy. And, as money has poured in to renewables, returns have been steadily falling.

But this trend may start to reverse as production costs come down and renewables become more widely adopted as an energy source, says Macquarie Infrastructure and Real Asset's Economist Daniel McCormack.

Government subsidies have been determining returns

“As it stands, government subsidies mean renewables are very low risk. The subsidy effectively determines the return on investment. This makes them both very stable and resilient to negative macroeconomic news. As more money comes in, returns tend to fall even lower," says McCormack.

Subsidies for renewables range from eight years in the Netherlands to 20 years in Germany.1 This means that they have tended to appeal to those seeking low-risk returns over a long timeframe.

But there are signs this paradigm may start to change.

Lower costs to rewrite the risk/return equation

For starters, the amount of money it takes to produce many forms of renewable energy has been falling sharply.

Costs for thin film solar cells have fallen by 56 per cent since 2009, or an average of 9.7 per cent a year. Costs for crystalline silicon solar cells have fallen by between 73 per cent and 81 per cent since 2009, or between 13.5 per cent and 15.1per cent a year. And the cost of producing wind energy has fallen by 19.9 for onshore and 30.9 for onshore over the same period.2

As a result of these cost savings, the price of producing offshore wind is expected to fall to $US54/MwH and solar to $US40/MwH, well below the current cost of gas or coal in some European jurisdictions.

“As renewables move to the low cost part of the supply curve, government subsidies will start to disappear. In fact, the UK’s first subsidy-free solar farm opened in September 2017,” McCormack explains. “This means they will be subject to market forces.” 

Electrification: the path to a renewable future

At the same time, as the cost of producing renewable energy falls, demand for the electricity they produce is rising across all of Europe. Spurred on by generous tax breaks for buyers, electric cars now account for 29 per cent of all motor vehicle in Norway, 6.4 per cent in the Netherlands and 3.4 per cent in Sweden.3

Even in the UK, which lacks similar incentives, there are now more than 132,000 electric cars or 1.5 per cent of all motor vehicles, according to OECD data. National Grid predicts that this number will rise to 9 million by 2030. Macquarie’s analysis shows that this should increase overall demand for electricity by anywhere between 1.3 per cent and 2.6 per cent. 

A second driver of demand for electricity should be the growth of energy intensive technologies such as blockchain. According to some estimates, simply powering bitcoin already consumes as much energy as the nation of Greece, or 15 per cent of the UK’s entire energy consumption.4

A third factor leading to greater demand should come from changes to the way Europeans heat and cool buildings, with a shift away from individual energy sources such as boilers or furnaces towards using energy from the grid.   

Weighing against this is the reality that energy consumption per unit of GDP has declined markedly over the past decade. As technology improves, the amount of energy required to power an economy is expected to decline further. 

Hedging risk through renewables

The European Commission is now targeting a 40 per cent reduction in greenhouse emissions and 27 per cent of energy consumption from renewables by 2030.5

As McCormack points outs, some countries have gone even further. 

“As government climate change policy tightens against carbon-intensive assets, it changes the risk profile of fossil fuels in a significant way also,” he explains. 

“Renewables are on the other side of the equation. So even investors looking at other energy sources are taking this into account and factoring in a carbon risk element.” 

“After all,” McCormack concludes, “it’s usually helpful to be swimming with the government tide rather than against it.” 

  1. Macquarie Infrastructure and Real Assets analysis
  2. Bloomberg New Energy Finance, 20 April 2017
  3. Global EV Outlook 2017 ‘Two Million and Counting’; Organisation for Economic Co-operation and Development (OECD)/International Energy Agency (IEA)
  4. BP Statistical Review of World Energy 2017
  5. European Commission, 2030 Energy Strategy

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