Powering up

Globally, the renewable energy industry is firmly on an upward trajectory but, locally, financing new renewables depends on the regulatory framework in place. Mark Nicholls looks back at five years of uneven development

Looked at from a global perspective, the past five years have seen steady growth in the installed capacity of ‘new’ renewables which, effectively, means power from wind and sun, given that technologies such as wave and tidal power are in their infancy.

According to the American Wind Energy Association (AWEA), there were 39 gigawatts of wind capacity in place globally by the end of 2003 – up from a mere 13.4GW in 1999. Credit Lyonnais Securities estimates that the figures for solar show a comparable rise – up from 1.14GW five years ago to around 4GW now.

Driven by growing appreciation of the benefits in terms of reduced pollution, energy diversity, and – increasingly – energy security, such growth is set to continue.

But the bald figures mask enormous regional variations. In solar photovoltaics, for example, Japan accounted for almost half of new capacity installed globally in 2003, despite having less sunshine that the western United States or southern Europe, for example. And Germany’s installed capacity of 14.6GW makes it the world’s largest generator of power from wind, dwarfing the 649MW of the UK – despite the latter boasting Europe’s best wind resources.

And these regional variations have been matched by often dramatic swings in new installed capacity over time. In the US, for example, 1.77GW of wind power was installed in 2003, following just 450MW the previous year. This year again, very little new capacity has been installed, following the expiry at the end of last year of a key incentive. In the UK – now expected to become a boom market for wind energy – the late 1990s and early part of this decade saw the industry becalmed, because of an incentive scheme that didn’t work.

But other figures paint a different picture. By some calculations, renewable energy as a share of total primary energy supply (TPES) has declined in recent years. Figures from the International Energy Agency (IEA), for example, include ‘mature’ renewable technologies, such as hydro, biomass and geothermal energy. By these calculations, the share of renewables in TPES in IEA countries peaked in 1992, at 5.98%. Since then, the slow growth of these old technologies, compared to increasing overall power demand, meant the share of renewables dropped to a low of about 5.5% in 2002.

However, Rick Sellers, the head of renewables at the IEA, notes that since then, rapid growth in the ‘new’ technologies – particularly wind power – has put renewable energy back on an upward trajectory, and he expects the 6% level to be breached by 2008 or 2009.

All of this adds up to a picture that is somewhat difficult to interpret. Growth in some countries, in some technologies, and at certain times is balanced by stagnation in other countries, in different technologies, at different times.

But while the picture is confused, the explanation is simple: when it comes to renewable energy, it’s the regulatory regime, stupid. Nothing has influenced the availability of finance, and therefore the speed of renewable energy growth, as much as the support framework in place in a particular jurisdiction.

The problem faced by renewables is clear: in terms of cents per kilowatt hour, ‘new’ renewables have been unable to compete with traditional fossil fuel generation (although this is changing, especially for wind – see box 2). However, in recognition of other benefits of clean power generation (fewer emissions, energy security, local generation), governments across the industrialised world – and, increasingly, among developing countries – have been prepared to support renewable generation with subsidies, grants, tax breaks, quota mechanisms and feed-in tariffs.

Furthermore, there is a recognition that such regulatory intervention can do two things. First, by increasing the market for new technologies, more funding becomes available for research and development, and economies of scale help bring down the cost of generation from new renewables. Secondly, healthy domestic markets for wind turbines, solar panels, or – going forward – wave and tidal generators can help foster domestic renewable power technology industries that, in some cases, have generated substantial export businesses.

In some respects, then, the past five to 10 years have been a global experiment in how to encourage renewable energy. The IEA maintains a database of policies and measures in place globally to support renewables. It lists no less than 25 different policy types, and a search under ‘obligations’ lists 62 different policies in place around the world.

The most successful renewable energy markets – in terms of new wind capacity, which is by far the most commercialised new renewable technology – are those with feed-in tariffs. These guarantee renewable energy generators a fixed tariff for their power over a set period and – assuming that the tariff is set over a long enough timescale – provide financiers with sufficient comfort to make lending attractive.

Germany, Spain and Denmark have all benefited from such support structures. They rank first, third and fourth in terms of installed wind energy capacity – and in Denmark, onshore wind accounts for 20% of electricity supply.

Long-term support for wind energy has also helped nurture wind energy industries. Vestas, the world’s largest turbine manufacturer, is Danish, while Germany supports a brace of turbine manufacturers, such as Nordex and Repower. Spain also boasts a leading manufacturer in Gamesa, and EHN is one of the world’s most successful wind energy developers.

But, even with similar support structures, the nature of the three countries’ wind development is very different. In Germany, for example, the incentive structure encourages communities to band together to erect small farms, typically in the 5–15MW range. In Spain, by contrast, much larger projects are the norm, with 50–100MW of capacity.

Spain and Germany illustrate the importance of consistency of support mechanisms – whereas the US provides a counterexample. Developers in the US benefit from the federal Production Tax Credit (PTC), under which they receive a tax refund of around 1.8 cents for each kWh of power they generate for the first 10 years that the wind farm is operating, alongside revenue from selling the power for around 4–6¢/kWh.

Because the PTC can only be used to offset taxable income in the US, the market has been dominated by the large US utilities with that type of income. But of more import to the development of wind power is the fact that the PTC expires every year, and must be renewed by Congress.

Despite enjoying largely bipartisan support, the PTC has often been caught up in unrelated wrangling on Capitol Hill. This year, for example, Democrats have refused to support an energy bill that opens the Arctic National Wildlife Refuge for drilling, exempts petroleum refiners from liability for earlier pollution – and renews the PTC. As a consequence, the latter expired at the end of last year, putting new wind energy development on hold, and was only renewed in late September (see Wind picks up US federal and state support ).This is not the first time it’s happened. In 2000 and 2002, only 67MW and 450MW respectively of new capacity was installed. In 2001 and 2003, these figures were 1.70GW and 1.77GW, according to the AWEA.

But the PTC is not the only support mechanism employed in the US. A number of states – 14 at the last count – have introduced mandatory ‘Renewable Portfolio Standards’ (RPSs), typically linked to tradable renewable energy (or green) certificate systems.

An RPS – or similar quota systems such as those in Australia and a number of European countries – imposes an obligation on electricity suppliers to source a certain amount of their power from renewable sources. In most cases, compliance with the obligation, which tends to rise over time, is demonstrated by delivering green certificates to the regulatory body.

Renewable energy certificate (REC) markets are gaining popularity as a market-based mechanism to support new renewables capacity. They allow for the disaggregation of the physical power from its environmental attributes, allowing the renewable energy generator to sell the power to one buyer and the green certificates to another. The certificates are given value because of the suppliers’ requirement – usually backed by a penalty for non-compliance – to surrender a certain number of green certificates each year. Thus, the renewable energy generator has another revenue stream which helps them to compete with fossil fuel generation.

Although a voluntary RECs market has been operating in Europe since the late 1990s, Australia introduced the first mandatory scheme in 2001. Since then, the UK, Italy, Austria, Sweden, a number of US states and others have followed suit.

Broadly speaking, such schemes have found favour with generators and financiers. Under some systems, the green certificate revenue has become a major component of generators’ revenue streams. In the UK, for example, Renewable Obligation Certificates are changing hands at around £45 ($81)/ MWh, compared to electricity prices in the £25–40 range. Strong mandatory targets have helped underpin dramatic renewables growth, with Texas, for example, installing 1,200MW in response to an RPS (backed with a RECs system) signed into law when George W Bush was governor.

But, as might be expected, such a novel market mechanism has had its teething troubles. The UK’s system started well, in 2002, until TXU Europe, a subsidiary of US energy company TXU, went into administration late that year. Because of a complexity in the UK system, designed to encourage – but not force – compliance, those suppliers that meet their targets are rewarded with a proportion of the ‘buy-out’ penalty paid by those that do not. This so-called ‘recycle’ value can be estimated in advance, and becomes a component of the price of the ROC.

However, TXU Europe’s bankruptcy suddenly removed £22 million from the buy-out pot, reducing at a stroke the value of every ROC on the market by around £4. This has put a brake on the open trading of ROCs, and has made banks cautious about providing finance based on ROC prices.

This myriad of support schemes – each with its idiosyncracies and peculiarities – significantly complicates the work of financiers. And efforts to forge regional policy support frameworks and targets – let alone a truly international system as is envisioned for carbon trading under the Kyoto Protocol – have so far come to nought.

Many in the renewable energy industry were disappointed by the European Commission’s 2001 Renewable Energy Directive. While it set an indicative target, of 21% of power from renewables (including hydro) by 2010 – compared to levels of around 15% in 2003 – it left the tricky questions of how to meet the target to member states.

In the US, too, there has been little appetite at the federal level to intervene to any great extent, beyond the PTC and in the provision of R&D financing. To the chagrin of many in the industry, the Bush administration seems to consider renewables an energy source of the future, rather than one that can already make a substantial – and cost-effective – contribution to the country’s power supply.

Some attempts were made, primarily by the EU and Brazil, to include an international target for renewable energy generation in the outcomes of the World Summit on Sustainable Development, held in Johannesburg in 2002. Such a declaration proved impossible, although the German government announced that it would host a major international conference in 2004, in an attempt to move the debate forward.

By the time Renewables 2004 was convened in Bonn in June, it had become clear that such a target remained out of reach, especially in the context of US opposition to further international obligations. The conference did, however, produce a wealth of commitments in its plan of action – including, most notably, an aggressive renewable energy target from China (namely, 10% by 2010). And it marked the first time that an international, ministerial-level conference had been convened on renewable energy – marking the growing importance of the sector.

This acknowledgement of the importance of renewable energy is gradually changing the financing landscape. Billions of dollars of investment have been made over the past five years in new renewables capacity, and tens of billions more will be needed to meet targets over the next decade. As the sums of money become greater, so does the interest of the banking community.

Larger deals are becoming more common, as are more innovative financing techniques. Last year saw Credit Suisse First Boston structure a $380 million bond on behalf of Florida Power and Light, linked to a portfolio of existing wind farms. This year, the £400 million ‘Zephyr’ transaction in the UK saw utility RWE-Innogy refinance a portfolio of existing wind farms, with a capacity of 128MW, and raise money to develop a further 300MW of capacity.

As wind farms become larger, and as developers begin building industrial-scale solar plants, such deals are likely to become more common. Bankers and investors will continue to face a bewildering array of support schemes, but demand for cleaner, greener power looks certain to grow. EF

BOX 1 - An investment rollercoaster

While renewable energy generating capacity has been steadily growing over the past five years, the same can’t be said for the shares of renewable energy companies. The sector has undergone something of a rollercoaster ride, as the chart from Dresdner Kleinwort Wasserstein (DrKW) below shows.

By the end of the 1990s, interest in the sector was picking up, with wind, particularly, benefiting from huge growth. With annual increases in installed capacity running at around 30%, turbine manufacturers looked like a sure-fire bet for strong returns. And, as the steam began to go out of the dot.com boom, the renewable energy sector promised investors growth – underpinned by a long-term outlook that was more credible than that offered by the internet bubble.

However, investors fleeing one bubble soon inflated another. “Anything linked to renewables was floated – too many stocks were coming to market,” says Alastair Bishop, an analyst with DrKW in London. But as growth rates in the wind sector were slashed, and forecasts revised about how long it would take fuel cells to come to market, boom quickly turned to bust.

“Many companies, often with extremely high cash burn, soon ran into difficulties,” says Bishop. Ballard, the leading fuel cell developer, has seen its capitalisation slashed. In the wind sector, Nordex and NEG Micon struggled to meet investors’ expectations, culminating in the latter’s ‘merger’ with Vestas – essentially a takeover – at the end of last year. However, it was only in the solar market that a major company went bankrupt, with Astropower finally throwing in the towel early this year.

“Valuations certainly got ahead of themselves,” says Bruce Jenkyn-Jones, a director at Impax Asset Management in London. “There’s been two to three years of huge disappointment, particularly in wind,” although that part of the industry is now recovering, led by Spanish manufacturer and developer Gamesa.

The collapse in equity prices, and the difficulty in raising new capital, has led to a degree of consolidation in the sector – a trend which analysts believe is set to continue. For example, America’s giant General Electric has been a major beneficiary, snapping up Enron Wind and Astropower.

But despite the disappointments, the prospects for the renewables industry remain bright, many believe. “This is clearly an emerging sector, and the growth potential is enormous. The fundamental story remains very strong,” Jenkyn-Jones adds.

BOX 2 – Counting the cost

The underlying reason for the plethora of support mechanisms for renewable energy is simple: ‘new’ technologies such as wind or solar often cannot compete with conventional sources of energy. The intention is that, over time, technological improvements and economies of scale will help to bring down the cost of generation, to a point when support schemes can be withdrawn.

Recent years have seen steady declines in the cost of wind and solar generation. According to Platts Research and Consulting, 25 years ago wind energy cost around $250/MWh. Now, in the US, it’s around $40/MWh. Indeed, in some electricity markets, wind farms in optimum locations can compete without financial support. The costs of generating power from coal range between $20 and $40/MWh, while natural gas generation is in the $20–70/MWh range.

Equally, the cost of generating electricity from solar photovoltaic systems is now around a fifth of its level in 1980, of around $1,000/MWh. While it is still much higher than wholesale power prices, solar PV specialists note that the cost of power from photovoltaic cells should be compared to retail power prices, as they tend to be run by the end-user. This makes them cost-competitive in markets such as Japan.

But renewable energy advocates argue that, if the environmental and societal costs of green generation are included, wind and solar start to look even more attractive.

They can point to a number of advantages: no emissions of acid rain-causing sulphur dioxide, of smog-forming nitrogen oxides, or of the greenhouse gases that are leading to climate change. There are also benefits in that generation is often close to the point of use, reducing distribution costs.

Analysts are confident that costs will continue to fall, and that as the environmental costs of ‘brown’ power are increasingly taken into account, the business case for renewables will only become stronger.