Renewables: Enormous growth potential for wind and solar energy challenged by country-specific regulatory risks
As the source of the largest share of world CO2 emissions, the power sector concentrates much attention on the global effort and search to reduce pollution. The deployment of renewable power technologies has been important in the last decade, with renewables today accounting for one third of the global electricity capacity according to the International Renewable Energy Agency (IRENA), well above the 25% in 2010. While hydropower represents almost half of the renewables capacity, wind and solar together account for nearly all the other half and have registered the largest growth. Today, solar energy has become the first renewable technology, before wind energy, both in terms of power generation capacity and amounts invested. In 2018, the wind capacity increased by 10% in comparison to the previous year, mainly coming from China and the USA (accounting for more than half of the increase when taken together), while the surge was almost 25% for solar, with Asia (China, India, Japan and South Korea in particular) accounting for 70% of the addition.
But this rapid development has not always been without hurdles. Bright prospects have led to oversupply in the production of solar panels in China, which has exported its (low-cost) surplus to the rest of the world, leading at the beginning of the 2010s to a wave of bankruptcies among solar panel manufacturers across the world and the imposition of tariffs and anti-dumping measures by the USA and the EU to counter the trend.
The targets set by many countries in the world in terms of future renewables adoption – possibly prompted by their adhesion to international conventions like the Paris Agreement – offer a glimpse of a further formidable expansion in terms of demand and opportunities for the sector. Indeed, more than 50 countries and hundreds of cities and regions worldwide have pledged to achieve a 100% renewable energy target in the long term.
However, as is the case for all new and rapidly expanding sectors, the outlook for the renewable energy industry by nature involves many risks.
Lowering costs and supporting government policies continue to encourage the expansion of the sector
The cost of variable renewable energy technologies (i.e. wind and solar) has decreased considerably in recent years. Indeed, the levelised cost of electricity1 (LCOE) from solar photovoltaics (PV) dropped by 72% between 2010 and 2017 according to IRENA, reaching the same cost range as fossil fuels. As for wind, the LCOE from onshore wind was 25% lower in 2017 than in 2010, while it declined to a smaller extent for offshore wind, which remains the most expensive of the three technologies (see graph 1).
Falling costs combined with support from government policies have helped the rapid expansion of variable renewable energies and many projects are now being launched without subsidies. But it is also the progressive withdrawal of public funding which is causing the LCOE to decrease to such an extent. Indeed, public support schemes are moving away from subsidised mechanisms towards competitive schemes, mostly auctioning, for projects, putting pressure on prices.
Originally, one of the main types of support scheme for renewable projects was a system of feed-in tariffs (FITs) or feed-in premiums (FIPs) consisting in an administratively set price, or (variable or fixed) premium above the market price, being paid by the authorities for electricity generated over a long-term period. The scheme has the advantage of providing some certainty as regards the return on investment. More and more countries are switching away from these support schemes towards competitive auction mechanisms with long-term power purchase agreements, where investors and installers offer their lowest price to win the market. This allows the authorities to better control the deployment of renewables while, at the same time, reducing costs. The competition resulting from such auctions is contributing to the global fall in costs throughout the supply chain while putting pressure on equipment manufacturers.
Another support framework for the adoption of renewables is quota obligations and certificates, which require a certain percentage of power to be generated from renewables. In this system, governments fix quantities and the market determines prices. Penalties for non-compliance must be higher than the cost of compliance for the mechanism to be effective. The sale of certificates on a dedicated market can provide financial support for low-cost renewable power generators. Because of design considerations and difficulties, this mechanism has not been implemented in many developing countries.
Other financial and fiscal support instruments are also being employed, such as investment grants, etc.
Demand for renewables across countries depends on the public backing schemes
The global renewable energy capacity is expected to grow strongly in the medium to long term. The “baseline” scenario (including current and announced policies) of the latest International Energy Agency (IEA) World Energy Outlook predicts that the share of renewables (all types) in the power capacity will rise to 52% by 2040, from 33% in 2017, with the total power capacity increasing by 74%. Fitch Solutions predicts that the non-hydropower renewables capacity should almost double over the next 10 years. These predictions share the common outcome that the increase in renewables capacity will mainly come from Asia, and China in particular (see graph 2).
China represented 26% and 28% of the global power generated by wind and solar respectively in 2017, according to the IEA (see graphs 3 and 4). Those shares are expected to rise to 30% and 34% respectively in 2040. Fitch Solutions expects that China will account for almost 50% of the global growth of the wind and solar capacity in the next 10 years. The development of renewables is programmed in successive five-year plans, with feed-in tariffs foreseen to be the main support scheme for the current plan (2016-20).
These optimistic predictions are in spite of and take into account the swing towards non-subsidised projects operated last June when China’s policymakers made the surprise announcement that they would cut subsidies and impose a cap on new solar projects for the year, with immediate effect. This meant a temporary freeze on the majority of planned photovoltaic projects for the rest of 2018. They also announced a reduction in applicable feed-in tariffs. The measure followed a previous policy announcement for the wind segment that the granting of all new wind projects would be subject to competitive auctioning mechanisms as from 2019. The country additionally announced in early January the launch of a series of subsidy-free solar projects, highlighting the definitive trend of a progressive withdrawal of public financial support for investment in renewables.
As a result of these measures, the new solar capacity installed in the country last year dropped by 18% in comparison to the previous year and, what is more, the glut of solar cells and panels produced domestically increased, while solar module production continued to increase at a double-digit rate. Since more than 60% of the world’s solar cells and modules are produced in China, the local glut is being felt worldwide as the country tries to export its surplus. As a result, large importers of Chinese solar components have implemented new import restrictions. The USA implemented a 30% duty on all solar panel imports in January 2018 and India imposed safeguard duty on imports of solar cells sourced from China and Malaysia as from last July for a period of 2 years. These measures only increased the Chinese glut and the situation today places the Chinese solar equipment manufacturing sector under great pressure and risk of closure.
Another rapidly expanding market for renewables in Asia is India. The growth of investment in renewables infrastructure is expected to exceed the global trend, supported by very ambitious plans by the authorities, using capacity auctions, feed-in tariffs and accelerated depreciation tax benefit as the main support schemes. Rooftop solar projects in particular will be promoted, whereas large utility-scale projects have been dominant up to now. A potential change of majority after the general elections, the results of which will be known at the end of May, is not expected to derail the clean energy ambitions. However, in the short term, the industry is facing headwinds due to the perverse effects of the imposition for 2 years of (progressively declining) safeguard duty on imports of solar cells and modules since last July. Indeed, the measure follows an investigation by the trade administration, which concluded that the share of domestically produced solar equipment represented less than 10% of the installed capacity as installers rather turned to cheaper Chinese and Malaysian products, which represented about 90% of imports. The measure is proving unproductive in terms of protecting Indian manufacturers since the Chinese components remain competitive in spite of the tariffs. What is more, solar module manufacturers in Special Economic Zones (where many are located) importing cells as raw material from China or Malaysia must pay the duties, while the domestic cell manufacturing capacity is limited. Several auctions held after the imposition of import duties were cancelled, with higher tariffs cited as the reason. As a result of these setbacks, combined with uncertainties related to the applicability of the new goods and services tax on renewables and land availability issues, a reduced new solar capacity was installed last year compared to 2017.
Japan has encouraged the expansion of renewables since 2012 by means of attractive feed-in tariffs (FITs) to fill the gap in power supply left by the Fukushima disaster. The adoption of renewables has been significant, with the non-hydro renewables capacity growing at an average rate of about 30% per year between 2013 and 2018. However, in the same period, the value of FITs for solar projects reportedly fell each year, putting pressure on the profitability of solar power generating companies and increasing the number of bankruptcies in the solar energy sector each year. New pending FIT cuts for large-scale solar generating units and the transition to an auctioning system last year could see this number increase further this year.
Among the Central and Eastern European countries, Turkey is expected to experience strong growth in renewables capacity implementation in the next few years. This view is supported by the willingness of the authorities to decrease reliance on coal and gas imports for power generation. The development of renewables is backed by the country’s vision for 2023 and the IEA predicted last October that the renewables capacity would increase by 35% until then, led by solar (5.1 GW out of 14 GW) and onshore wind (4.4 GW). Turkey still offers feed-in tariffs for renewable energy power plants. However, Turkey’s Energy and Natural Resources Ministry is reportedly planning to end the current scheme by 2020 and it is still uncertain what will happen afterwards. For wind, the transition from FITs to the auctioning system has already started and is allowing the authorities to realise a substantial cost reduction. The first 1 GW wind project tendered in 2017 broke a world record with the lowest offered price per kilowatt-hour of electricity produced from wind technology. Tenders tend to require local content, which is not a problem, at least for wind projects, given that the wind equipment manufacturing sector is well developed in the country. But these positive projections are being hampered by financing issues in the wake of the recent economic developments in the country. Last January the government postponed the tendering for 1 GW solar capacity after the majority of the candidate companies in the auction reportedly required more time to secure financing. Obtaining financing remains a challenge for investors these days.
In Central and Latin America, auction mechanisms are used in many countries. Chile has been a pioneer in technology-neutral auctions, enabling renewables to compete with fossil-fuel plants in calls for tenders, thereby allowing wind and solar to actually lead the recent power capacity expansion thanks to their competitive cost. Brazil is expected to add the biggest variable renewables infrastructure in the region in the next decade and offers low-cost financing for projects including locally manufactured content. Mexico and Argentina have cancelled auctions for power supply planned for this year, which could hit investor confidence.
In the Middle East and North Africa, the wind and solar power capacity should grow rapidly from a low base, led by the United Arab Emirates and Egypt, according to Fitch Solutions. They predict that the non-hydro renewables capacity will more than triple in the region in the next decade, driven by solar expansion. Bids offered in auctions have been particularly low in the region, which has incentivised calls for further projects.
In Sub-Saharan Africa, the adoption of wind and solar technologies remains limited due to competition from lower-cost hydropower in the long term. However, mini-grids2, notably solar hybrid technology, are gaining traction as an instrument for economical and efficient electrification of rural areas which are not connected to the main electricity grid. The World Bank is providing important financial support in this respect. Auctioning mechanisms are also emerging as support schemes for renewables, backed by multilateral development banks in many countries (including Senegal, Zambia and Ethiopia). The primary market for future wind and solar capacity installation is South Africa, which is predicted to expand annually by 8.3% and 5.5% respectively on average between 2019 and 2024, according to Fitch Solutions. The government wants to turn to private investors to fulfil its ambitions in terms of renewables adoption while the national power supplier, Eskom, is in a dire financial situation. However, Eskom will be required for connecting part of the renewable energy generated to the national grid and has recently received a USD 180 million sovereign guaranteed loan from the New Development Bank for this purpose. Increased requirements for local content in competitive tenders are a boost for the domestic renewables equipment sector.
Changes in public support schemes are among the top risks
As illustrated by the examples cited above, changes in public support scheme modalities and formats are a key risk for players in the renewable energy sector, directly for investors and developers of capacity but also, as a consequence, for the whole supply chain. A related risk is the ongoing transition to auctioning mechanisms for projects, which are proving to be very competitive and push players to offer very low prices which could eventually make the projects unprofitable. The risk is further increased by the nature of the sector since, as a new industry, it includes many new and small players.
As the building of renewable energy capacities is capital intensive, projects are very sensitive to the cost of capital and investors are vulnerable to the tightening of global financial conditions. Although the US Federal Reserve has signalled a pause for this year as regards raising interest rates, a continuation of its tightening policy could lead to tightening of the global financial conditions.
The imposition of import tariffs and trade barriers in a context of already existing oversupply of renewables equipment poses increasing risks for manufacturers of such components, not only in China but also in other countries not protected by such measures, as competition increases and prices go down further. The tendency to link calls for tenders for new capacity to the requirement for local content in equipment increases the threat for non-local producers yet further. Developments in the ongoing trade war between the USA and China could also impact the price of raw materials and revamp market shares. For example, since 2014, China has imposed 57% import duties on US polysilicon, a key ingredient in solar cells. The move has decimated the US polysilicon industry and propelled the expansion of polysilicon manufacturers in China. Polysilicon is reportedly part of the current trade negotiations between the two countries and an easing of Chinese tariffs could lead US exports of polysilicon to China to resume somehow.
The constant progress of renewables technology means that technology risk must not be underestimated: that is to say, the risk of the technology not performing as originally planned or becoming rapidly obsolete and less competitive than newer technologies. The evolution of performance over time may also be uncertain. Ageing wind turbines in Europe have started to be dismantled and replaced by taller towers with larger and more powerful blades on existing sites to gain efficiency. As for solar, bifacial solar panels, which allow more sunlight to be converted into energy, are the new trend. The market share of bifacial technology is expected to grow from less than 5% in 2017 to nearly 40% by 2028, according to the International Technology Roadmap for Photovoltaic.
With growing investment in renewable energy around the world, conflicts over land access by local communities in areas where capacities are planned to be built are emerging. These conflicts can eventually lead to the cancellation of a project, to significant legal costs or to reputational damage. In Kenya, for example, a planned USD 150 million wind power project was cancelled in 2016 following protests and land disputes.
Analyst: Florence Thiéry – email@example.com
1 “Levelised cost of electricity (LCOE) represents the average revenue per unit of electricity generated that would be required to recover the costs of building and operating a generating plant during an assumed financial life and duty cycle. LCOE is often cited as a convenient summary measure of the overall competitiveness of different generating technologies.” (US Energy Information Administration)
2 Systems involving small-scale electricity generation (from 10 kW to 10 MW), and the distribution of electricity to a limited number of customers via a distribution grid that can operate in isolation from national electricity transmission networks and supply relatively concentrated settlements with electricity at grid quality level. (www.usaid.gov)