Financing the European energy transition

Financing the European energy transition

By Max Dreiner, Alternative Investment Associate, Aquila Capital

Renewable energy’s contribution to Europe’s electricity generation mix has increased substantially in recent years and will continue to do so. One of the main reasons for this development is the introduction and implementation of new policies by European governments that aim to make its member states independent from fossil fuels by 2050.

Although increasing renewable energy generation has an overwhelmingly positive impact on Europe’s environment, this development also represents a serious challenge to the continent’s energy infrastructure. Since renewable energy is variable by nature because of its dependence on weather conditions, it requires a more flexible grid system that can regulate periods of over- and under-supply.

This requires a major transformation of Europe’s energy infrastructure going forward - and presents huge opportunities to investors.

The changes that lie ahead are creating investment opportunities throughout the whole value chain of the energy system, including generation, storage and adaption of the transmission system to modern demands.

Renewable energy plants’ production costs have fallen to such an extent now that they can compete on price with traditional sources. This further incentivises the build-out of renewable energy power plants. But greater reliance on renewable energy means the existing electricity infrastructure must become more flexible and ‘smarter’.

For example, decentralised renewable generation and other trends such as increasing numbers of electric vehicles and electrification in general change the load profile of grids dramatically, making the transition heavily dependent on improvements to energy infrastructure and more intelligent management of supplies.

New technologies such as smart meters and sensors or automation and digital networks will create opportunities to make grids more advanced and sophisticated, while intensifying electricity demand will create challenges for the ageing and unreliable infrastructure that produces losses.

These changes create investment opportunities throughout the whole renewable energy sector.

Numerous opportunities in energy generation

First, with regards to renewable energy generation, institutional investors can benefit from a proven asset class that continues to benefit from technological advancements and which offers stable and attractive risk-adjusted returns over the long term.

The sector’s dependency on government subsidy schemes such as Feed-in-Tariffs (FiTs) is decreasing, which reduces regulatory risks. While electricity spot markets can expose renewable energy suppliers to market price risk, this can also be mitigated through the growing market for power purchase agreements (PPAs) arranged with large corporates or utilities as off-takers. In its simplest form, a PPA would require a off-taker to purchase all electricity of a generation asset for a fixed price over the tenor of the PPA: However, more complex structures are available that allocate the relevant price and volume risk between the parties. Generally, PPAs may include physical delivery of the produced electricity or purely consist of financial hedge.

There are numerous opportunities throughout Europe to invest in renewable energy generation. The Nordics, for example, represent an attractive location for onshore wind because weather conditions are highly favourable. The political backdrop is supportive too in Scandinavian countries generally. Sweden aims to be completely renewable dependent by 2040.

The potential for greenfield solar projects is also substantial in Spain and Portugal, which benefit immensely from their superior sunny conditions.

District Heating has significant market share

Another segment of the market offering investors substantial opportunities to secure stable profit margins is District Heating (DH), whereby i.e. the waste heat generated by power plants is redirected to local buildings. Heat could also, amongst others, be generated by biomass and geothermal power plants or through electricity. DH currently provides 9% of heating within the EU, and most of these networks are concentrated in the Nordics and Eastern Europe. Germany is also one of the largest markets for DH and in Finland, Denmark and Sweden, DH dominates the heating sector.

Energy storage has a huge role to play

Due to its intermittent nature, renewable energy generation benefits significantly from the improvements made in storage technology, which has a huge role to play in the energy transition. The build-out of electricity storage systems such as lithium-ion batteries present particularly interesting investment opportunities. These batteries can generate revenues by providing high-frequency balancing or so-called ‘enhanced frequency response’ services to the grid, optimizing the load management and improving the time taken to respond to demand levels.

Cross-border transmission has great potential

If electricity cannot be stored then selling it to other European markets is an excellent alternative. Cross-border electricity transmission has great potential since regions such as the Nordics can sell surpluses to countries with deficits, such as the UK. The capacity of interconnectors in the form of under-sea cables between countries is expected to double between now and 2030. This increase in capacity will drive electricity prices in surplus-markets higher as these tend to be below those in deficit markets.

The entire value chain offers opportunities

Investing in the entire value chain of the European energy transition can yield synergies for investors. For example, battery storage facilities can be installed as co-location batteries and share a grid connection with a generation asset, thereby reducing costs.

But investing in this sector in general requires specific expertise and knowledge across the renewables infrastructure spectrum. Investors should look for asset managers with a proven track record in renewables and the ability to actively manage assets and de-risk strategies throughout the investment lifecycle.


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