Summary 2021 (part V): Financing for renewable energy becomes marred by regulatory instability

AleaSoft Energy Forecasting, December 31, 2021. After two extraordinary and complicated years in many ways, such as 2020 and 2021, the development of new renewable energy projects continues despite the difficulties. This article summarises the situation of PPA and renewable energy projects financing in general during 2021.

The renewable energy projects financing in 2021

The previous year, 2020, was an atypical year in terms of the renewable energy projects financing. The global energy halt due to restrictions caused by the COVID‑19 pandemic stressed the supply chains for new electricity generation facilities and caused delays in projects under construction. This situation alerted investors and financial institutions that, while showing interest in investing and financing new projects, were much more cautious.

The year 2021 relieved the last months of 2020, when the pace of new projects regained momentum. But after the summer came the unprecedented price spike in the energy markets. This, which, a priori, could seem like good news for electricity generation projects, ended up becoming a scenario of instability and uncertainty that made the vision of the future of the projects more blurred.

But the worst was yet to come. On September 14, the Government of Spain approved the Royal Decree‑law 17/2021. This RDL included the mechanism for reducing the remuneration excess for high gas prices, which brought a great feeling of legal insecurity to the energy sector and practically paralysed the financing of projects. The subsequent Royal Decree‑law 23/2021, of October 26, which greatly limited the type of facilities that were subject to the reduction in their income, was not enough to clear up the feeling of regulatory instability in Spain.

AleaSoft - Global corporate PPASource: Prepared by AleaSoft Energy Forecasting using data from Bloomberg NEF.

Are PPA necessary in a scenario with auctions that returned in 2021?

PPA, the long‑term power purchase contracts, were and continue to be one of the instruments most used by renewable energy projects to mitigate or eliminate market prices risk and to be eligible for better financing conditions. But, in 2021 a new player appeared in this scenario: renewable energy auctions.

With auctions, in addition to mitigating the market prices risk, a producer can eliminate the risk of the offtaker, because with auctions they obtain the guarantee of the State. In a situation like this, it might be thought that PPA will become obsolete. But, despite the existence of auctions, experts agreed that PPA will continue to be a basic tool for both renewable energy producers and consumers.

For producers, a PPA will generally mean a higher price for energy, in compensation for being exposed to higher risk depending on the credit quality of the offtaker. In auctions, obtained and offered prices are lower than in a PPA. Among the main differences between PPA contracts and the REER (Renewable Energy Economic Regime) of the auctions that explain the price differences between them, there are facts such as the additional complexities of a PPA and the extra guarantees that it requires, the average duration shorter of a PPA compared to 12 years of REER, or the possibility of leaving the REER before the stipulated period and that is not possible in a PPA.

Advantages of PPA for producers and buyers

Although at first glance it may seem that in a PPA there is always a winner (who obtains better prices than in the market) and a loser (who obtains worse prices than those that are subsequently in the market), it was already commented plenty of times that the signing of long‑term energy supply contracts represents a benefit for both buyers and producers. The key is understanding that PPA are a risk management tool and that it represents an insurance that guarantees a price, and this is advantageous for both the buyer and the seller regardless of the prices that are finally in the market.

For renewable energy projects, the predictability of long‑term cash flows offered by this type of bilateral contract makes it a very appropriate option for the Project Finance of new projects. Hence the importance of PPA for generators, since it allows them to obtain financing with high leverage.

For consumers, a PPA means knowing long‑term costs with certainty, which facilitates and, in many cases, makes planning and investments possible. Precisely in a year like 2021, with the escalation of prices, is when the need for large and electro‑intensive consumers to have long‑term contracts that protect them against these adverse situations in the markets was seen.

AleaSoft Energy Forecasting’s analysis on the prospects for energy markets in Europe and the renewable energy projects financing

The most complicated part in the renewable energy projects financing is related to electricity market prices in the future, because there are usually significant differences between the long‑term price forecasts used by the different parties. Sponsors have a more optimistic vision of the future, which is logical because their objective is mobilising capital and convincing their investors. However, banks tend to be more conservative because they need to ensure the return of all borrowed money.

This situation of different visions of the future on market prices makes contracting products that cover the markets risk essential, especially in very large projects. This is the reason for the importance of PPA, which, although they do not cover the prices risk during the entire life of the plant, can cover 10 to 15 years at the beginning of the project’s operation, facilitating the project’s bankability.

In order to quantify the value of the energy that an installation will produce throughout its lifetime, it is necessary to have a long‑term vision and reliable and coherent electricity markets prices forecasts with hourly details.

The impact of the current regulatory situation on the development of PPA, both offsite and onsite, and on the renewable energy projects financing will be analysed by the invited speakers from PwC Spain in the next webinar organised by AleaSoft Energy Forecasting, which will be the first of 2022 of its series of monthly webinars, and which will also analyse the evolution of the energy markets in Europe during the last months.

Source: AleaSoft Energy Forecasting.

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