sectors. Expectations for escalating multi-decade growth and development in the sector is expected to underpin the investment case for renewables as a valuable, long-term investment.
Global commitment to renewables
The Paris Agreement, signed in 2016, set a target for the 196 government signatories to limit the increase in global average temperatures to within 1.5 degrees above pre-industrial levels by reducing greenhouse gases.
This agreement, along with the establishment of universal objectives such as the UN Sustainable Development Goals (SDGs), forms the core of a coordinated effort by governments around the world to raise awareness and individually commit to reducing their own carbon footprints through Nationally Determined Contributions (NDCs). By 2019, 172 countries had renewable energy targets, with 161 having established their renewable energy policies.
There are many signs that these agreements are now bringing about real change: China has recently announced plans to achieve carbon neutrality by 2060. President Biden has recommitted the US to the Paris Agreements as well as announcing potential infrastructure spending and renewables tax cuts; and Europe has established the Green Deal, a set of policy initiatives that commits to a climate neutral Europe by 2050.
At the same time, there is also a growing pledge by corporates to renewable sources of energy. For example, the RE100, a collective of over 280 businesses, has committed to sourcing 100% of their energy needs from green electricity by 2050 or sooner. Many in this group source their energy from renewable energy companies directly via Purchase Power Agreements.
Such commitments lay the foundations for a virtuous cycle where supporting policies put in place by governments, pave the way for investment in the sector which de-risks the sector, leading to attractive and sustainable investment returns which then supports further renewable energy development.
Governments have made efforts to attract capital into the renewables sector by:
- Setting clear policy objectives and targets to increase visibility for companies looking to develop energy generation, transmission and storage projects as seen in the Green Deal, established by the European Commission.
- Promoting co-investment and blended finance mechanisms that share the risks and returns among stakeholders. This has further increased interest from institutional investors, developers, commercial and development banks looking to provide more capital into the sector. Project examples include Walney offshore wind farm in the UK and the Butendiek offshore wind farm in Germany.
- Providing guarantees (via development banks) and insurance products that mitigate credit and default risk by a counterparty. Mitigation of default risk has increased certainty around the successful development of the asset, while additional guarantees, particularly in relation to forward power purchase agreements, has increased the likelihood of operational success once the asset has been commissioned. These are more prevalent in
emerging economies, where risks are higher.
- Introducing renewable energy quotas and obligations - an incentive system where the government sets the percentage or an amount of energy that comes from renewable sources such as the Renewable Energy System quota scheme in Sweden.
- Setting regulatory and pricing policies such as feedin-tariffs which set the price of renewable energy production, potentially over long timeframes. These have been enacted in over 50 countries worldwide.
- Providing tax incentives, such as investment and production tax credits, accelerated depreciation and tax reductions; and grants and subsidies to promote renewable energy production. The US government promotes these at various government levels.
Some of these actions pose a potential risk if revoked. However, the commitments made are supportive of further accommodative policies geared towards the ambitious targets adopted by most governments.
Cost reduction through technological advancement
Renewable energy is particularly sensitive to declining costs of equipment. Having no fuel costs during the operational phase of a project means a significant portion of the 'Levelized Cost of Electricity' (LCOE) of renewable energy is accounted for at the initial stages of the project. This is a key difference to traditional utility business models that pay for their 'fuel' as an ongoing expense.
As Figure 1 demonstrates, the cost of renewable energy generation has reduced dramatically over the last decade, especially for wind and solar which are now at grid parity (comparable cost) to coal production, making them a competitive choice for utility grade production. Costs for coal have remained stable at around US$100/megawatt hours (MWh), while wind and solar have decreased by 30% and 82% to US$84/MWh and US$68/MWh respectively.
These cost reductions have been driven by technology advances, competitive procurement, declining finance costs and a growing base of experienced, internationally active developers, some of which are listed companies. The result being the emergence of an established, scalable industry that now generates three times more new energy than fossil fuels (Bloomberg, 2020) and will continue to benefit from further cost reductions in both established technologies and complementary enablers such as battery storage.
Increasing investment to meet global ambitions
Energy production contributes around 74% of worldwide greenhouse gases, and the transition from fossil fuels to renewable energy will be a major contribution reducing greenhouse gases which should see large-scale capital flows into renewable power in virtually every jurisdiction.
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