Profits might be rising in the renewable energy sector, but this asset class is also looking more risky for investors, according to new research.
EDHECinfra, which provides research on infrastructure investing, has studied the UK as an example of an economy that has made a rapid transition to solar and wind energy, while relying very little on hydro and nuclear capability. Its latest report looks at the impact of this renewable energy on the UK’s electricity market and system, as well as examining the challenges that emerge as intermittent renewables become a bigger part of the mix.
It found that risks in this market are increasing as a direct result of renewables becoming a more prevalent source of energy. It says this will, in turn, impact the returns required by investors to hold such assets.
EDHECinfra found that political risks associated with this asset class was also increasing. While the growth of renewable benefits from strong political support, the recent EU and UK announcement on capping renewable profits show that renewables are not exempt from the type of intervention more commonly seen in the oil industry.
It said that investors’ appetite for such assets remains strong. However while the equity risk premium required by the market in unlisted wind and solar projects has declined for a decade, EDHECinfra noted that it had started to increase slightly since the start of 2022.
EDHECinfra said that some of this risk can be managed through effective diversification, be it geographical spread or between different renewable technologies. It said risks can also be mitigated by investing in energy storage or hedging revenue risk through contracts.
But it added that the increase of renewable energy production leads to a more volatile energy system, the option value of gas must increase. It pointed out that a key beneficiary of the transition to a higher share of renewable energy generation — at least until enough low carbon storage capacity is available — is gas power, a readily dispatchable source of power. The report adds that gas may in fact be the best hedge against more volatile green power.
It concluded that price stabilisation mechanisms are still needed. Supportive regulation has been a cornerstone of renewables’ success, but current market challenges cannot be solved by emergency fiscal measures
It said that regulatory support in the form of price stabilisation for renewable and energy storage could benefit both investors and consumers. For example, revenue hedging mechanisms such as CfDs (a form of contract fixing the price at a level set at auctions) have proven successful at attracting large capital inflows. While categorised as “subsidies”, these contracts are actually securing a long-term supply of clean power at an affordable and predictable price.