The Western European markets have been the main driver of several of the renewables markets (wind and solar) for more than a decade and the German EEG (Renewable Energy Act) has been the model for many other countries in their attempt to create a regime which would attract foreign investors and financing. However, are these markets still as attractive - or is it advisable to look elsewhere, i.e. how should we structure our investment strategy today?
What is the status on the Western European markets today?
Looking at the Western European markets today we see a higher political risk in a number of Southern (and Eastern) European countries, falling tariffs, tariff taxes and a lack of debt appetite from the banks in respect of several of these markets.
At the same time we see a maturing investor market with more institutional investors wanting to invest in renewable energy, although still with a cautious approach.
Many of the investors who had earlier moved on to Spain, Italy, Greece and Eastern Europe seem to seek back to the perceived "safe harbours" such as Germany and France, while most of the newcomers to the renewable energy scene seem primarily to be focusing on exactly the same markets. The markets have thus become overcrowded with the result that the yields offered have in many cases become unattractive.
However, in spite of the often rather unattractive returns investors still invest. And why? Is it not common knowledge not to seek the most crowded market?
We may not know the full reasoning, but many investors seem to have accepted the current low yield as being the norm, and many managers with mandates within that geographic scope do not have much of a choice, i.e. either they invest or they risk having a much lower income as their investment mandate runs out. Further, the current market does not offer many alternatives outside the renewables space for getting a decent risk/return on your capital.
Does that mean that the newcomers to the renewables market should rather stay away?
We are definitely not trying to scare away neither the old investors in the renewables market nor the newcomers. However, we do believe that investors could benefit from taking a broader perspective on both the geographic markets and, to some extent, on the technologies.
Our experience shows that even with the costs of various risk mitigators that may be needed to align the risk profile of projects outside the old, matured safe harbour markets, projects outside those markets often offer a better risk/return profile.
Such projects will require more insight and work in order for investors to fully understand and mitigate the potential risks involved, but the possibilities of sculpting the projects are often also much greater, the returns more attractive and the investor is generally not subject to bidding processes which may be both costly and cumbersome and often result in sunk costs.
Even if investors want to keep some geographical restrictions to jurisdictions with a perceived low political risk, the risk/return ratios offered in Canada, Australia and New Zealand are generally better than what is generally seen in the Western European markets.
Alternatively, investors can look to the north. Sweden and Norway offer an attractive political risk profile and are not (yet) as crowded. However, considering the electricity price market risk attaching to the Swedish and Norwegian projects and the current low prices offered, investors will need to look into alternative power sale structures and find comfort in the forecasts for the future power price development. Especially the latter currently seems to keep away many investors.
On the technology side, we still believe that wind energy is a good choice. However, it is definitely also worth having a look at (for example) hydro power projects (potentially with pump storage capacity), geothermal facilities and biomass.
Each technology offers its own challenges and risks, but they also carry different advantages. One of the advantages of such other technologies is the counter-peak electricity output which can be used to reduce the balancing costs often attached to wind energy production.
The Investment Strategy
The bottom line is, as with any market, that it makes little sense for all investors to all look at the same markets and the same projects. This narrow focus of many of the existing investment strategies has driven down yields to a level which makes alternative markets and technologies more attractive, but as many of the investment strategies are not flexible in scope, many investors are nevertheless staying in the less attractive markets.
The renewables markets have developed significantly over time, markets become more or less attractive and new markets develop. In fact, the life cycle of the individual markets in terms of attractiveness has become significantly shorter over the past 5 years and is today often as short as 18 months.
We thus recommend adding a reasonable degree of flexibility to the investment strategy by allowing for the investments that are necessary to follow the trends and opportunities in the market.