The price of uncertainty in renewable projects

  • Market Insight 2023年2月16日 2023年2月16日
  • 英国和欧洲

  • 氢能

Renewable energy projects are dogged by uncertain regulatory and political criteria. Here, Jack Birchenough and Rebecca Armstrong take us through some of the challenges and options to overcome them.

This article was originally published in New Energy World by the Energy Institute, and is available here.

Regulatory and political stability are pre-requisites for the renewable energy industry to flourish, as these lead to access to the finance and insurance necessary to allow long-term investments. The path to more certainty in this sector still seems long. Let’s examine historical and upcoming challenges for the sector and the options available to overcome them.

Historically, the renewable energy sector has suffered political and regulatory instability.

Feed-in tariffs (FITs), power purchase agreements (PPAs) and contracts for difference (CfDs) played an important role in encouraging early investment in renewables technologies. By guaranteeing the price that a project will receive per kWh over a decade or more, many countries have provided the ‘certainty’ to enable projects to be financed.

In the majority of states, the desire to support and encourage renewable energy projects continues to strengthen. However, the war in Ukraine has provided a timely reminder that governments can be tempted to intervene in energy markets in ways which make sense in the short term, but ultimately might damage investor confidence.

In late-2022, in a bid to combat rocketing gas prices, the European Commission (EC) introduced a market revenue cap of €180/MWh for generators of electricity. Similarly, the UK government has introduced the Electricity Generator Levy, which deems any generator revenue in excess of £75/MWh to be ‘exceptional generation receipts’, which will be taxed at 45%.

While both measures have sought to avoid penalising projects on FITs, PPAs or CfDs (which would be unlikely to exceed the cap), they remain squarely aimed at any renewable energy project which is exposed to spot-market prices. At least one UK wind power project appears to be seriously affected by the levy, with Community Windpower stating publicly that it intends to challenge the Electricity Generator Levy in the courts, describing it as ‘a smash and grab raid on renewables’.

Regardless of individual effects, many have argued that the levy does not take account of the wider investment context of renewables projects, which are exposed to spot pricing. Separately, the UK House of Commons Environmental Audit Committee has recently suggested that the Treasury should consider tempering the levy with a low-carbon investment allowance similar to the one already enjoyed by oil and gas producers.

In the UK, the levy comes on the heels of the Energy Prices Act 2022, which grants the UK government very broad new powers to intervene directly in energy markets in wide-ranging ways, including licencing, which was previously the preserve of the UK energy regulator, Ofgem.

Well-intentioned as they are, the result of these measures and others like them worldwide is to move energy regulation back into the political arena. Existing and prospective investors may justifiably feel that the regulatory and economic certainty upon which they previously relied is arguably being chipped away.

Case study 1: Photovoltaic plants in the 2010s – a historic assault on tariffs

For a historical insight into the challenges that the renewables energy sector can experience when the regulatory and pricing environment becomes volatile and politicised, examination of photovoltaic power (PV) provides a useful case.

During 2006–2010 there was an explosion of investment in the PV sector, with governments around the world entering into long-term tariff commitments (often some combination of framework legislation and secondary regulations setting out particular FITs and PPAs with developers with term periods of 15– 30 years). Without any doubt, the offer by states of economic certainty was a large part of the investment decision for developers and those financing them.

In the years that followed, however, advances in PV technology led to a dramatic reduction in the levelised cost of producing PV power. (In the period 2009–2014, the levelised cost of unsubsidised PV power is estimated to have reduced by approximately 75%, reported FT/Lazard.) This caused a number of governments to re-examine the long-term tariffs which they had guaranteed to investors only a few years previously. The 2010s saw Spain, Italy, the Czech Republic, France and many others unilaterally reduce the tariffs that PV projects could expect to receive over their lifetimes (by a variety of measures – some less direct than others).

PV investors were left to consider what recourse they had, in circumstances where domestic courts were unwilling or unable to challenge changes to government energy policy. For those who qualified, the solution lay in the largest multilateral investment treaty in existence – the Energy Charter Treaty.

In total, during the 2010s, Spain, Italy and the Czech Republic were subject to at least 32 Energy Charter Treaty arbitrations, in which investors asserted their right to ‘fair and equitable treatment’, including, first and foremost, a right to hold states to the tariff and regulatory regimes on which investments had been initially based. In many cases, the investors were successful.

Who will carry the risk?

A major hurdle that all renewables projects must overcome is that of obtaining suitable insurance cover. Where possible, developers must ensure that any uninsured risks are suitably allocated between themselves, customers and suppliers. Difficulties on this front can arise in all areas of the industry, and they are not limited to new and untested technologies.

Case study 2: Lingering issues for mature technology

In 2023, fixed-bottom offshore wind sits firmly in the category of mature technology. However, from an underwriter’s perspective, the sector remains beset with issues. Chief among losses in terms of severity are subsea cable (both export and inter-array) and foundation failures. The causes of failure vary but continue to be attributed to errors in installation and/or quality control issues in the components and materials used. In both cases, the finger is often pointed at a tendency by projects to opt for the lowest bidder.

Underwriters have made clear in recent years that they will not continue to tolerate such high failure rates. Policy wordings are being modified accordingly, and pressure will continue to grow on developers to demonstrate that quality control is being taken seriously, both by contractors and suppliers.

Developers must therefore take a rigorous approach to their contracting with suppliers and contractors when losses occur. Indeed, it is increasingly likely that recourse will be against those counterparties; warranty provisions will need to be hard-negotiated and enforceable against a solvent entity.

“A major hurdle that all renewables projects must overcome is that of obtaining suitable insurance cover. Where possible, developers must ensure that any uninsured risks are suitably allocated between themselves, customers and suppliers.”

The difficulty of underwriting new technology

In younger areas of the renewable energy industry, brokers and underwriters continue to work to address the complex challenges presented by new technologies.

Green hydrogen projects remain a point of difficulty, both in terms of new risk (large-scale output of hydrogen, and particularly its use and storage in infrastructure previously designed for use with natural gas, remains relatively novel; while the issues of leakage and hydrogen embrittlement remain a concern) and due to the fact that every project has its own unique combination of more familiar risks.

For instance, in addition to the plant itself, a green hydrogen project will always require electrical input from another renewable energy generator, and its output will often go to a specific industrial offtaker; each will have its own unique risk profile.

While a number of brokers and underwriters have the expertise needed to support green hydrogen projects, in our experience there are clear differences in approach. In some instances, we know that hydrogen-specific teams are being put together, whereas in others we are seeing greater reliance upon separate business lines cooperating properly with each other. There is no one correct approach, but in this area, the importance of picking the right team cannot be overstated.

Investment treaty arbitration – not just a tool for fossil fuels

There are a few key issues to consider:

The renewable energy industry should not shy away from using available investment treaty protection and engaging the relevant dispute resolution procedures with states where necessary. These rights are the bedrock upon which foreign direct investment is built.

In times of political uncertainty, we would urge developers to focus carefully, at the earliest stage, on the extent to which a project will be protected by investment treaty rights when making final investment decisions. At the most basic level, it remains the case that international investors are often better protected from government overreach than their domestic counterparts.

Where necessary, projects should be structured to ensure that they obtain the benefit of one or more treaties. The Energy Charter Treaty remains a versatile option, for now, but there are also many bilateral investment treaties which offer similar or better protection.

The Energy Charter Treaty is about to become more complicated. In November 2022, the EU parliament signalled an intention to withdraw from the treaty, and it is anticipated that EU states will agree with each to disapply ‘sunset’ clauses that would otherwise protect investors for a period of 20 years after the date of withdrawal. Separately, the contracting parties to the Energy Charter Treaty have agreed in principle to ‘modernise’ some of its protections, including a narrowing of the fair and equitable treatment standard, and an attempt to prevent ‘treaty shopping’.

In any event, projects must be clear-eyed and realistic about the strength of the primary and secondary legislation (particularly FITs, PPAs and CfDs), underlying contracts and more informal promises and inducements to invest and upon which they rely.