A subsidy-free road ahead for renewable energy?

The need to move to a clean, affordable and reliable energy system has never been more obvious, and at PwC Strategy& we are determined to play our part in supporting this paradigm shift. We’re currently working on a series of articles focused on the various sections of the power and utilities ecosystem, aimed at helping you navigate the energy transition. Having been involved in preparing a piece on renewable generation, I thought it’d be good to summarise some of the key takeaways here. 

Going it alone

First and foremost, the renewable power industry – onshore wind, offshore wind and solar – is proving a prime example of how a sector can be built up and rolled out with considerable help from subsides, then continue to develop further free of this support. The shifts we are seeing away from subsidies is promising but not without risks. How can renewable companies best go it alone? What’s the smartest way to manage this move? And do subsides still have a role to play? 

The answer to the latter question is yes, subsidies will still be required to support many future renewable developments in the medium-term due to tricky market conditions and lower profitability. But the nature of the subsidies seems likely to change from economic support to risk mitigation, and from there to stimulating continued market growth. 

Improving economics

Subsidy support mechanisms have been around for a long time to improve the business case for renewable technologies, providing higher and more stable revenues, reducing exposure to wholesale power prices and lowering capital & operational expenses. Over the past decade, however, the economics of renewable power generation have much improved thanks to higher power price projections (15% in NL, 40% in Germany by 2035) and lower development/construction and operations/maintenance costs.

Capture prices

The largest and most uncertain factor in moving to subsidy-free renewable developments is the capture price. This is the average amount at which renewable power is sold to the wholesale market and can be lower than the average wholesale power price. Being more exposed to the merchant power market and power price, unsubsidised renewables face greater revenue uncertainty.

They’re also prone to price cannibalisation when technologies overlap and depress wholesale prices. For example, capture prices for solar, onshore and offshore wind are up to 10% and 20% below the average wholesale power price in NL and Germany respectively. You can read more about this in the next LinkedIn Pulse article in this series: ‘An unconventional future: the role of gas in a low carbon world’, which we will launch next month.

Financially attractive

Nonetheless, based on current expectations of future power and renewable capture prices, we see unsubsidised renewable developments being similarly attractive in pre-tax IRR close as fully-subsidised developments. Development costs will fall by up to 25% over the coming period thanks to efficient manufacturing, long-term supplier agreements, larger turbines and enhanced efficiency. And operational cost reductions of around 15% are anticipated due to automation, predictive maintenance and lean management.

And yet…

The business case upside from cost reductions and life extension is likely to offset the impact of lower revenue subsidies and declining capture prices. PwC Strategy& identifies three major uncertainties that need to be considered for subsidy-free developments, namely the phasing out of coal power plants in Germany and NL, the deployment of additional renewable technologies with similar supply profiles, and the effect of factors such as the CO2, gas commodity and coal commodity prices. Our sensitivity analysis suggests that each would reduce the pre-tax IRR for solar, onshore and offshore wind developments from 7-8% to, possibly, less than 4%. 

Managing exposure

As a result, managing exposure to merchant markets will be a priority for subsidy-free renewable developments. Approaches that can be taken include securing offtake under a PPA, leveraging storage to control dispatch and focusing on self-production from the renewable asset. To give an example, onsite renewable power for C&I customers for self-consumption essentially decouples the development from the merchant power market. Revenue is then calculated as the avoided cost of power, which can often generate attractive returns due to the taxes and levies typically applied to purchased power.

 What does this mean for you?

The developments outlined above make clear why all industry participants must plan effectively to address future market challenges and make the most of emerging opportunities. Our report on this subject includes specific recommendations for investors, developers, operators, consumers & off takers and policy makers.

In the meantime, all feedback and comments on this Pulse article are welcome… In an industry evolving as fast as this, we can surely all learn from each other. 

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