McKinsey: Merchant risk management: The new frontier in renewables

If stakeholders move away from subsidizing the renewable-energy market, developers would be exposed to wholesale prices. Renewables players thus need to position themselves strategically in their approach to long-term merchant risk.

Subsidy-free renewables projects: A reality

In recent decades, renewable electricity generation has been subsidized to encourage investment. This has resulted in the rapid expansion of renewable electricity generation, accompanied by technology advances that have allowed a constant lowering of construction and operating costs. Moreover, energy pioneers willing to take on construction and technology risks could benefit from stable cash flows during operation.

In turn, regulators, faced with having to adjust and revise a complex scheme of feed-in tariffs constantly, adopted a more market-driven approach. They introduced auctions whereby the bidder with the lowest electricity price would win the development rights for a certain location. Fierce competition ensued, with prices dropping by as much as 50 to 80 percent from 2015 to 2018. The merchant risk undertaken by developers remained limited—but this is changing rapidly.

Auctioning schemes are allowing “zero bids” whereby the developer is no longer guaranteed a minimum electricity price. Several subsidy-free projects, such as the solar photovoltaic and onshore projects in Spain and multiple offshore projects in Germany and the Netherlands, have been announced and are under development. While these projects have benefited from favorable site conditions and economies of scale, this change in the renewables marketplace indicates that the industry is transitioning into the next phase of market integration in which governments will abandon subsidies and developers will be fully exposed to wholesale prices (Exhibit 1). . . .

Click to expand...