Common hurdles for renewable energy financing and how to overcome them

TL;DR

• To achieve net-zero by 2050, it’s estimated that global investment in renewables must more than triple to around $4 trillion by 2030.

• Despite potentially significant returns, investors are wary of the risks associated with renewables and potential challenges, from development delays, currency fluctuations, and limited grid capacity to public opposition to projects and changes in government policy.

• The most significant concerns preventing investment in the sector range from higher interest rates and energy prices increasing the upfront costs of each project, delays in connecting renewable energy providers to the grid, objections from local communities that can derail projects entirely, and governments not taking a proactive approach to legislation and subsidies.

• However, these challenges are being addressed by initiatives operating worldwide. Power Purchase Agreements (PPAs) and government-operated auction processes are providing more security around funding, outreach schemes are engaging with affected communities, investment programmes focused on renewable storage are helping to offset issues with the grid, and countries are fast-tracking projects through streamlined permitting.

• While concerns still need to be eased, these initiatives prove that a degree of certainty can be introduced into the renewable energy sector, providing much needed reassurance to investors.

The detail

If the renewable energy sector is to fulfil its potential and power the clean energy transition, it will require a substantial amount of cash. In fact, it’s estimated that global investment in renewables must more than triple by 2030, to around $4 trillion, if we are to achieve net-zero by 2050. To put the scale of this increase in perspective, in 2023, just $1.8 trillion was invested in clean energy, a third of which was concentrated in solar PV and wind projects.

This funding gap is alarming but it’s not insurmountable. Investment in renewables has seen significant growth in recent years -  annual spending on solar PV and wind projects, for example, has increased by more than $300 billion in the last five years.

This has been driven by several concerted efforts. Indeed, the Inflation Reduction Act – introduced in the US in August 2022 – has been described as the single biggest climate investment in the country’s history, while global investment in renewable energy in the first half of 2023 broke records by hitting $358 billion – a 22% increase year-on-year.

Investors are also being attracted by the potential returns they could expect on their investment; it’s thought that the renewable energy market could be worth between $9 and $12 trillion by 2030. Further, a study by Imperial College London estimates that, over 10 years, a publicly traded portfolio of renewable power assets would generate higher investment returns, see lower volatility in some regions, and deliver higher diversification benefits than a portfolio that ignored the renewable sector.

Even so, many investors continue to err on the side of caution as opposed to using their finances to help close the renewable energy funding gap.

Critically, the sector faces many hurdles that make it appear be a risky proposition for potential investors, a fact that dissuades funds from taking that chance despite there being an “abundance of capital” available to back clean energy assets, according to Romain Talagrand, Head of Renewable Energy at BNP Paribas. These anticipated challenges range from development delays, currency fluctuations, and limited grid capacity to public opposition to projects and changes in government policy.

It’s important to note that these challenges aren’t always apparent, nor insurmountable. There are several ways that governments and renewable energy companies can mitigate investors’ concerns and increase confidence in the sector.

Unexpected delays and unpredictable pricing

The structure of clean energy projects can be difficult for investors to navigate. They typically require relatively high upfront costs that are compensated over time by much lower operating expenses, so a return on investment can take several years to materialise. With equipment, infrastructure and land acquisition all requiring upfront investment, potential investors can be thrown by unexpected delays or additional expenses.

Higher costs for commodities, energy and shipping have also impacted the renewable energy market. The IEA estimates that investment costs for utility-scale solar PV and onshore wind are 25% higher than they were in 2019. The result of these rising costs has been wind manufacturing facilities operating under capacity, with companies like Iberdrola cancelling an 800MW project in the US due to financial complications, and an offshore wind auction in the UK in 2023 being left with no bids.

Headlines such as these of course don’t help matters, while fluctuating interest rates also have a direct impact on renewable energy investment. Not only do higher interest rates make financing more expensive, but it can also increase projects’ reliance on more expensive equity. Plants have a lifecycle of around 30 years, but are often financed with debts that mature in around seven years, meaning projects that received financing in a period of low interest rates can suddenly find it much more difficult to find continued investment should the financial climate change.

What is often less spoken about is the clear ways in which these financial uncertainties can be tackled.

Public and private partnerships are one way forward as they combine public resources, expertise, and regulatory support with private-sector innovation and capital. Financing models like Power Purchase Agreements (PPAs) can also provide additional stability by allowing developers to secure long-term contracts with energy buyers and benefit from a steady revenue stream.

Other countries have addressed this problem by taking over pre-bid work and managing the tender auction process. India has taken this approach in some solar auctions and Germany and the Netherlands have stepped in with some offshore wind tenders. It’s also possible for governments to guarantee a grid connection to auction winners. Vietnam has taken proactive steps to combat the issues that arise when developers buy equipment in US dollars but earn revenue in local currency by designing auctions to manage currency and inflation risk.

Inspiring collaboration

Public opinion can also affect the feasibility of planned renewable energy projects. Local opposition can cause new plants to be delayed or even cancelled completely. Here, there are several ways that these community objections and concerns can be eased. One way forward is to introduce crowdfunding and community investment schemes. This approach not only allows projects to secure the investment they need, but also instils a shared sense of ownership with the local community and means local people can be compensated and rewarded for the potential inconvenience these developments cause.

Actively engaging with local communities can also be integral for developers hoping to win the fight for hearts and minds. Low Carbon harnessed the power of public consultations when constructing the Maldon Wycke Solar Farm in Essex in 2018. It used these sessions to educate the community and explain the benefits of the farm, attracting 1,990 visitors and 217 contributions. While the Low Carbon project was based around one singular development, Rethink Glasgow is an evergreen community engagement climate action plan that aims to create a greener and more connected city. It invites residents to drop pins on an interactive map and make sustainability suggestions. The site has received over 24,000 views and accepted more than 1,300 contributions.

Making connections

Historically, connecting renewable energy to the grid has lacked investment and attention. It’s estimated that at least 3,000GW of renewable power projects – half of which are in advanced stages of development – are awaiting grid connection. $607 billion needs to be invested in the grid each year to 2030 to meet net-zero goals, which is why countries like India and Brazil are increasingly reliant on private capital to expand their grids. In the UK, provider Octopus Energy has been told by the National Grid that they need to wait up to 15 years for some connections and projects worth £200 billion are currently sat in connection queues.

The UK government is currently addressing this shortfall. The National Energy System Operator (NESO) has been created to oversee the strategic planning and design of the country’s electricity and gas networks to progress the energy transition and ensure renewables are integrated into the grid successfully. The government has also just introduced the Long Duration Electricity Storage investment support scheme. This is designed to boost investor confidence and unlock billions in funding for vital renewable energy storage so that it can be effectively held before being released to the grid. It follows a ‘cap and floor’ structure, which offers a guaranteed minimum income for developers in return for a limit on revenues.

Aiming for consistency

Governments also have a role to play in streamlining the renewable energy planning process. Permissions and permits can be a significant roadblock for projects and their investors. The landscape is incredibly confusing – 68 different carbon initiatives are currently impacting the renewable energy sector in different countries. Further, nations can also often send mixed messages with their subsidies; France subsidising fossil fuels, for example, and Spain taking steps to reclaim profits from renewable energy operators, are not conducive with incentivising investment in renewables. Indonesia also subsidises its coal sector and Angola and Senegal subsidise their gasoline markets, which is then used instead of solar to provide back-up power.

Subsidies, tax credits, and feed-in-tariffs (FITs) directed towards clean energy instead can all reduce the financial burden on the renewable energy sector, but they aren’t a fix quick; investors may still be spooked by the fact that 75% of global solar is linked to FITs, which makes the market susceptible to changes in regulation. That’s where clear and stable regulatory frameworks can be a major help. More permissive regulations and streamlining of processes is already happening across Europe. In 2020, Denmark established a one-stop shop for its offshore wind permitting and Germany is also limiting lawsuits against potential wind farms, a move that has cut the permit pipeline from 11GW to 3GW between 2019 and 2023. The country approved over 7.5GW of projects in 2023, an 80% increase on 2022.

Investment is crucial if the clean energy transition is to be successful, but it’s undeniable that the renewable energy industry is imperfect. It’s a fast-moving sector that lacks well-established policy and is susceptible to changes in the financial markets, supply chain constraints, regulations, and licensing – all risks that discourage investors.

The solution? Certainty. The more certainty there is, especially with regards to climate policy, the more confidence there will be among investors. This also means tackling some of the persistent problems head on; holding regular auctions, accelerating the permitting process, and building out the grid are all essential to make the renewable energy market sustainable. In a sector where access to traditional financial institutions is limited, long-term thinking and continued policy support from global governments can make a real difference to the levels of private investment.

An element of risk will always exist, but it does not have to derail the renewable energy project entirely. A more stable, sustainable, and profitable future is possible.

— Lew 👋

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