Why are costs of capital so important for renewables?

May 5, 2018

 

 Photo credits: Andreas Gücklhorn, Unsplash.com

 

Germany and the UK are among the largest markets for renewable energy within the EU. On the one side this is because they both have very favourable conditions for developing wind power, especially offshore wind, which seems to be booming at the moment. However both of them have also developed among the largest solar energy capacities, despite being some of the darkest, gloomiest parts of Europe. When northern Europeans flock to Greece or Croatia, they come there for the sun. But unlike tourism, another weather related branch that has had a less of an upswing are renewables. 

 

Despite very favourable conditions, investors have not favoured these countries due to political and economic instability, administrative barriers for investors and last but not least, the high costs of capital for renewable energy. A uniformed reader might at first think that costs of capital are a minor issue, however they have a huge impact on the profitability of these projects. According to the Dia Core research, in 2014 a wind power plant with the same equipment costs and wind potential would have been twice as expensive to build in Croatia, than it is to develop in Germany, simply because at that time the costs of capital for such projects was 12% in the later and only 3.5% in the former. 

 

Essentially the EU is facing a resource efficiency problem, as projects are built not based on the renewable energy potential, but on capital costs and risk perception. 

 

Unlike traditional power plants, such as coal and gas plants, renewable energy projects are highly capital intensive. Fossil fuel based power plants have lower upfront capital costs but higher operating costs during their lifetime, primarily in form of fuel costs. Renewable energy projects such as wind energy have on the other hand practically zero fuel costs but very high upfront investments. 

 

 

Hence renewable energy projects, and especially solar and wind energy, are very sensitive to changes in costs of capital. Therefore if a bank charges a larger interest rate on their loan to a wind power plant, this translates into greater costs during the lifetime of the project. The plants levelized cost of electricity is higher. This means that it needs greater government support to make it profitable. Since most support systems are financed by levies that are paid by consumers, higher costs of capital ultimately translate into higher electricity bills. 

 

But just how sensitive are renewable energy projects to costs of capital? 

 

This obviously depends on what you are comparing as you could choose among various renewable energy and fossil fuel power plants. For the purpose of this analysis I have compared two technologies that are representative of Croatia. 

 

Although most of Croatian electricity comes from large hydro plants, the country does have one 335 MW coal power plant called Plomin, and consisting of two blocks fuelled by hard coal. The plant is operated by Hrvatska elektroprivreda, the main Croatian power company owned by the government. Until recently HEP intended to develop Plomin C, another 500 MW block but these plans were cancelled in 2016. At the same time Croatia is intending to build a total of 744 MW of wind energy until 2020. After conducting the Pricetag project in 2016 I have learned that the average plant size for Croatia is 35 MW. Based on this data and also other assumptions regarding the capital costs, operational costs etc. I have calculated that an average wind plant in Croatia would be 40% more sensitive to changes in costs of capital a coal powered plant the size of Plomin C. 

 There would be much to debate about the assumptions that are used for this calculation. However the point remains that financing conditions have a very large effect on the final price we pay for developing renewables. Such considerations are very important for countries such as Croatia, where changes in electricity prices have large social implications. According to the latest Eurostat data about 30% of Croatian households struggle to pay for electricity bills, compared to just 4% in Germany. In environments where increasing the renewable energy levy is not an option, all means of reducing the costs of the energy transition should be taken, including creating an environment where loans for projects are cheaper. 

 

The author would like to thank Oliver Sartor from IDDRI for providing him with the assumptions and the model for the LCOE comparison

 

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Mak Dukan is the co-founder and CEO of Starfish Energy, a Croatian consultancy with offices in Zagreb and Berlin. With its unique positioning in the capital of the Energiewende and the latest EU member state Croatia; the company places itself at the forefront of knowledge transfer in energy and climate policy between Germany and Southeast Europe.  Its mission is to inform climate and energy policy through action oriented research.

 

 

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