Mercoledì, 8 aprile, 2015
With around 50GW of installed renewable energy capacity, Italy is one of the core RES (Renewable Energy Sources) countries across the EU with Germany and Spain, now followed closely by the UK and France. In Italy RES went through boom and bust in the past decade, mainly due to the “green bubble” cycle, which attracted new investors. The current situation shows a slower investment pace than in the past due to: a) lower incentives, electricity prices, financial leverage; b) a fragmented asset base; c) disappointed investors due to uncertain and lower than expected returns.
At the same time, risks on the electrical system are becoming relevant considering the share of RES, now representing over 40% of the generation mix in terms of output, the aging capacity of RES which needs appropriate investment in maintenance and performance improvement, and the possibility that non-energy RES players might be tempted to shift to other, more remunerative investments.
The latter, in particular, could become a relevant issue. Besides the segment of the large RES operators – all energy players mainly focussing on wind or hydro – the vast majority of the installed capacity is owned by non-energy players (around 90% of PV, 60% of wind), initially attracted by high financial leverage (made possible due to high incentives backed up by the Italian Government) and business plans showing “double digit” IRRs (Internal Rate of Return – the key output / measure of all financial business plans). This segment of owners is increasingly disappointed due to lower than expected returns, since both revenue components, electricity and incentives, have proven more volatile than expected; real incentives are lower than what estimated in the business plans (also due to retroactive incentive cuts); additional burdens have lowered expected cash flows (new taxes, imbalances costs, etc.). Risk of early abandonments / decommissioning is therefore surfacing since this segment of investors has a clear slant towards being risk adverse and the tendency to shift from one IRR to another, in favour of the higher and safer one – a phenomenon which we can call “IRR to IRR competition”.
Aging capacity (mainly in wind, but also in hydro and, soon, in PV) adds to the issue of disappointing returns the need to show serious long-term commitment, invest in life-cycle extension and performance improvement. Moreover, starting from 2015 some 2 GW of wind will no longer have access to Green Certificates and another 3 GW will follow in 2016-17; the same, even though with different figures, is going to happen to hydro. These plants are located in the most RES interesting provinces, however, given their aging, are the least efficient in the industry (old technology, degradation of main components). If owned by financial / small players, available cash won’t be sufficient for retro-fitting.
The Italian decree July 6th 2012 provides access to specific incentives for RES plants investing in retro-fitting / substitution of components but, so far, surprisingly no wind plants have requested access to these incentives despite 450 MW of specific incentive space available as stated in the decree vs. around 350 MW capacity which was eligible in 2014. At first sight, since no player has shown interest, those incentives might look not financially attractive enough for financial / small players and, probably, procedures regarding the approvals needed for retro-fitting / substitution of main components are unclear, incomplete or interminably long and complex – as everything when it comes to permitting.
The following chart refers to Italian PV and Wind (1996-2014, total installed capacity at year end). The chart shows the relevance of aging mainly for wind and the 5 years-old PV cluster.
Figure 1 - 1996-2014, PV and Wind total installed capacity at year end.
Sources: BP “Statistical Review of World Energy 2014”, ANSA, Qualenergia
In summary, in the “do nothing” scenario, two areas of risk might emerge: 1) Technical distress – mostly impacting aging assets equipped with outdated technologies, low performing or degradated components. Aging assets close to life-cycle end need revamping and technology update to continue delivering adequate returns to owners – but, also, service to the system. 2) Financial distress – mostly related to more recent assets impacted by disappointing / volatile returns and incentive cuts, often under-capitalised. These assets might suffer from early abandonment / decommissioning and create issues for lenders as they might no longer be able to comply with the required financing parameters (zero equity and / or low DSCR – Debt Service Coverage Ratio, the “safety measure” for lenders).
The system could therefore bear the effect of renewables twice: expensive incentives to attract investments delivering overcapacity, then escapes and additional system issues when returns prove to be low or uncertain. Someone will pay the bill for this anyway, but should not suffer from its negative consequences.
The issue revolves around the impact of a second wave of speculative investments: “Vulture funds” are seeking to purchase assets from disappointed owners already and at the expense of the system – and bill payers.
The wake up call has not reached the legislator yet, however technical degradation and the impact of early abandonments could be a shock for the Italian electrical system and policy should aim at improving the quality of RES players stimulating investments in maintenance, retro-fitting, long-term over-haul. By the way, most issues are applicable even to conventional generation and relates to the capacity mechanisms literature.
Provided some available budget space – as it seems to be the case looking at the most recent figures from the GSE, the state-owned company which promotes and supports renewable energy sources (RES) in Italy – the Government should look at system security, technology development, RE market integration instead of supplying additional funds for currently un-needed capacity, leveraging upon the RES industry which is developing in Italy.
Taking the opportunity of redesigning the RE budget scheme, some questions should find the right place to be answered: Is the current quality of RES players still adequate for the system? Is fragmentation still an adequate industry structure for RES vis-à-vis long-term system stability? Is consolidation appropriate now, and who should be candidate for consolidation? Which are the technological segments that could turn RE from a burden to a key ingredient of the energy system? Or, in summary: is it the right time for conceiving a RE industry shift?