Renewables: Normal service resumes, with improved economics

October 30, 2024
By Audrey Lee, Daniel McCormack

Executive summary

• Renewables have faced an unusually large number of challenges in recent years. 
• However, costs and interest rates have since come back down and power prices have adjusted upwards, helping to preserve margins and maintain (or even improve) the economics of projects. 
• The long-term outlook for renewables remains compelling:
  • The demand for clean power remains robust, with new data-intense technologies, such as artificial intelligence (AI), driving strong demand for power. 
  • The long-run cost trajectory continues to forecast significant declines in the per unit cost of renewables power, as scale and technical improvements drive gains. 
  • New, cheaper forms of energy historically have helped to unlock extended periods of rapid economic growth, and renewables could play a similar role in the decades ahead.

Investments in wind and solar are generally seen as lower risk and more reliable, given the long-term contracted nature of revenues and expenses, the high EBITDA¹ margins, and the fact that the technologies (wind and solar) are mature and well understood. They also benefit from powerful structural tailwinds courtesy of society’s need to move to a much lower-carbon energy system. But in recent years the sector has faced an unusually large number of challenges:

• Supply chain challenges. The supply chain disruptions as the world emerged from COVID-19 caused the prices of many of the commodities used in the production of wind turbines and solar panels (steel, copper, aluminium, polysilicon) to rise significantly, with knock-on effects for the cost of wind and solar projects. 
• Increased cost of capital. The cost of capital also went up not long after, as the world’s central banks battled the post-pandemic surge in inflation. Being more capital intensive than coal-fired power plants or CCGTs² (the fuel is ‘free’ for renewables), renewables were hit harder than others. 
• Permitting challenges and queues for grid connection. Government approval times have lengthened, adding to uncertainty and risk for the sector. 

These developments manifested themselves very publicly in a number of cancellations, write-downs, and divestments. For example, Ørsted impaired $US4 billion against its US offshore wind portfolio and abandoned the development of two wind farms off the coast of New Jersey in November 2023, citing rising US interest rates, inflated costs, and supply chain challenges.³ The company further suspended development of two offshore wind projects in Maryland in January 2024, stating that the projects were no longer economically viable.⁴ All of this saw some listed renewables and clean energy companies experience a selloff.⁵

Many of these developments have been only transitory, however. And for those that have proved more durable, the sector has now adjusted. Indeed, in the cases that garnered much of the headlines, the main issue appears to have been one of timing – many of the affected projects locked in electricity prices with customers before securing build costs, leaving them vulnerable to input price fluctuations and changes in market conditions. Costs have now subsided, or power prices have adjusted to compensate.

Moreover, the baseline need for renewable power to drive the energy transition, and the need for private capital to build that capacity, remains. At the same time, power demand is being boosted by a range of data-intense, and therefore energy-intense, new technologies such as AI. Finally, renewables remain the world’s cheapest form of power on a levelised cost of electricity basis and have the potential - like other cheap sources of power before them – to unlock a period of sustained, strong economic growth. 

Higher costs: Supply reaction and upward adjustment of power prices

Between one-third and one-half of the cost of a wind turbine is made up of commodities such as steel, copper and aluminium, and the surge in the price of these commodities over 2021 and into early 2022 (Figure 1) amounted to a sizeable increase in underlying project costs. In Europe, these pressures resulted in an up to 40% increase in the cost of wind turbine manufacturing by 2023 compared with 2021.⁶ The price of silicon, a critical material for solar panels, also underwent substantial price fluctuations in the same period, impacting the overall cost of solar projects (Figure 2).

Sources: Macrobond, Bloomberg New Energy Finance (BNEF) (October 2024).

Across the Atlantic, the US government’s strategy of incentivising domestic renewable energy production while imposing restrictions on imports exacerbated the supply chain challenges. The Inflation Reduction Act (IRA) promoted a surge in renewable projects by supporting domestic equipment manufacturing. But the supply of materials was initially unable to keep pace with the increase in demand, with import tariffs and regulations on essential components like solar panels, wind turbines, and batteries complicating sourcing from abroad. Markets have since adjusted to these shocks, however, with silicon prices falling all the way back down to pre-pandemic levels as supply has improved.

At the same time, power purchase agreement (PPA) prices have adjusted to the higher cost environment to preserve project margins. Since 1H21, PPA prices in the US and Europe have experienced compound annual growth rates (CAGRs) of about 23% and 20%, respectively.⁷ Some contracts signed pre-COVID-19 have also been renegotiated, in recognition of the escalated project costs and to create a more secure financial footing for supply. For example, in June 2024, New York State awarded updated contract prices to Empire Wind and Sunrise Wind, two offshore wind projects developed by Equinor and Ørsted, respectively. The renegotiated contracts secured offshore renewable energy certificate prices of $US155/MWh for Empire Wind and $US146/MWh for Sunrise Wind,⁸ which represent a more than 30% increase from the prior respective contract prices of $US118/MWh and $US110/MWh signed in 2019.⁹ In our view, the combination of the substantial correction in costs and the recent uplift in PPA pricing has resulted in significantly improved economics for many of today’s renewable energy projects.

Cost of capital turns back down

When inflation rose in mid-2021 as a result of the fiscally induced surge in consumer demand against the backdrop of severe supply chain disruptions, central banks responded by increasing interest rates and taking monetary policy into restrictive territory. This was particularly challenging for renewables, given their capital-intensive nature and the amount of capital needed to drive the rapid growth in the sector.

But with the inflation problem now under control (Figure 3), central banks are moving to take monetary policy back to neutral territory. Based on futures markets pricing, the US Federal Reserve is expected to lower the federal funds rate to 2.75% by the end of 2025, which is more than 200 basis points below where it is now (Figure 4). Similar moves are expected from the European Central Bank and the Bank of England. The lower financing costs and cost of capital this implies will increase the cash flow generation of renewables projects and work to reverse the negative impact on value from higher interest rates and improve the relative attractiveness of renewables for investors.

Recognising the need to address the grid connection queue backlogs, governments around the world have taken steps to resolve grid congestion. In the US, the Federal Energy Regulatory Committee (FERC) now requires more substantial financial commitments from project developers to ensure that only serious projects enter the queue.¹² The UK’s National Grid also changed the queue management approach in late 2023, switching away from ‘first-come, firstserved’ to a process with project milestones designed to terminate stalled projects.¹³ In some countries, the reform impact has already been visible. For example, Germany granted permits for 7.5 gigawatts (GW) of onshore wind in 2023 – almost twice the 3.9 GW issued in 2022 – after regulatory reforms in 2022.¹⁴ The growth has continued into 2024, with permits for 4.8 GW issued in 1H24, a 32% increase compared with the same period last year.¹⁵ These developments underscore the effect of regulatory adjustments in enhancing grid connection processes and facilitating the expansion of renewable energy infrastructure.

Compelling long-term outlook: The energy transition, price declines, new cheap energy, and AI-related surging demand for clean power

If we step back from the short-term dynamics, the long-term outlook for renewables remains compelling, in our view. First, the need to reduce carbon emissions has not changed and neither has the crucial role that wind and solar will play in the energy transition. In 2024, the world is set to see a new record in installed renewables capacity, with 341 GW expected to be put in place (Figure 7), bringing the total installed renewables capacity to 2,300 GW. By 2028, that number is expected to be 5,108 GW, a CAGR of 10.4%.

Figure 7: Actual and forecast annual increase in installed renewables capacity (GW)

Source: BNEF, New Energy Outlook 2024 (September 2024).

Second, the long-run drivers of costs continue to put downward pressure on the per energy unit cost of both wind and solar. For instance, since 2021 there has been a threefold increase in solar manufacturing capacity driven by record investment, resulting in a 50% year-on-year reduction in solar photovoltaics (PV) module pricing. The module price is now at near-record-low levels again (Figure 8). The cost of wind has stabilised after the increases in 2021 and 2022 and continues to benefit from larger blades and better wind capture. In short, the long-term outlook for significant declines in the per unit cost of power from both wind and solar remains in place (Figure 9).

Figure 8: Solar module pricing

Figure 9: Average cost forecast of wind and solar

Source: BNEF (September 2024).

Finally, the surge in AI adoption and other emerging technologies (such as driverless cars and the internet of things) is driving rapid growth in demand for data and power. Data centres consume vast amounts of electricity to power servers and cooling systems to prevent overheating, and the process of training AI and machine-learning models is notably energy-intensive. Large models, such as those used for natural language processing and image recognition, require extensive computational power and vast datasets, leading to substantial electricity usage.

For perspective, processing a ChatGPT request consumes 2.9 watt hours (Wh) of electricity – nearly 10 times that of a Google search (Figure 11). The expansion of edge computing, which facilitates real-time AI processing by analysing data closer to its source, further escalates electricity usage. Electricity demand from data centres dedicated to AI is projected to jump from 6 terawatt hours (TWh) in 2022 to 90 TWh in 2026, which is equivalent to a 97% CAGR (Figure 12).

Figure 11: Electricity consumption per request (Wh)

Figure 12: AI data centres electricity demand, 2022 and 2026e

Source: International Energy Agency (2024).

This surging demand for electricity is complicating matters for some of the large technology companies, with many now falling short of their net zero carbon-emission goals. For instance, Google aims to achieve net zero by 2030, yet its emissions have risen due to insufficient carbon-free energy to keep up with the growing electricity requirements of its data centres (Figure 13). This situation underscores the pressing need for an expanded and more reliable supply of renewable energy, highlighting the significant growth opportunities within the renewables sector.

Figure 13: Google’s total electricity consumption and percentage of carbon-free energy (CFE), 2019-2023

Source: Google 2024 Environmental Report.

In conclusion, while the renewable energy sector faced challenges and disruptions in the immediate aftermath of COVID-19, the sector has since adjusted. Costs have come back down and PPA prices have increased, resulting in much improved economics for the sector. In addition, governments have been working to reduce the permitting and connection delays. We believe the long-term outlook for renewables remains compelling: the need to transition our economies to a much lower-carbon structure remains, renewables are still the cheapest source of power around and we believe are likely to get even cheaper in coming decades, demand for electricity could be on the rise as new technologies (such as AI) proliferate, and corporates’ demand for clean power to meet their public commitments remains strong.

Authors

1. Earnings before interest, taxes, depreciation and amortisation
2. Combined cycle gas turbines
3. Reuters, “Orsted hit by up to $5.6 billion impairment on halted US projects,” November 2023.
4. S&P Global, “Ørsted pulls Skipjack offshore wind projects out of Md. state contracts,” January 2024.
5. The S&P Global Clean Energy Index fell around 60% peak-to-trough, although it is worth noting that it includes several service and supply businesses that are not pure renewables businesses and therefore not the same as what private markets renewables funds invest in.
6. The Guardian, “Giant windfarm off Norfolk coast halted due to spiralling costs,” July 2023.
7. LevelTen Energy, LevelTen’s PPA Price Index, 2024.
8. S&P Global, “Rebid New York Contracts Highlight New Normal for Offshore Wind Costs,” July 2024.
9. Offshore WIND, “Equinor, Ørsted Sign New Empire Wind 1, Sunrise Wind Contracts with New York State,” June 2024.
10. Energy Monitor, “Could too much permitting reform hurt EU renewables?”, June 2023.
11. Energy Monitor, “Could too much permitting reform hurt EU renewables?”, June 2023.
12. Reuters, “US overhauls electric grid to make way for more renewables,” May 2024.
13. Transport and Energy, “Ofgem to clear ‘zombie projects’ to cut grid connection queue,” November 2023.
14. Wind Europe, “German onshore wind sees record auction volumes, permitting improvements and crucial new port investments,” April 2024.
15. Montel News, “Germany to miss annual onshore wind target by 3 GW – lobby,” July 2024.

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