Over the past few years, both the European and North American markets experienced a significant rise in capital investments in renewable energy assets. Global investors have drawn an interest in solar, wind and nuclear options.
Renewable energy projects have been particularly attractive for sovereign and other institutional investors globally. On the pre-development level, they provided higher returns. And for those investors buying operating assets, they provided a more predictable stream of revenues. The push toward environmental, social and governance (ESG) strategies has encouraged many investors to diversify and increase their exposure to the renewable energy industry. Russia's war on Ukraine also highlights the energy security element, since renewable energy is still a limited part of the energy mix in many major economies. In 2020, for example, renewable energy sources made up around 37% of gross electricity consumption in the EU, according to the European Environment Agency, and thus oil and gas dependencies still play a role in national security and foreign policy.
Although renewable energy investments are becoming increasingly important to global markets, recent geopolitical events and economic developments have increased investors’ concerns. Renewable energy transactions may take a long time to negotiate and the risk profile of a project may change dramatically over time.
Consequently, there are several key elements that investors and entrepreneurs should consider when evaluating renewable investments, especially in light of the current economic and political environment.
- Higher energy prices due to limited supplies and geopolitical tensions can impact electricity prices and Power Purchase Agreements (PPAs). We already see amended PPAs in the marketplace and changes to financial models may lead to renegotiated or canceled projects. Reassessing the valuation of these projects periodically is necessary considering the current climate.
- Governments react to changing energy markets in conflicting ways. While most countries–especially with developed economies–have increased their renewable energy goals, several others have already adjusted their energy regulatory framework to bring back coal, oil and gas resources in order to respond to the emerging energy crisis. Italy, for example, is investing more capital in the renewable grid and better connectivity between the Italian South and North. Germany, however, reactivated a coal power plant amid Russian gas supply threats. These regulatory inconsistencies could deter certain investors from moving forward. Understanding the political and regulatory risk is crucial.
- The combination of a renewable energy investment boom and remote work during the COVID-19 pandemic has led to an acceleration of the investment process, both in terms of timing and the relationships between the parties. Companies have negotiated renewable energy deals under time pressure and without necessarily meeting in person, which could lead to a failed transaction. Parties should spend adequate time and financial resources to gather necessary business intelligence before engaging in a transaction.
- The dramatic increase in cyberattacks on strategic infrastructure has also impacted renewable energy assets. The SolarWind attack, which impacted many companies using the popular software in the solar energy industry, was just the tip of the iceberg. This new reality calls for better operational and cyber due diligence on potential targets in the renewable energy industry. Cyberattacks tend to be accelerated during geopolitical conflicts, increasing the importance of expanding cyber defense capabilities.
- Many renewable energy projects in Europe are located in areas that are more exposed to security instability. Spillovers from existing conflicts to other parts of Europe should encourage companies to adopt emergency and continuity plans to ensure that projects can continue and run smoothly while employees are rescued, if needed.
- Many renewable energy investors are sovereigns, which could mean a state linkage between an asset and liability under the current circumstances. Inflationary pressures and recession risk–supported by the instability of capital markets and Russia's war on Ukraine–may push many investors to spend more money on other assets, such as traditional energy sources and social benefits. Sovereign investors also may have less financial resources to allocate to renewable energy projects. Engaging sovereigns as co-investors in renewable energy projects in times of political uncertainty provides the long-term patient capital to critical projects, but this capital is also tied to internal and external economic forces and changes.
- Finally, the success story of recent years was also supported by high levels of liquidity in financial markets. Alternative energy-related companies have seen record-high valuations. Recent uncertainty in many markets may put significant pressure on renewables investors to find additional sources of financing. We already see the impact of tight capital markets on some parts of the industry, such as Special Purpose Acquisition Companies (SPACs).
There is no doubt that investing in renewable energy assets is necessary to achieve climate goals, improve energy security by adding renewables to the energy mix and could provide better financial results. The events of the past month were a wake-up call for the industry, reminding everyone of old and new risk factors in the energy transition. A more cohesive and comprehensive approach to risk management in the renewable energy investment process can address many of these factors. It remains to be seen if and how market participants will take advantage of this critical moment to solve longer-term challenges.