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    Riding The Energy Transition Wave

    Solar Photovoltaic

    As the world races towards net-zero CO2 emission goals, the European Union has set an
    ambitious agenda for the upcoming decades that supports investments in renewable energy sources. Investors with a keen eye on the future of the continent are looking to profit from this wave of change.

    Dario Bertagna
    Managing Director
    Co-Head of Clean Energy Infrastructure
    Capital Dynamics

    “We are seeing more and more news about natural
    disasters all over the globe,” says Dario Bertagna, Managing Director and Co-Head of the Clean Energy Infrastructure team at Capital Dynamics, a US$15 billion asset management firm focusing on midmarket corporate private equity and credit investing, and clean energy infrastructure.

    “The severity of extreme floods in Germany and
    Western Europe, the alarming number of wildfires
    in the US and the hottest summer in the history of
    Europe with Italy reportedly reaching almost 50⁰C
    are all signs of a fundamental structural problem.”

    As a result, European policymakers have moved global warming to the forefront of their agenda. “Europe wants to establish itself as the first carbon neutral continent in the world. This means that the policy environment across Europe will remain accommodating for renewable energy,” Bertagna adds.

    An Accommodating European Policy Environment

    To this end, the European Commission increased the CO2 emission reduction targets. The latest Green deal, and the “FIT for 55 package” in particular, set a number of new ambitious goals, including a minimum 55% reduction of greenhouse gas emissions by 2030 compared to 1990, and net-zero by 2050. The package also includes reforms for the carbon pricing market and a number of regulatory reforms, including changes to the Energy Efficiency Directive and the Renewable Energy directive. “Renewables will largely benefit from the new polices as we are seeing an increase in momentum in the sector. As of today, about 40% of the capacity mix is generated from renewable energy sources. The balance is provided mostly by gas, nuclear, coal and a very small amount of oil.

    “If we fast-forward to 2030 we can expect renewable energy to account for about 50% of the generation mix. Renewables will almost entirely replace coal, oil, and nuclear to some extent. By 2050, renewables are expected to be the dominant energy source, representing 75% of the generation mix.” “In the short term, this shift will create a scarcity of operating assets across Europe, particularly after the end of the subsidies regimes, at a time of incredible demand for renewable electricity and renewable assets,” Bertagna says.

    The Rise of Power Purchase Agreements

    “We believe that this dynamic will increase the value of renewable assets and favour players with an already secure pipeline of assets, particularly assets benefiting from Power Purchase Agreements (PPAs), which mimic the cash flow structures of subsidised assets. We also believe that asset owners will be able to benefit from more attractive PPA terms,” Bertagna adds. A PPA is a supply agreement between two parties, usually between a power producer, such as a solar plant or a wind farm, and a customer, such as an electricity consumer, a corporation or a trader. The PPA defines the conditions of the agreement between the two parties, such as the amount of electricity to be supplied, the duration of the contract and the price, which normally is fixed.

    “Since it is a bilateral agreement, a PPA can take many forms and can be largely different from one to another. Certain PPAs for instance push the volume risk on the producer while others on the consumers. For instance, we talk about ‘pay as produce PPA’ or ‘base load PPA’ depending on the arrangement around the contracted volume and who is taking the
    risk. In general, PPAs can be used to reduce price risks and volatility for both suppliers and customers,” Bertagna says.

    The general market environment in Europe is making PPAs more popular according to Bertagna. “If we step back and look at how we reached the current renewable energy penetration we can see a trend. Although up until 2015/2016 most investments were backed by subsidies, the cost of renewable energy technology has decreased significantly. Subsidies for new project are largely unnecessary and have been replaced by PPAs,” he explains.

    The number of PPA contracts more than doubled in the last three years, according to Bertagna. “2020 was a record-breaking year in terms of new contracts signed worth almost 4 Gigawatts (GW) in PPAs, up from the previous record of 2.5 GW announced in 2019,” he adds.

    The Allure of Southern Europe

    According to Bertagna, Italy and Spain are currently among the most attractive European markets for investments in renewable energy. “Both countries benefit from high solar irradiance, which is favorable for solar investments in the post-subsidy world. Both the Italian and Spanish governments are also very supportive of renewables, particularly solar energy,” he says.

    “Spain is one of the fastest growing markets in Europe when it comes to renewables, and they have very ambitious targets. Meanwhile, Italy is the second largest solar market in Europe after Germany,” Bertagna explains. However, Italy and Spain are very different markets.

    “Italians also have very ambitious targets, and they plan to achieve 52 GW of solar PV and 19 GW of wind by 2030. The majority of the photovoltaic (PV) solar plants will be on a smaller scale. Compared with Spain, Italy does not have the same availability of vast flat land. Therefore, projects tend to be smaller,” Bertagna continues.

    The Spanish Appeal

    One of the key appeals of Spain is the country’s government support of renewables, according to Bertagna. “Between 2020 and 2021, they introduced a number of new reforms. In particular, in April this year they approved a new Law for Climate Change and Energy Transition (LCCTE), which was endorsed by almost all parliamentary groups,” he adds noting that Spain’s solar sector is expected to grow from the current 17 GW to 60 GW by 2030, mainly thanks to solar energy. The main goal of the LCCTE is to achieve carbon neutrality by 2050. Interim goals include pushing renewable energy to represent at least 74% of the country’s electricity generation by 2030 and a reduction of emissions in Spain by at least 23% visà-vis 1990 levels. According to Bertagna, other supportive measures include upgrades to the grid connection to ensure that there is sufficient grid capacity for the renewable projects, new regulation designed to allocate capacity exclusively to upcoming projects, and a reform of administrative processes to aid developers.

    “Over €240 billion of investment will be required by 2030 to achieve these targets. A great number of projects are currently in development over the next two years. Capital Dynamics entered into an agreement to acquire ready-to-build assets from a local developer with a visible pipeline,” Bertagna explains. PPAs and Solar PV in Spain According to Bertagna, Spain is one of the most interesting PPA markets in Europe. “PPAs play an important role in Spain’s Solar PV market,” he explains. “The government abolished Feed-in-Tariffs (FIT) retroactively in 2013 and replaced them by a new capacity payment mechanism. The issue with FITs is that the price that the government was paying was unsustainable and caused a so-called ‘tariff deficit’,” he says.

    “At their peak FIT were almost 6 times higher than merchant prices. From an equity owner perspective, any cut to a tariff of this magnitude has a significant negative effect on the revenues that a plant generates. PPAs offer a solution to that particular problem. They are one of the reasons we have not invested in subsidised assets in Spain in the past,” Bertagna adds.

    “PPAs, as opposed to FITs, trade at a price which is lower than the merchant prices, equivalent to a 15-20% discount. The result is that even in a worst-case scenario where a PPA offtake fails to maintain its contractual obligations and defaults on the PPA, a plant can still sell the power to the market, without losing any money,” Bertagna continues.

    Although the Spanish government still offers some form of subsidies, Bertagna argues that PPAs are still better value, because of their flexibility and the opportunity to monetise additional revenues streams and public support, such as the €600 million government-backed FERGEI fund. Until 2020 about two-thirds of PPAs were signed with utilities, traders and energy suppliers, while from 2021 about 60% of PPAs are expected to be signed with corporates benefitting from the FERGEI fund, according to Bertagna.

    A Leader in Italy

    Capital Dynamics is among the top owners of solar assets in construction in the Italian subsidy-free market. “Other players include utilities, developers and smaller managers. If we exclude Italian utilities, we are a leader in the subsidy-free solar market,” he says. To leverage its leadership position as the second-largest Solar PV market in Europe, the Italian government has decided to focus on administrative reform. “The Italian permit process is quite slow and cumbersome. Fortunately, in June 2021 the Italian government issued a new decree, called the ‘Decreto Semplificazioni’, to help streamline the authorisation process,” Bertagna continues. Progress has also happened on the PPA front. “Until recently, 5 years was the longest contract available in the market. Now, it is common to negotiate at least 10-year fixed-priced PPAs,” he adds. There is a growing demand from corporate utilities and traders to contract clean power from renewable energy providers via PPAs, according to Bertagna. “Although some subsidies are still available in Italy, the lack of available projects led the last auction to not reach its target capacity,” Bertagna adds. Effectively there is a mismatch between projects in construction and demand for PPAs, he explains.

    Applying the Lessons Learned in the UK

    Capital Dynamics’ investments in Southern Europe were informed by its previous experiences. “We began our European journey in the UK, positioning ourselves as one of the leaders in the construction ready space,” Bertagna says. Similar to other European countries, PPAs have replaced the subsidy regime in the UK, which hosts one of the most mature markets in Europe, and is driven by an increased number of corporates looking to achieve their ESG and sustainability goals, according to Bertagna. “We were an early mover in the country and have become one of the leading players in that market. We built very strong relationships with local developers to access bilateral deals at above-market returns, and have robust partnerships with off-takers, enabling us to acquire a large portfolio of assets,” he adds. “We took the same approach in southern Europe, securing a very attractive pipeline of construction-ready assets at above-market returns and negotiating PPAs to sell our power at a fixed price with long-term agreements with the goal of building a de-risked portfolio,” Bertagna concludes.

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    Featured image: Maximilian Weisbecker on Unsplash

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    Filipe Albuquerque
    Filipe Albuquerque
    Filipe is an economist with 8 years of experience in macroeconomic and financial analysis for the Economist Intelligence Unit, the UN World Institute for Development Economic Research, the Stockholm School of Economics and the School of Oriental and African Studies. Filipe holds a MSc in European Political Economy from the LSE and a MSc in Economics from the University of London, where he currently is a PhD candidate.

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