The renewables market in Australia has been heavily impacted by COVID-19 principally because it is compounding challenges which arose over the course of 2019. Some of the short-term impacts are severe and there is a slowdown in projects reaching commercial operation – the result of a combination of physical problems, delivery constraints and financial barriers. In the midst of these pressures, it should be remembered that instruments such as corporate renewable power purchase agreements, are a long-term play – offering a long-term energy market hedge and/or emissions reduction benefits. For those considering a PPA, there may be advantages in pursuing the opportunity now, rather than ‘kicking the ball down the road’ so to speak. In this article we share the key discussion points arising from Energetics’ podcast; a conversation between Anita Stadler, Associate and Mark Asbjerg, Senior Manager, energy markets experts and advisors to a number of large corporate renewable power purchase agreement (PPA) transactions[1].

Summary of recommendations

• Don’t forget the strategic reasons for considering a corporate PPA in the first place. Those drivers are as strong as ever: managing long term electricity market risk, ensuring greater budget stability and reducing emissions as the economy decarbonises.
• Keep the long term perspective but make short term tactical adjustments for when and how you approach a PPA.
• A well-designed corporate PPA is a very important tool within your overall risk management strategy. Inevitably, the economy will rebound and it will come more swiftly than the resurgence in investment in renewable energy capacity. Higher prices could re-emerge and given the slowdown in investment to replace capacity that must inevitably retire, we can expect volatility in electricity market prices. If your business has been considering a PPA, there may be advantages in pursuing a PPA now, despite the uncertainty we see across the economy.
• With a softening of market prices in the NEM, it is important that companies who have a PPA review how they properly integrate the PPA into their retail strategy to manage their risks.
• PPAs as a revenue strategy for generators and a risk management strategy for corporates, remain an important tool:
  • They help projects get to financial close because the level of merchant risk they can now take is reduced.
  • From the corporate side we expect a pretty competitive marketplace for offtake contracts, and whilst the prices might not necessarily continue their downward path because of increasing project costs, benefits can still be realised for off-takers. It is sound mechanism for managing risk in the longer term.
• In the short term, more scrutiny is needed within a PPA transaction to make sure elements like counterparty risk and grid connection risks are managed in contract and pricing models. However, corporates should keep a holistic approach and ensure their PPA and retail strategies work synergistically so that the outcomes envisioned when choosing to pursue a corporate PPA, are achieved.

Issues as raised in discussion

A review of the dominant issues over 2019

2019 was a big year for renewables. More than 2.2 gigawatts of new large scale generation were added to the grid across 34 different projects in 2019[2]. However, the year was also notable for the slow down in the number of projects reaching financial close.

One of the biggest shocks came when marginal loss factors (MLF) for many projects were reduced, sometimes by >20% (23% in case of Broken Hill in NSW)[3]. Over time, wind and solar projects have experienced some improvement in MLF assignments as the pipeline of new projects reduced and there was a scale back in project size proposed. However, some projects, notably Bannerton, Weman, Karadoc and Gannawarra, all located within Victoria’s so-called ‘rhombus of regret’ still suffered downgrades in MLF[4]. Given the capital intensity of these large wind and solar projects, MLFs are a major hit for equity and potentially, for PPA offtakes. As a result, there is a push to upgrade network capacity in areas with a lot of solar and wind resources.

In 2019 we also saw:

• evidence of renewable energy generators being constrained, particularly in Queensland
• delays with AEMO approving network connections
• high cost of equipment (such as synchronous condensers) having a material impact on the viability of projects
• investor concern for long term electricity market price trajectories, with an upward adjustment due to the slowdown in new project development and additional network constraints. The result has been the renewables market pulling back until there is further augmentation of the grid
• a softening of spot market prices towards the end of the year, which exacerbated investment risks. However, Energetics notes that uncertainty around market prices remains; particularly with the announced closure of Liddell Power Station.

Adding to the uncertainty is the long-standing challenge of a lack of clarity on carbon policy and resulting renewable energy investment signals.

Impact of COVID-19: short term

As COVID-19 has put a brake on the economy resulting in a drop in demand for electricity, there will be further pressure on renewable energy projects. Supply could exceed the demand within the grid, leading to further price adjustments. Certainly, we have seen falling spot prices recently – partly due to COVID-19 but also the drop in domestic gas prices. This may leave some merchant operators exposed.

It is a dynamic situation which will continue to play out well into 2020.

In the construction of new wind and solar farms, there have been disruptions in the supply chain for key components from China, Italy, Spain and Germany. Noting that Bloomberg recently reported the production of some components in China has started again[5].

There is the added challenge to projects of international and domestic travel restrictions and key technical professionals not being able to come to Australia or travel domestically to attend site works. With domestic travel bans, interstate teams cannot get to construction sites. While there are many issues for current projects to navigate, Energetics doesn't see major delays to any of the projects currently under construction.

Longer term impacts

The capital intensity of the renewable energy sector means that decisions made today play out into the longer term. One of the most significant impacts of COVID-19 has been increased volatility in the AUD$ which is a big risk for developers to manage if not appropriately hedged. Nothing is locked in until a project reaches financial close. The fact that the AUD$ is now the lowest it has been in 17 years is going to both increase the cost of key equipment being imported for projects, and international investors will likely require higher returns to offset this currency risk.

For a lot of these projects, 60 to 75% of the total capital costs are affected by exchange rate movements. If Australia enters into a prolonged recession, the weakness will only increase the capital intensity of new generating assets in the country.

Energetics notes that while these factors may reduce the attractiveness of the Australian market in the near term due to increases costs and lower returns, the requirement for replacement capacity remains a long term imperative.

Outlook for corporate PPAs

2020 is still expected to be a relatively strong year for PPAs, largely because of transactions that have been under development for some time. Significant announcements are expected in the first half of 2020 for both financial PPAs and retailer-mediated supply-linked PPAs. For utility scale wind and solar projects to get up, PPAs have always been a significant part of a developer’s revenue strategy.

However, there are cost risks. The capital structure of these projects plays a role in determining the long term cost of a PPA. The market benefited from very cheap capital flowing into Australia, and long term investors, particularly pension funds, were attracted to renewable energy projects. With the government adjusting foreign investment thresholds and requiring time to consider new foreign investment proposals, every renewable energy project backed by foreign equity, is subject to this process.

There are concerns that the market will come to rely more on local equity and local debt which could drive up the cost of equity and push up the returns required by renewable energy project investors. If that is the case, there could be upward pressure on PPA prices.

Interestingly – and it is counter intuitive – with more projects competing for a small pool of PPA contracts, lower prices would be expected in a rationally functioning market, especially when it is increasingly important for developers to secure long term offtake deals. More competition typically equates to lower prices. However, prices are rising because of expected futures risks (foreign exchange, capital, continued increases in EPC prices). The spot market risk is significant for financiers to manage, and they are seeking minimum requirements for off takes.

Energetics’ advice on corporate PPAs: there are risks but they can be managed

In light of developments leading up to and with the pandemic, Energetics knows that many corporates are considering whether they should conclude their transactions in the same shape and form as originally anticipated. However, while elements of the PPA may change, most of our clients are very committed to closing out their deals.

For those already holding a PPA, it is important to remember the original objectives for choosing a PPA and look at the contract over the entire term of the agreement rather than judge its performance solely under the current conditions. These are long term agreements. Their effectiveness as a hedge to manage electricity prices should be assessed over the life of the deal.

Remember, a PPA is a risk management instrument. If done for the right strategic reasons with appropriate design assessments, the PPA should be robust. That said, there may be tactical adjustments that can be made to start dates / timing considering the current market conditions and forecast. If at the beginning of designing a PPA, consider the different pricing models and their design in terms of the level of market exposure. In some cases, they may also be benefits in looking at a more structured and shaped hedge that is better aligned with your organisation’s load profile and therefore your appetite for risk.

LGC prices

For some organisations a PPA may serve an environmental target. There are different options here too. Perhaps a long term LGC only deal.

Given the slowdown in new renewable energy projects, Large-scale Generation Certificates (LGCs) are likely to maintain their 2020 and 2021 price levels for longer. Though, in the long term, the floor price for LGCs will be set by the value of carbon in the Australian economy, which is tied to the climate change policies of the federal government.

Energetics sees value in LGCs in the long term, but opportunities to price LGCs upward from current levels are probably limited.

References

[1] We note that the information in this article was current at the time of the podcast (15 April), circumstances have changed since then and not all data will be up to date.

[2] Clean Energy Council | The Clean Energy Report

[3] Australian Financial Review | AGL takes renewables hit as grid congestion worsens

[4] Reneweconomy | Good news and bad for solar farms as AEMO reverses some transmission losses

[5] Bloomberg News | Top Solar Producer Says China's New Plan Will Sustain Growth