Portfolio optimisation | FS sustainability

Taking a portfolio approach to renewable investment

As published on FS Sustainability

Decarbonising Australia’s national energy market is a central tenant to achieving the goal of reducing carbon emissions in line limiting global warming to 1.5°C. But there is investment risk related to the coincident timing of when renewable energy generation is dispatched and the impact it has on spot energy prices and thus revenue and return.

A recent report by the Clean Energy Investor Group (CEIG) found that decarbonising Australia’s National Electricity Market (NEM) is possible, but requires $421 billion in investment between now and 2050.

The report identifies six areas for action - a carbon budget for the electricity sector; national coordination of the transition to accelerate coal powered generation closures and renewables roll out; investment in long duration storage; support for offshore wind development; accelerating network infrastructure build; and investment in skills, supply chains and communities.

One challenge that needs to be managed is the fact that renewable energy generation isn’t matched with enough battery storage.  The Australian Energy Market Operator (AEMO) noted in its report on the third quarter of 2023 that higher output from renewable energy generators and lower demand particularly in the middle of the day “increased the occurrence of negative prices in the NEM to its highest ever level, 19% of all dispatch intervals. All regions in the NEM saw an increase in negative price occurrences.”

Q&A with Gilles Walgenwitz, general manager energy and carbon markets, Energetics

Q: Where is Australia in terms of renewable energy generation and investment build out?

A: We are moving into a fast-changing electricity market – we are seeking to replace quickly aging coal-fired power stations, and potentially gas-fired stations, with renewable energy assets – wind and solar farms and behind the meter rooftop solar generation with dispatchable capacity such as storage and demand response.

Around $100 billion in renewable energy generation/storage capacity needs to be invested over the next 7 to 10 years if Australia is serious about achieving our net zero target. The current level of investment is half of what we need to meet these objectives.

Q: What are some of the challenges hindering that further investment?

A: Intermittency poses challenges in the spot energy market but so is coincident generation.

We have world leading penetration of rooftop solar in Australia and we have utility-scale wind and solar as well, so in the middle of the day, demand minus behind-the-meter rooftop solar, i.e., net operational demand is decreasing year on year.

On top of that, you have coal-fired power stations, which have higher short run marginal costs and cannot switch off all their capacity because if they do that at the end of the afternoon, they won’t collect any revenue. The objective for them is to maintain operation to capture higher end-of-the-afternoon prices and to hedge low spot price exposure by entering into fixed price contracts.

All of this is to say that there may be a continued race to the bottom and more and more negative price situations due to coincident generation of low marginal cost renewable energy sources.

As an investor I’d look at investing in renewable energy generation, and I’d want a solid return on investment, which can be difficult, when the market value of the asset is trending down because of eroding production weighted average price but cost of capital and cost of materials are going up

Q: How do you overcome this?

A: The solution is for investors not think about a specific standalone asset like a solar farm, but to say, I need to couple my solar farm with battery storage, potentially collocated, so that it charge when price is cheap or even negative, and dispatch when the price is expensive such as the end of the afternoon, when sun is not shining and, in some instances, wind not blowing enough.

Financers and investors should not think about investing in a standalone solar asset but investing in a diverse portfolio that will capture more value in the market. This can be done by being able to dispatch when prices are high at the end of the afternoon via storage coupling or by selling more expensive fixed volume products and managing volumetric risk at a portfolio level.

Q: Does geographical diversification apply as well?

A: Yes. For example, If you’re a large electricity retailer you may have a strong customer load and a high spot exposure, so to properly physically hedge this position you need to own or contract with a portfolio that can generate on the spot market when you’re mostly exposed, i.e. when spot prices are expected to be high. You would build a portfolio seeking to reduce the risk of having all your assets dispatching at the same time as this is typically when prices are low. Mitigating this negative correlation between renewable electricity production and price can be achieved with storage or through geographical diversification such as contracting with both an offshore wind provider and an onshore wind provider with different production patterns.