Can Renewable Energy Investment Survive Subsidy Cuts?

With more players chasing development, and lower absolute subsidies in many cases, Morningstar analysts think renewable energy investment returns may fall

All around the world hundreds of millions of people are pushing for higher living standards, leading to increased consumption of polluting resources. But the current consumption of fossil fuels, and related air pollution, water pollution and public health costs, is unsustainable – and governments around the world are acting.

With governments meeting in early this month for the Paris climate conference COP21, stronger commitments are possible, although we do not expect legally binding agreements on all parties to emerge from the talks.

With policy support, high investment in renewable energy is set to continue: Though some governments have throttled back support following inefficient overbuild, the trend points upward in the largest markets, primarily the United States and China, and key new markets in emerging economies like India, Mexico, South Africa, Turkey, and others.

With more players chasing development, and lower absolute subsidies in many cases, we think renewable energy investment returns may fall.

We recently cut our mid-cycle outlook for Texas power markets by 20%, primarily because of the state’s huge pipeline of renewable energy projects that we expect to go into service during the next three to five years. There are more than 24.5 GW of active generation requests under review for new-build wind generation through 2020, including 11 GW in the next two years, with the state’s primary grid operator, the Electric Reliability Council of Texas.

Renewable Energy Economics Still Need Help

Renewable energy investment remains driven largely by policy and public support. Some herald the dawn of grid parity for renewable energy, but the reality lags the hype. The levelised cost of electricity is a measure used to compare different types of energy production, representing the per-kilowatt hour cost of establishing and running a power plant. Renewable energy projects’ levelised cost of electricity, or LCOE, in remains significantly higher than LCOE for more-traditional power generation technologies.

However, the rationale for renewable energy isn’t purely economic in the classical sense, since classical economics ignore the massive external costs of fossil fuel, particularly coal, consumption. Incorporating these costs into our analyses shows the playing field is more even, though many countries are slow to incorporate these external costs in their visions for electric power systems.

Mandates and financial support are in flux: Financial subsidies and government mandates have been the two pillars of support for renewable energy. Financial subsidies in key markets such as China, Europe, and the U.S. face increasing risks.

But there’s potential upside from new policies: In the U.S., the Clean Power Plan, or CPP, could require aggressive renewable energy development in many states as one possible path toward compliance if the CPP survives legal challenges. Carbon emissions regulation in Europe has proven mostly ineffective due to terrible design flaws, but the EU is considering policy changes that aim to drive CO2 credits higher and incentivize investment in carbon-free energy.

Europe’s trajectory is the least attractive, sending its multinationals scrambling: With schizophrenic policy and cuts to incentives, we recommend avoiding exposure to European renewable energy development, relative to that in other markets. Furthermore, Europe’s multinational utilities are desperate to rebrand themselves, increasing the risk of weak capital allocation chasing development elsewhere and putting pressure on returns for all players.

Invest in Infrastructure

Implications for power systems are higher grid investment even with weak demand growth: Renewable energy capacity should grow strongly during the next decade, requiring substantial investment in electric grid infrastructure – both distribution and transmission – to facilitate the new assets and power flows. We view state renewable energy policy and the U.S. Clean Power Plan as tailwinds for electric utilities growth.


In Europe, EU and national policies should support similar grid investment needs. Transmission investment in the U.S. has a clear growth runway, while Europe’s transmission growth outlook is much less certain, given the difficulty of financing large-scale projects.


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