Financing Renewable Energy

The problem at the heart of financing renewable energy is not whether to subsidize it, but how. Rather than concocting schemes to lend directly, guarantee loans, or invest in renewable projects on the theory that the private sector somehow lacks this capability, governments can best stimulate low-cost renewable energy by keeping subsidies simple and predictable.

NEW YORK – There is plenty of money in the private sector to build up the world’s renewable infrastructure as long as the numbers add up, and profit-seeking private investors will figure out how to do it without any financing help from government. 

But the numbers do not add up without some sort of subsidy.  Wind energy, for example, is about 1.5 to 2 times as expensive as electricity from coal-fired plants.  Even though wind is free and coal must be paid for, the initial capital costs of a wind turbine and transmission cables are much higher than for conventional power plants.  Investors require above-market rates for renewable power or similar compensation that reflects the social benefits of emissions free energy.

The case of my own firm, Christofferson, Robb & Company (CRC), illustrates how private capital markets can finance renewable energy when the subsidy is right. In 2005-2006, my firm acquired 330-megawatt onshore projects in Germany and France.  Our fund contributed the equity, and a bank lent the money needed to finance construction. Once the portfolio was assembled, we sold the projects to a special-purpose vehicle called CRC Breeze Finance, which issued €470,000,000 of asset-backed securities.

The wind farms that we built convert the wind’s kinetic energy into electricity. The revenues gained from selling the electricity is used to repay CRC Breeze Finance’s long-term debt. CRC keeps the money that’s left over.  Even if the wind does not blow as hard as usual or operating and maintenance expenses turn out to be higher than we assumed, there is enough of a cushion that bondholders will be paid out on schedule.  Three years later, it’s proceeding on course. 

The CRC Breeze portfolio generates expected annual returns of about 8%, which were boosted to 15% with the help of leverage. None of this would have been possible without government subsidies.

In Germany, the Renewable Energy Act guarantees a feed-in tariff for 20 years and mandates the grid operator to purchase all the electricity a wind farm can produce at the guaranteed price.  Our feed-in tariff was about €83.6 per megawatt hour (MW/h), compared with free market prices that have mainly ranged from €30 - €70 per MW/h.

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In the United States, the subsidy regime prior to July 2009 was based on production tax credits: for every MW/h of wind energy produced, the owner can deduct about $2.5 from its tax bill.  This had two big defects. First, investors who could not use the tax deductions had to go to considerable expense to “monetize” the credits. Second, tax credits were subject to on-again, off-again authorization from Congress. This lack of certainty undermined investment in plant and equipment or R&D.

The US Department of Energy now provides an upfront payment to wind developers equal to 30% of costs. This is a step in the right direction. But a 30% cost rebate is not enough to stimulate development of offshore wind capacity.

The US has no offshore wind farms, and no prospect of having any for at least five years. To consider just one obstacle, no vessels suitable for installing offshore foundations comply with the Jones Act, which requires that work on such projects use US-flag ships, constructed in the US, and owned and wholly operated by US citizens. Such ships would take two years to build, at a cost $50,000,000. No one, insofar as I know, is rushing to build one.

The reasons for offshore wind’s failure to fulfill its promise in the United Kingdom are equally straightforward and have nothing to do with a lack of money. The subsidies are too small and too complicated to inspire capital outlays for expensive specialized equipment, including jack-up barges, heavy-lift cranes, pneumatic hammers for pounding the foundations into the sea bed, and high-strength gearboxes that will not corrode in humid, salty air.

This is a pity, because the UK is missing out on the opportunity to build offshore generating capacity along its long, windy coastline. The UK needs offshore wind to meet its renewable targets, and in a few years it will need electricity from any source it can find just to keep the lights turned on.

Fifteen months ago, in a submission to the Economic Affairs Committee of the House of Lords, I predicted that all existing UK projects except Thanet Offshore Wind would be abandoned or postponed unless Parliament radically altered its Renewable Obligation Certificates (ROC) scheme. I argued that, otherwise, the UK would be on track to add fewer than 300 MW of new wind capacity per year. This would lead to approximately three gigawatts of capacity by 2020, which equates to 1 GW of continuous production – less than 2% of 2007 consumption. So far, this is precisely what has happened.

At the time, I proposed that the UK switch from a ROC regime to a 20-year feed-in tariff.  I still believe that this is the right way to proceed. At a similar social cost to ROCs, a feed-in tariff would give confidence to utilities and suppliers of components to undertake the required heavy investment. It is vitally important that existing projects, as well as new ones, benefit from any policy shift. If investors sense that new projects may obtain special treatment, everyone will decide to wait.

The topic of how to finance renewable energy is the same topic as how to subsidize it.   Governments should not concoct programs to lend directly, guarantee loans, or invest in renewable projects on the theory that the private sector somehow lacks this capability. Rather, policymakers should figure out how much renewable energy is worth to society (possibly attributing a different value to solar, wind, geothermal and biomass) and make utilities or governments pay extra for it.  The most effective subsidies are simple and stable, as in the German model.

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