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Renewables: winds of change

2024 Outlook

5 December 2023 |
Active ESGImpactSustainable
If the energy transition is a must-have in the fight against climate change then renewable energy is in the eye of the storm.
The Federated Hermes 2024 Outlook

The sentiment towards renewables has been overly negative over the past 12 months. This has been driven by perception that renewable projects no longer offer attractive returns due to the higher cost of capital, the view that rates will remain higher for longer combined with elevated construction costs as a result of the inflationary pressures.

The negative sentiment was exacerbated recently by Orsted, Danish wind company, which cancelled two offshore wind projects in the U.S. and took a $4 billion write-down due to escalating costs and higher interest rates. This was followed by BP cancelling two of their U.S. offshore projects at a cost of $540 million, citing similar reasons and calling out governments for not keeping pace with the fast growth of the sector.

if we are to get at least close to 1.5 degrees, we need to considerably amp up spending on clean and renewable energy.

However, short-term headwinds should not take the focus away from the issues we need to address to ensure sustainable living conditions for our planet. It is becoming a reality that we are unlikely to reach the Paris Climate targets. However, if we are to get at least close to 1.5 degrees, we need to considerably amp up spending on clean and renewable energy.

The energy transition is still in the early stages and the demand for renewables remains elevated as they account for less than 30% of the total global energy generation. The path to renewable energy is not a nice to have, but a must, which means the sector is poised to grow over the long-term, despite the short-term headwinds. This will be supported by regulatory tailwinds such as EU Green Deal and Inflation Reduction Act in the U.S.. As such we consider, renewables as one of the most attractive investment opportunities for the long-term.

In 2024, the outlook for renewables is promising as the world continues to prioritize sustainable solutions in response to environmental challenges. Solar energy, in particular, is witnessing significant advancements as innovations in photovoltaic technology are driving increased efficiency and affordability of solar panels. Wind energy is undergoing a transformation with the development of more efficient turbines. We are hoping to see more government policies and incentives post COP 28 and expect, in 2024, global commitment to clean energy to strengthen as countries are expected to implement ambitious renewable energy targets and carbon reduction goals.

From a low base: the growth of renewable energy since 2000

2023 proved to be a challenging year for developers of new renewable energy projects globally. Rising supply chain and debt costs, essential for funding construction, have weighed on the industry. The macroenvironment in the UK has been exacerbated by the Government’s windfall tax on ‘exceptional’ generation revenues, whilst extended delays for grid connections and planning consents continue to hamper progress.

The last year has seen several leading players postpone construction of previously approved projects, citing cost increases of 40% to 50%, and the Government’s imposition of a windfall tax on renewable energy. However, 2024 should see activity resume.

Following zero bids in the UK’s 2023 wind auction – reflecting the low maximum strike price on offer – the UK Government has increased the strike price for offshore wind at the 2024 wind auction by over 60%. Softening inflation will help supply chains to adjust and the cost of debt should stabilize and may even begin to reverse. From a longer-term perspective, focus will be on the National Grid’s Ofgem approved reforms to the connection management system that will dispense with the first come first served queuing system and prioritise shovel ready projects, and the Government’s commitment to radically reduce the time required to obtain planning permission for new developments. These changes are essential if the UK is to meet its target to increase offshore wind capacity four-fold to 50 gigawatts by 2030.

The events of 2023 are a timely reminder that renewables are not a one-way investment bet.

The events of 2023 are a timely reminder that renewables are not a one-way investment bet. The capital-intensive nature of building renewable energy infrastructure means that rising input prices during construction can expose over optimistic construction cost, debt and power price assumptions. Once operational, there are few levers to pull to address financial challenges or to respond to regulatory developments that increase operating costs. If power prices are lower than expected when debt costs were hedged or power purchase agreements entered into, then the underlying economics can begin to unravel compromising the investment. In 2024 and beyond, it will remain prudent to create headroom in the investment case to provide a buffer against the known unknowns and unknown unknowns.

The Federated Hermes 2024 Outlook

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