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Investment risk and return under renewable decarbonization of a power market

Citation Munoz J.I. and Bunn D.W. Investment risk and return under renewable decarbonization of a power market. 2013. https://doi.org/10.1080/14693062.2012.750473.
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Author(s) Munoz J.I. and Bunn D.W.
Opus Title Climate Policy
Pages 87-105
Volume 13
DOI https://doi.org/10.1080/14693062.2012.750473

How does financial performance risk affect investments in low-carbon electricity-generating technologies to achieve climate policy targets? A detailed risk simulation of price formation in the Great Britain wholesale power market is used to show that the increasing replacement of fossil facilities with wind,ceteris paribus, may cause a deterioration of the financial riskreturn performance metrics for incremental investments. Low-carbon investments appear to be high risk, low return, and as such may require a progressively higher level of support over time than envisaged by the conventional degression trajectories. The increasing riskiness of the wholesale market will to some extent offset the benefits of lower capital costs and operational efficiencies if investors need to satisfy cautious debt coverage ratios alongside positive expected returns. This increasedrisk is additional to the well-known merit order effect of low-carbon investments progressively depressing wholesale prices and hence their expected investment returns.

Policy relevance

Policy support for renewable technologies such as wind is usually based upon levelized costs and is expected to reduce over time as capital costs and operational efficiencies improve. However, levelized costs do not take full account of the risk aversion that investors may have in practice. Expected policy support reductions may be moderated to some extent by the increased financial performance risk that intermittent technologies bring to the power market. The annual risk-return profiles for incremental investments deteriorate for all technologies as wind replaces fossil fuels. This extra risk premium will need to be incorporated into evaluating policy incentives for new investments in a decarbonizing power market.