Big Power Flexing Their Muscle Boosts Risk for Green Markets

With wind and solar generators becoming more mainstream sources of energy, governments around the world are weaning the industry off subsidies and creating new openings for older utilities built on coal and nuclear power to land their own renewable-fuel projects.

Across Europe, Latin America and India, major electricity suppliers including Enel SpA, Vattenfall AB and Engie SA are proposing to build wind and solar farms, offering low-cost construction bids to win energy-supply contracts. While that can mean cheaper power for consumers, it’s eroding profit margins and increasing competition for small, independent generators who have dominated what was once considered a fringe industry.

“What you see is that this industry is getting more mature,” said Gunnar Groebler, head of wind energy at Vattenfall, a Swedish utility that has installed more than 1,000 wind turbines in five countries. “It’s a maturity question rather than increasing risk. We’re better prepared to handle risk and also more mature in terms of project management.”

Unwittingly or not, governments and regulators are encouraging the trend through a change in the way they support renewables. Instead extending traditional subsidies and above-market prices for clean electricity, they’re auctioning off contracts to buy power from renewables. In more than 45 countries where those auctions are in place, costs typically fall as much as 50 percent for solar and 60 percent for wind within two years, according to analysis by Bloomberg New Energy Finance.

Specific figures on returns from clean energy projects vary widely and are a closely-guarded secret by the companies that win them. Even so, there is anecdotal evidence showing the big developers are triumphing over smaller ones most everywhere they compete.

In India, the biggest 10 developers now are winning 60 percent of all new contracts, almost double the portion they got two years ago, according to Vinay Rustagi, an analyst at the research firm Bridge to India. Enel of Italy and Fortum OYJ of Finland have access to cheaper capital than local developers who must borrow in their home markets, he said.

“They can also negotiate lower equipment costs and invest in design and technical competencies which further reinforces the scale advantage,” Rustagi said. “Scale begets more scale, forcing smaller players out of the market.”

Rahul Gupta, founder of Rays Power Experts Pvt Ltd., hasn’t participated in an auction in two years after winning contracts for 50 megawatts.

“A big chunk of solar auctions has gone to 15 big companies,” Gupta said. “No one sees participation from 200. Smaller companies bidding for smaller project sizes have to kill their margins or have to drop out if competing with a large company bidding for a large project of, say, 250 megawatts. It becomes a business only for a few.”

In Brazil, Rafael Brandao, a partner at the Sao Paulo-based Rio Alto Energia, has the same concerns.

“Big companies are crushing prices in auctions, which makes it not feasible the participation of smaller developers,” said Brandao, whose company is building three solar projects each with about 30 megawatts of capacity. “In the next auctions, we will see a consolidation. Big companies have cheaper corporate funding. The smaller ones have to focus on project finance and rely on development banks.”

At Enel, the biggest power provider in Italy with a growing renewables business overseas, the trend reflects a natural “weeding out” of some less competitive bidders, said Chief Executive Officer Francesco Starace.

“What is the space for a small player?” he said in an interview in New York earlier this month. “Can they be successful? Probably yes. But only if they specialize in what they are good at.”

Smaller companies “are good at opening up a country, developing the first projects,” Starace said. “They are nimble. They can move fast. They can anticipate the market. Big players typically come a little bit later on. They tend to be slow at realizing what the new markets are. So, they can live together.”

Engie said falling equipment prices and low interest rates are most responsible for driving costs out of the business.

“Smart developers of renewable energy projects will always bid in a manner that ensures the securing of an adequate return on their deployed capital, while balancing the risks inherent in the project,” Ramani Hariharan, Engie’s director of centralized generation, said in an emailed response to questions. “We do perceive a materially increased competitive pressure to win these renewable auctions, but not necessarily an increased inherent risk in the projects themselves.”

Investors are taking note because the risk-return ratio is changing in the clean energy business. Funds that seek the highest returns have scaled back their support, giving way to more conservative pension and generalist funds. Institutional investors are starting to accept returns more akin to what they get from utilities than those of a startup, said Mark Mansley, chief investment officer at Environment Agency Pension Fund, which has assets of 2.73 billion pounds ($3.36 billion).

“It’s something that we’re aware of,” Mansley said. “We have to be careful about who we work with. There’s a difference between genuine cost decreases and when things have gone a bit too far. We have seen massive cost decreases. But then there’s also a risk that a developer goes beyond that.”

The industry is being pushed to cut corners and could make promises it can’t keep, said Michael Andresen, head of asset management at Danish wind consultancy K2 Management.

“There is increased pressure from developers on the supply chain,” Andresen said. “On the supplier side, you will be faced with pressure on cost, quality and scope of the contracts. We could also see a movement into new suppliers entering the market that are potentially lower-cost and lower-quality.”

Developers say they’re concerned some suppliers may not be able to cope with the swift plunge in the cost of renewables. Project developers are thinking carefully about the long-term effects of putting pressure on their supply chains, said David Maguire, a director at the Dublin-based developer BNRG Renewables.

“I don’t want to squeeze my suppliers,” Maguire said. “I want them to be able to take a margin and be profitable. I want them to still be around in 10 years. I have warranties with them.”

Consumers welcome lower costs, no matter what damage it does to the industry, and say higher risks and compressed returns are something companies will have to live with.

“The renewables industry will have to accept what every other industry’s done,” said Jeremy Nicholson, director at Energy Intensive Users Group in the U.K., which represents industries such as steel and chemicals-making. “It can’t live on subsidies forever. It will have to show that it can stand on its own two feet. That’s what’s going to make these industries financially stable in the long run.”

For those smaller developers vying for contracts, the CEO of Italy’s Enel had a few words of advice.
“If you try to fight the big players, it is difficult,” Starace said. “Maybe you win one. But the next one you win, they might kill you.”

Source:bloomberg