Cost of capital for renewables varies hugely across EU

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wind turbine in Germany photo Christian Dembowski

wind turbine in Germany (photo Christian Dembowski)

It is much more expensive to undertake onshore wind projects in some European countries than others, according to the first-ever study of these costs for the entire EU-28. The EU-funded “Diacore” project finds moreover that market actors single out the design and reliability of renewable support schemes as the single biggest risk (after generic country risk) driving up the cost of capital. Best practice policy design could cut support costs for wind by 15% out to 2030.

Renewables had a good year in Europe in 2015. Wind grew by 12.8GW and solar PV by 8GW. The wind sector installed more than any other form of power generation (44% of the total) and called it a “record year” for investments (up 40% on 2014). The solar PV industry meanwhile, announced 15% growth after three consecutive years of decline.

But these reports from the European Wind Energy Association (EWEA) and SolarPower Europe on 9 February – issued a day before the European Commission’s public consultation on a new EU renewable energy directive closed – also warn that the overall figures mask enormous national differences.

The Average Weighted Cost of Capital (WACC) ranged from 3.5% in Germany to 12% in Greece in 2014

In fact, it turns out that nearly half (47%) of new wind installations in 2015 took place in just one country: Germany. Meanwhile, the solar PV comeback was “primarily based on a strong UK market”, said SolarPower Europe. Demand in other “most” other countries “stayed flat or declined”. The trade association actually expects the overall market to shrink again in 2016.

What explains the differences? The primary answer is the same in both cases: policy. National variation reflects “the relative effectiveness of policy and regulatory frameworks and uncertainty over future energy policy in EU member states,” says EWEA. Spain, previously a strong wind market, “saw new installations fall to zero as a result of inadequate policies”. SolarPower Europe said: “Solar needs clear signals from policymakers in Europe. Investors need a secure political framework.”

Landmark study

Both the huge differences across the EU-28 and the insistence on policy to explain these are backed up by a new report for the European Commission published on 10 February. The “Diacore” project was carried out by a consortium of researchers from Ecofys, Fraunhofer ISI, eclareon, the National Technical University of Athens (EPU-NTUA), the Technical University of Vienna (TU Wien), and the Lithuanian Energy Institute (LEI). It was paid for by the Commission’s Agency for Small and Medium Enterprises (EASME).

This is the first time that anyone has mapped out the costs of capital for renewables – in this case, onshore wind energy – for all 28 EU Member States. “What is new is that it is for all European countries, and that it’s done through a theoretical approach that we then validated with interviews,” explains lead author David de Jager from Ecofys. “So this is much more accurate [than previous work].”

The results are clear: it is vastly more expensive to undertake onshore wind projects in some European countries than in others. (See map below)  More precisely, the Average Weighted Cost of Capital (WACC) ranged from 3.5% in Germany to 12% in Greece in 2014. Renewables are capital-intensive projects and so the cost of capital – the fee that investors ask for making capital available – is a “decisive” factor for their realisation. It will be higher if projects are seen as risky. The purpose of renewables policies is to reduce risk and therefore the cost of capital, to make it more likely that projects get built.

WACC estimates onshore wind

Prioritising risks

When it comes to risk and what drives it, policy design – that is the design of renewables support schemes – is identified as the single most important barrier in all EU Member States by market actors interviewed by the Diacore team. That is, aside from generic country risk, which the researchers acknowledge but do not further investigate. (Best practice renewables policies could bring the average cost of capital down from around 8% to 6% but not more, say the authors – the rest is down to country risk. That helps explain the enormous difference in cost of capital between Germany and Greece too.)

Markets with relatively mediocre wind conditions (such as Germany) can be financially much more interesting than markets with very good wind energy conditions (such as Spain or Portugal)

Design of the support scheme is still one, if not the key, pre-requisite for stable investment conditions,” concludes the Diacore team. Second are “administrative risk” (think permitting – EWEA reports that permits can take anything from 2-154 months), “market design and regulatory risk” (including broader energy strategy) and “grid access risk”.

What’s interesting is that apart from support scheme design and grid access risks, the priority worries change by region. (See figure below.) So for example, “sudden policy change risk” (think retroactive subsidy cuts) is a top-3 priority for many Eastern European countries, while “financing” (stemming for example from a weak local finance sector) is in the top-3 for several Southern states. Conversely, “social acceptance risk” is ranked highest in the Northwest of Europe. The Diacore team plots out how priorities change too with the degree of market development and project maturity.

figure Diacore

Source: Diacore

 Why Germany does so well

The overall cost of capital or WACC is determined by the cost of debt (provided by banks and financial institutions) and the cost of equity (provided by (private) investors), plus the ratio between them. A project is typically funded by 70% debt and 30% equity.

So why does Germany do so well and Greece so poorly? One reason is the big difference in country risk, as described earlier. But Germany scores well on all components of the WACC equation: it has much lower costs of debt and equity, as well as a higher ratio of debt to equity because of its better country risk profile (80:20 vs. 50:50 in some Southeast European states). Interviewees also reported “fierce competition” between banks in Germany to fund onshore wind projects, putting further downward pressure on the cost of debt.

The effects of all these financial factors are “remarkable”, the Diacore team concludes: “Markets with relatively mediocre wind conditions (such as Germany) can be financially much more interesting than markets with very good wind energy conditions (such as Spain or Portugal).” The energy transition in Europe has been possible in part because of very low costs for capital, the authors suggest.

The ideal support scheme

Despite the primary importance of policy design as a risk factor, the researchers did not immediately spot an obvious link between choice of a particular support scheme and a low or high WACC value. The picture is blurred by the specific design of a scheme and country risk. Nevertheless, the authors compared different feed-in schemes. Based on just 14 completed surveys, the results are unfortunately “indicative” at best.

As expected, riskier market-based feed-in premiums result in a higher cost of capital than safer market-independent feed-in tariffs (6-7% vs. 4.5-5%). Exactly what kind of feed-in premium (e.g. with tendering or without) is considered most risky, depends on the region.

Policymakers should look at renewables as an investment in a value chain that triggers industrial development

The researchers suggest that the sliding premium or Contract for Difference (the public purse tops up the market price to give generators a guaranteed minimum) is a good balance between risk and expense: “Six Member States, which have intensely discussed the optimal design of feed-in premium systems (Denmark, Finland, Germany, Italy, the Netherlands and UK), use this design option.”

As exposure to the market – and cost of capital – goes up, the cost to the public budget and finally consumers goes down. Best practice policy design could cut support costs for onshore wind across Europe out to 2030 by some 15%, the Diacore team calculates. De Jager believes that savings of a similar magnitude, 10-20%, could be achieved for all renewables.

Renewables as industrial policy

Despite the optimistic figures presented by EWEA and SolarPower Europe for 2015, the Diacore team presents its work against a backdrop of falling annual investments and blames in part a decrease in renewables support in the wake of the financial crisis. The current low oil price threatens to re-impose this trend going forward.

This project is intended to inform proposals for a new EU renewable energy directive later this year, as well as a review of state aid guidelines for energy and environment pencilled in for next year. Costs of capital must be taken into account if the EU wants to align support schemes or have joint renewables projects, De Jager explains: “If you ignore these differences in costs of capital you could pay too much or too little.”

But he goes further: “Policymakers should not look at renewables and think ‘we need more kWh of green power’, but as an investment in a value chain that triggers industrial development.” This kind of thinking has inspired the Netherlands to reclaim a stake in the offshore wind industry – in service and maintenance, based on its offshore expertise – after abandoning it to Denmark 15 years ago, he says. By contributing to economic growth, renewable energies can help reduce country risk and improve their own prospects by a whole lot more than support schemes ever will.


  1. Pedro Caixote says

    First I would like to say congratulation Germany for doing well on renewable energy development will help to reduce the carbon dioxide emission.

    Second I would like to say that Mozambique have recently approved the feed-in-tariff as well as the renewable energy atlas that show good potential of wind energy along the coastal and some interior areas. According to comments from private companies at last seminary about feet-in-tariff, they that the price are very good. One of the challenge for wind energy Development in Mozambique is lack of financial capacity.

    Is there any possibility to get financial support from Germany or other country which have experience in wind energy development?

  2. Ian Partridge says

    I haven’t read the whole report yet (162 pages), but I certainly will. Sounds like a really interesting analysis, though it seems to contain some pretty obvious stuff along with the genuinely new and important. For example, they will not win a Nobel prize by noticing that political risk was high in Greece in 2014, and a lot lower in Germany. A key issue will be how they estimate the required return on equity. Their theoretically valid approach relies on defining a portfolio of quoted companies operating primarily in generation using renewables. I doubt that this is possible for more than half a dozen EU countries. The alternative is to ask investors how much they want to earn on their money – the chance of getting honest answers must be minimal as investors can maximise their returns by persuading us that their costs are higher than they really are, so we keep on paying generous subsidies. The figures should maybe be taken with a pinch of salt, but the analysis of which risks really affect investment decisions should be very valuable.

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