The rising cost of capital faced by developers of renewable energy projects such as onshore wind and solar PV may reduce the number of new projects and cause some already commissioned projects to become financially non-viable.
Data from Cornwall Insight’s report into capital costs and their impacts on the UK government's fifth round of the Contract for Difference (CfD) scheme has shown that rising inflation and interest rates, supply chain problems, and labour shortages have increased the weighted average cost of capital (WACC) for renewable projects by about 4% since early 2021. Developers are becoming increasingly concerned about bidding for projects in the next round of the government's CfD renewables subsidy scheme, fearing they may not get a return on any investments they make.
Under the CfD scheme, developers can take part in an auction for renewable energy projects, with successful generators awarded a strike price for each unit of power generated. Although CfD strike prices have typically fallen, a rising WACC and the subsequent increase in the levelised cost of energy (LCOE)2 may lead to higher strike prices in the upcoming fifth allocation round (AR5).
If the strike prices that generators assess as realistic were granted during AR5, it would likely enable them to offset the escalating capital costs. However, the government sets a limit, known as the administrative strike price (ASP), on how high the strike prices can go, and despite the rising costs, the ASPs have decreased significantly since the start of the subsidy scheme, with many in the industry highlighting that these are now set too low to allow projects to succeed.
Alongside the concerns for AR5, rising capital costs may also impact the success of projects from previous CfD allocation rounds, which originally bid in at prices that may no longer be economically viable.
Cornwall’s Renewables Pipeline Tracker shows a pipeline of renewable energy projects ranging from scoping to under construction, exceeding 215 GW. This could drive down prices through competition, and possibly compensate for the impact of rising capital costs. Additionally, the movement of offshore wind into the same CfD pot as solar PV and onshore wind for AR5 could also facilitate greater competition and reduce submitted prices.
Jamie Maule, Research Analyst at Cornwall Insight commented:
“Investors and developers are rightly worried about the government's cap going into the fifth round (AR5) of the Contract for Difference scheme. After all, if the high cost of capital cannot be compensated for by an increase in the return, the money will simply not be enough for projects to be successful and could act to stifle competition and deter investors and developers from bidding for renewable projects.
“Even if AR5 strike prices remain low, as a result of high competition or due to optimistic bidding, rising capital costs may still act as a barrier to the type of large-scale investment needed if the UK is to reach net zero. The added competition from the US and EU for international investors will only add to the challenge.”